51RMd9Gll+L This is a clever book with a simple insight.  When good times are expected to continue, golf does well, as a competitive professional sport, as a recreation (it’s expensive), and the markets do well as well.  Vice-versa when bad times are expected to continue.

There is a second insight, in how business gets done on the golf course, as relatively well-off people connect in person over something they enjoy.

The book describes these connections in many ways through history, over different nations, etc.  It spends time on two of the greats of the game, Jack Nicklaus, and Tiger Woods, comparing them and the economic environments they lived in.

This book surprised me… I liked it better than I expected.  That said:

Quibbles

A lot of the correlations he describes could very well be spurious.  When I look at the graphs, I am on the borderline between being convinced and not.  I give him the benefit of the doubt.

Summary

This is a well-written and entertaining book, and maybe it would make a good gift for a friend that likes golfing and investing.  Anyway, if you want to, you can buy it here: Bulls, Birdies, Bogeys & Bears: The remarkable & revealing relationship between golf & investment markets.

Full disclosure: The author asked me if I would like a copy and I said yes.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

I think alternative investments should analyzed the same way that ordinary investments are analyzed.  After all, I have written: On Alternative Investments and Alternative Investments, Illiquidity, and Endowment Management.  So when I read an article like this one at Militello Capital (not to pick on them, but I read it there), I say that I agree with points 1-4, and disagree with points 5-6.  What are points 5 and 6?

5. Alternative investments are more volatile than stocks and bonds.

As a whole, private alternative investments tend to be less volatile than the stock market. Why?  Because investors tend to view alternatives as long term investments, and cannot constantly trade in and out of them.  In this day and age of high frequency trading and quantitative arbitrage (by the way, do most investors even know what this even means?), it is refreshing to know that long term investments still exist.  According to 10 Myths Surrounding Alternative Investments by Nancy Everett and Mark Taborsky of BlackRock, “Adding alternatives to a diversified portfolio has the potential to provide lower volatility than a portfolio composed exclusively of traditional stocks and bonds.”

6. Investors cannot access their capital if invested in alternatives.

As with most stereotypes, this one does not always apply. Yes, many alternatives are less liquid than traditional investments but the level of liquidity is dependent on the investment itself. Everett and Taborsky agree by stating “As with all aspects of investing, there is a tradeoff between risk and expected return and liquidity is no different. When investing in less liquid assets investors should, of course, expect to be compensated for that illiquidity through improved risk-adjusted returns.” Alternatives that are illiquid also allow individuals to invest in tangible assets. Investments you can talk to.  Investments you can visit.  When’s the last time you visited your hedge-fund?

As for point 5, anything that you measure over longer time horizons will have lower annualized volatility than what is measured over short horizons.  Whether a business is public or private does not affect the underlying volatility of the economics, though it may affect the accounting.

As for point 6, there are far more limitations in accessing capital from alternative investments than from ordinary investments.  Alternatives are not as liquid, except when times are bullish.  The same is true of condomiums, which indeed are fungible, but are rarely liquid, with a tight bid/ask spread.

As such, I don’t think points 5 & 6 are myths.   They are the truth, those that argue against them are proposing myths.

17 months ago I wrote a post How to Become Super-Rich?  Now, many of my articles are timeless — they will still have value 10 years from now.   I like to write for the long-run.  Teaching basic principles is what this blog is about.

The surprise for me is that article is the most popular one at my blog.  That says something about the desires of mankind.  Now, if you do want a chance to become super-rich, you create your own company, and focus your efforts on it exclusively.  Diversification is not  a goal here.  We are swinging for the fences here.

But just as in baseball the guys who swing for the fences to hit home runs, they also tend to strike out the most.  The same is true of businessmen.  Many start companies, put their all into it, and end up broke.  Many end up with marginal businesses that give them a living, but not much more.  A few prosper and become moderately wealthy.   A tiny amount of them create a hugely profitable company that makes them super-rich.

