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A Letter from a Young Investor

Saturday, July 19th, 2014

Before I get to the letter, I recommend reading, You’re Ready for Retirement, but Your Savings Aren’t by Jonathan Clement, if you have access to the Wall Street Journal.  Main point: if you can work until age 70, do that, and then retire.

Here’s the letter:

Hi David,

A little background about myself.  I am a 24-year male, and have been working for a little over a year.  The only knowledge I have on investing is passive index fund investing through the book Bogleheads.  I don’t really look at my holdings other than to re-balance every year.

I am currently investing for retirement by maxing out a RothIRA, maxing out a 401k  (that allows a Brokerage account) and some in a taxable Vanguard index fund.  My holdings consist of the total stock and total bond market index funds (90/10). From my current positions my portfolio return has been 20.6%. I calculated the return by return = (market_change + dividends) / total_money. I don’t know if this is a correct formula. The time frame of my holdings is from Jan2012 – June2014. 

I went to a finance workshop that my church was hosting and there was a panel of finance experts (CPA, lawyer, financial advisor) that were indirectly encouraging active investing over passive investing through personal anecdotes. 

Looking at my current portfolio performance, I have a hard time seeing the value in spending time in learning how to actively invest and about finance in general. Currently, I do not follow up on business and market news nor am I reading any economic/investing blogs or magazines. Again, my only investing knowledge is from the Bogleheads book, and so I feel that active investing would be a daunting task. 

Do you have a comparison of an active investment portfolio’s returns (that uses your 8 portfolio rules) against an index fund (such as the Vanguard total stock market) during a bull and bear market?  Also, do you have any advice on where to begin learning about active investing in general? How should one invest for different goals, say investing for retirement in 40 years vs. investing for a home purchase in the Bay Area in 5-10 years? I’m having a hard time seeing how I would balance time in regards to learning about investing, advancing my career through outside studying, serving in my local church, spending time to witness to family, friends and co-workers, and communion with God.  It seems like passive investing is a simpler solution with a decent average long-term return of 7%. I know I am young, have a lot to learn about life and sometimes stubborn in my thinking, so any thoughts and/or advice would be greatly appreciated.

These are the questions I will try to answer:

  1. Should you move to active investing, and are there some alternatives that would allow you gain some of the benefits of active investing, without costing you a lot of time?
  2. Do I have a track record that is publicly available?
  3. Where to learn about active investing?
  4. How should I invest if I want to buy a house in the Bay Area in 5-10 years, and how does that differ from investing for retirement?
  5. Is the time put into learning about investing really worth it when I have so many other social and spiritual commitments?

But  I will answer them in a different order.

Is the time put into learning about investing really worth it when I have so many other social and spiritual commitments?

You can’t be good at active investing without putting time in at least at the level of a hobby, say, one hour per day, six days a week.  When I launched into studying investments at age 27, I already had two advantages — A mother who was self-taught in investing (and beat most mutual fund managers handily), and an academic background in economics and finance (which had its pluses and minuses).

But my commitment to learning about investing was one hour per day, six days a week.  After 5 years, I was an investment actuary, which was pretty rare at that time.  After 11 years, I was hired into