Anyway, after I was cold-called by Militello Capital, I reviewed articles on the blog, including one called CRACK THE WEALTH CODE.  I’ll quote the most relevant portion of the post:

According to Get Rich, Stay Rich, Pass It On: The Wealth-Accumulation Secrets of America’s Richest Families by Catherine McBreen and George Walper Jr, “Building up a nest egg with the equity in your home is a fine thing. But what distinguishes the model for getting rich, staying rich and passing it on is its emphasis on investing in current and future income-producing real estate”. Andrew Carnegie, the wealthiest man in America during the early 20th century, said that “90 percent of all millionaires become so through owning real estate.” If that’s not enough to peak your interest, consider this: “The major fortunes in America have been made in land”, coined by John D. Rockefeller. What does he know…..his net worth in today’s dollars is onlyaround $300 billion. Invest in areas you know. Real estate gives you the opportunity to visit and connect with your investment. When’s the last time you connected with your mutual fund?

Don’t forget about the second part of the winning combo: private companies. Open your eyes to entrepreneurial opportunities. McBreen and Walper advise that at least one-quarter of your investment dollars should be in enterprises that develop products and services or invent breakthrough technologies. In 10 things billionaires won’t tell you, number seven’s title, “We didn’t get rich investing in stocks”, hits the nail on the head. Billionaires like Steve Jobs, Bill Gates, and Mark Zuckerberg made their fortunes in start-ups, says Robert Klein, founder and president of Retirement Income Center, a retirement and income planning firm in Newport Beach, California. The article confirms that “you’re far more likely to become a billionaire in Silicon Valley than on Wall Street.”

In one sense, I agree with what they say.  If you want to become super-rich, pursue one goal with your one company.  Less than 1% will succeed.  Maybe 5-10% will attain to being multi-millionaires.  Most will muddle or fail.

Running your own business, including real estate investing, is not a magic ticket to riches.  A lot depends on:

  • Solving problems people didn’t know they had.
  • The time period that you invest during — were financial conditions favorable for speculation?
  • The ability to manage a large enterprise is an uncommon skill.
  • The ability to be an entrepreneur is also not common.  Most people don’t want to take that much risk.
  • Discipline, hard effort, taking time away from family and friends.

There is a cost to trying to be super-rich, and most people die at that altar of greed.  I suspect that most that succeed, did not aim to be super-rich, but pursued that task because they found it interesting.  They were idealists who happened to be in business, and their ideals matched up with what would enable society to pursue its goals more effectively.

So does it make sense for average people to invest in private equity funds or private real estate funds because the wealthy ran their own companies and invested in commercial real estate?

No.  First, remember that the super-wealthy were swinging for the fences.  They were the rare success stories.

Second, note that those who invest in private equity funds or private real estate funds are diversifying.  As such, they are seeking more certainty, and will not gain an abnormally large return.

Third, recognize the data bias.  Those who succeed with private equity funds or private real estate funds, their data exists, while those who fail disappear.

There is no advantage to being public or private as a business.  Private businesses can keep things secret, but public businesses have a lower cost of capital.

Conclusion

Just because the wealthy got that way by making big bets that most people lose, does not mean that average people should do that.  Alternative investments like private equity funds or private real estate funds are not an automatic road to wealth, and are less transparent than their liquid alternatives on the stock exchanges.

Average people should avoid low probability bets — they tend to impoverish, with high probability.

PS — that said, I like commercial real estate as a diversifier, but it won’t make you rich.

The FOMC statements are much longer than they used to be, and as such, are less clear, giving faulty signals to the markets.  If language is not likely to change much  for a while, why not drop the language  entirely, especially in cases where it affirms ideas that are obvious.

We may all know people in our lives who will say more and more if you don’t agree with them, because if you don’t agree with them, you don’t understand.  More words will bring clarity to you, and you will understand.  But what if they are nuts, and you are a sane person?  This is how I think about the FOMC — they are bad forecasters, and they don’t understand how weak monetary policy is in a period where there is too much debt.

So let’s try some pictures to replace the words of the FOMC:

central tendency_10374_image001

 

As I have said before, the FOMC is composed of overly optimistic neoclassical economists, who don’t know that their theories don’t work when and economy is too indebted.  They think: Real growth is our birthright, and price inflation promotes growth.  Neither are true.

central tendency_22274_image001

 

Note that they have been consistently pessimistic on the unemployment rate, flawed measure that it is.  Thus they think they need to keep monetary loose.

central tendency_26254_image001

 

Their views of PCE inflation reflect a view that monetary policy can easily achieve a 2% rate of inflation in the long run.  Pray tell, when have actions of the FOMC ever led to an equilibrium result?

Aside from that, the PCE index does not fairly represent inflation for the average person in the economy.  Maybe it reflects what the rich experience.

central tendency_29831_image001

 

This is a study in contrasts.  They were once more optimistic that Fed Funds rates would rise sooner, and that has not happened.  That said, they are now more certain that the Fed Funds rate will rise significantly in 2016.  As for the long run they are getting more pessimistic about economic growth, at least in their Fed Funds forecasts.

central tendency_1915_image001

This is another example of where the FOMC should take a step back, and not try to interpret every short-term wiggle.  As a group, they whipsawed in their view of when tightening would happen over the last three datapoints, when I would not have changed much.

To the Fed I say, “Say less, and provide more graphs.”  I understand that you don’t want to discredit yourselves because you are bad forecasters, but maybe you could get your points across in a more potent way by not diluting your message by many needless words.

 

 

April 2014June 2014Comments
Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions.Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months.The FOMC has constantly overestimated GDP growth, They forecast badly because they serve their political masters, who demand optimism to delude the public.
Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated.Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated.No significant change.  What improvement?
Household spending appears to be rising more quickly. Business fixed investment edged down, while the recovery in the housing sector remained slow.Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow.Shades household spending down, raises their view on business fixed investment.

The FOMC needs to stop interpreting every short-term wiggle in the data.  They whipsawed on business fixed investment over the last three periods.

Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.No change.  Funny that they don’t call their tapering a “restraint.”
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.No change.  TIPS are showing slightly higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.46%, up 0.05% from April.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate.The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate.No change.
The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced.The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced.No change.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.No change.  CPI is at 2.1% now, yoy.  Hey, above the threshold, and no comment from the FOMC?
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month.In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month.Reduces the purchase rate by $5 billion each on Treasuries and MBS.  No big deal.

 

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.No change.  But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.No change.  Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.No change.  Monetary policy is like jazz; we make it up as we go.  Also note that progress can be expected progress – presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.No change.  Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo.Stanley Fischer is an interesting addition to the FOMC, because he would be capable of an independent opinion, not that he will ever do that.  Brainard and Mester are sock puppets.  If we see a dissent out of them, I will be shocked, and revise my opinion.

 

Comments

  • Small $10 B/month taper.  Equities and long bonds both rise.  Commodity prices rise.  The FOMC says that any future change to policy is contingent on almost everything.
  • They shaded household spending down, and raised their view on business fixed investment.  Don’t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • The FOMC is ignoring rising inflation data.
  • The FOMC needs to chop the “dead wood” out of its statement.  Brief communication is clear communication.  If a sentence doesn’t change often, remove it.
  • In the past I have said, “When [holding down longer-term rates on the highest-quality debt] doesn’t work, what will they do?  I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.  The Fed is playing with forces bigger than themselves, and it isn’t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent increases in employment, or a US Dollar crisis.  Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.

There are several reasons to avoid illiquidity in investing, and some reasons to embrace it.   Let me go through both:

Embrace Illiquidity

  • You are offered a lot of extra yield for taking on a bond that you can’t easily sell, and where you are convinced that the creditor is impeccable, and there are no sneaky options that you have implicitly sold embedded in the bond to take value away from you.
  • An unusual opportunity arises to invest in a private company that looks a lot better than equivalent public companies and is trading at a bargain valuation with a sound management team.
  • You want income that will last for your lifetime, and so you take some of the money you would otherwise allocate to bonds, and buy a life annuity, giving you some protection against longevity.  (Warning: inflation and credit risks.)
  • In the past, you bought a Variable Annuity with some good-looking guarantees.  The company approaches you to buy out your annuity at a 10-20% premium, or a 20-30% premium if you roll the money into a new variable annuity with guarantees that don’t seem to offer much.  Either way, turn the insurance company down, and hold onto the existing variable annuity.
  • In all of these situations, you have to treat the money as money lost to present uses.  If there is any significant probability that you might need the money over the term of the asset, don’t buy the illiquid asset.

Avoid Illiquidity

  • Often the premium yield on an illiquid bond is too low, or the provisions take value away with some level of probability that is easy to underestimate.  Wall Street does this with structured notes.
  • Why am I the lucky one?  If you are invited to invest in a private company, be skeptical.  Do extra due diligence, because unless you bring something more than money to the table (skills, contacts), the odds increase that they are after you for your money.
  • Often the illiquid asset is more risky than one would suppose.   I am reminded of the times I was approached to buy illiquid assets as the lead researcher for a broker-dealer that I served.
  • Then again, those that owned that broker-dealer put all their assets on the line, and ended up losing it all.  They weren’t young guys with a lot of time to bounce back from the loss.  They saw the opportunity of a lifetime, and rolled the bones.  They lost.
  • We tend to underestimate how much we might need liquidity in the future.  In the mid-2000s people encumbered their future liquidity by buying houses at inflated prices, and using a lot of debt.  When everything has to go right, the odds rise that everything will not go right.
  • And yet, there are two more more reason to avoid illiquidity — commissions, and inability to know what is going on.

Commissions

Illiquid assets offer the purveyor of the assets the ability to pay a significant commission to their salesmen in order to move the product.   And by “illiquid” here, I include all financial instruments that carry a surrender charge.  Do you want to know how much the agent made selling you an insurance product?  On single-premium products, it is usually very close to the difference between the premium you paid, and the cash surrender value the next day.

Financial companies build their margins into their products, and shave off a portion of them to pay salesmen.  This not only applies to insurance products, but also mutual funds with loads, private REITs, etc.  There are many brokers masquerading as financial advisers, who do not have to act strictly in the best interests of the client.  The ability to receive a commission makes them less than neutral in advising, because they can make a lot of money selling commissioned products.  In general, it is good to avoid buying from commissioned salesmen.  Rather, do the research, and if you need such a product, try to buy it directly.

Not Knowing What Is Going On

There are some that try to turn a bug into a feature — in this case, some argue that the illiquid asset has no volatility, while its liquid equivalents are more volatile.  Private REITs are an example here: the asset gets reported at the same price period after period, giving an illusion of stability.  Public REITs bounce around, but they can be tapped for liquidity easily… brokerage commissions are low.  Some private REITs take losses and they come as a negative surprise as you find  large part of your capital missing, and your income reduced.

What I Prefer

In general, I favor liquid investments unless there is a compelling reason to go illiquid.  I have two private equity investments, both of which are doing very well, but most of my net worth is tied up in my equity investing, which has done well.  I like the ability to make changes as time goes along; there is value to being able to look forward, and adjust.

No one knows the future, but having some slack capital available to invest, like Buffett with his “elephant gun,” allows for intelligent investing when liquidity is scarce, and yet you have some.  Many wealthy people run a liquidity “barbell.”  They have a concentrated interest in one company, and balance that out by holding very safe cash equivalents.

So, in closing, avoid illiquidity, unless you don’t need the money, and the reward is very, very high for making that fixed commitment.

The equity strategy that I have run for the last 13+years always has a slightly higher yield than the S&P 500.  But I never look for dividends.  It’s not a factor in my process.  That said, looking for businesses that produce free cash flow, and voila, the dividends appear.

At present, with interest rates so low, many people look at dividend paying common stocks as a means of obtaining income.  They also add REITs, MLPs, BDCs, and an assortment of other things that trade like stocks and have yield.  I don’t think this is a safe way to get yield, at least not now.  Here’s why:

1) Think of the 1970s, when I was a teenager.  Not only were interest rates higher, and inflation eating away at purchasing power, but when companies got into trouble, they would cut their dividends, and often severely.  During that era, you had to make sure that the company was actually earning the dividend, or were they borrowing to pay it.

2) There have been many flameouts in REITs, especially mortgage REITs.  I remember buying broken mortgage REITs in the mid-90s at less than half of their net worth after they had bought exotic CMO pieces, trying to create funds where the value rose as interest rates moved higher.  They got crushed in the early-90s by Greenspan’s hyper-easy monetary policy.  In 1994, as rates were rising, they rallied significantly.

Mortgage REITs also got crushed in 2008-9.  But Equity REITs have their times of trouble as well — they tend to be bull market babies.  When commercial real estate is doing well, they do extra well.  When it goes badly, extra badly for the REITs because of all the leverage.

3) I mentioned 1994.  In 1994, as rates rose, dividend paying stocks underperformed.  The value manager that Provident Mutual used at that time was an absolute yield manager.  In other words, that manager only bought stocks that had a yield higher than a fixed threshold.  At that point, the threshold was 4% or so.  From 1982 to 1993, as interest rates fell, this manager was golden, but it was an artifact of the era.  In 1994, the performance was abysmal.  The manager was replaced the next year.

High yielding stocks paying out a large portion of their earnings as dividends tend to have their dividends grow slowly, because there is little left over to reinvest into new business.  It is akin to owning a bond disguised as a stock.  Lower-yielding stocks often grow their dividends more rapidly, as they reinvest more free cash into new business.  With Equity REITs, the latter strategy has generally been more successful.  Better to buy the lower yielding REITs that grow their dividends faster.

4) The REITs, MLPs, and BDCs that pay out a a high proportion of their taxable income are weak vehicles because they are forced to pay out so much.  During crises, that really bites them.

(This wasn’t as short as I thought it would be.  Oh well.)

Conclusion

If interest rates rise, and I do mean if, because the economy is weak, be ready to see these modern income vehicles take a hit.  If we have a severe recession, be aware that dividends do get cut.  Do not rely on stocks for income.  Bonds are designed for income and return of principal.  Stocks are designed for gains or losses depending upon the underlying business performance.  They aren’t income vehicles, but performance vehicles.

I got cold-called this last week while I was away on business.  I googled the phone number, and found that it came from Melitello Capital.  I went through their site, and read most of their articles.

It’s an interesting firm, though I have no interest in working with them.  The article I would like to comment on tonight is “HOW DOES AN RIA JUSTIFY ITS 1% FEE?

I will explain why a 1% fee can be justified.  Now, I am an old school RIA [Registered Investment Adviser].  I only manage assets.  I don’t allocate across asset classes.  I don’t manage taxes in entire (though I help).  I don’t structure the means to escape estate taxes. I don’t set up insurance schemes to minimize taxes; I could do it, but it would be boring.  I could make a lot more money than I do, but I make enough, and I really like the challenge of outperforming the market.

RIAs offer value to clients in a large number of ways:

  1. Reducing income taxes
  2. Holding the hands of clients during the manic and panic periods of the market.  Discourage them from taking more risk when the market is hot, and encourage them to take more risk, or at least, don’t leave when the market is panicking.
  3. Hedging risks, whether it is a collar on a large single stock position, or a macro hedge.
  4. Aiding in covering insurance needs.
  5. Setting up financial plans.
  6. Structuring estates, such that everything goes where the client wants, and estate taxes are minimized.
  7. Asset allocation, including regular rebalancing.
  8. And more… free advice on other issues, entertainment, bragging rights, etc.
  9. Putting everything together in one neat package.
  10. Oh, and in a few cases, alpha.  (that’s my game)

Now, is that worth 1% on assets?  Point 2 alone is worth more than 1%, so yes.  Those who have read me for years know that people get greedy and panic.  If you can avoid that, you are doing well, very well.

Look, it’s easy to trash talk your competition.  Some registered investment advisers are worth their ~1% fee, and some not.  It depends on the package of services that they deliver — alpha, taxes, insurance, legal help, asset allocation (tsst… be wary of the efficient frontier.  It does not exist.).

In general, if the investment advisers themselves do not give in to panic and greed, they are worth a 1%/year fee.  So seek out advisers that do not give in to market pressure.

Note: this is unpopular, because that means hanging onto advisers that underperform during hot markets.  In the long run you will do better following advice like this– after all, they dissed Buffett in 1999, and my Mom told me I was a fuddy-duddy.  (Note: when a parent tells you that you are behind the times, it stings.  It does not mean that you are wrong.)

I am not telling you to invest with me; that is not what my blog is about.  I am saying that there is value in separate accounts with RIAs.  And, be choosy.  Lower fees are better, subject to the same levels of competence.

91-dHFmqgGL._SL1500_ This is a great book.  I encourage  you to buy it.  Though it talks of “effortless savings,” sorry, you’re going to have to work to get those savings.  Often the work won’t be much, but you have to focus your life to save, and that takes effort.

What area do I have the most expertise in?  Insurance.  When I read the book, I looked at the insurance area closely, and said to myself, “a very good chapter, except he excluded warranties.”

Then as I read on, he handled warranties later, in discussions on electronics, where warranties are presently hot.

This is one of those books, that as you read it, you should make a list.  Prioritize the areas where you are overspending, and take action one-by-one, to reduce your spending in a wise way.  If you did this over a whole year, you might be able to do this in such a way that you don’t notice any significant changes to your life.

Quibbles

None.

Summary

This is a great book and you should buy it here: Effortless Savings: A Step-by-Step Guidebook to Saving Money Without Sacrifice.

Full disclosure: The author asked me if I would like a copy and I said yes.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

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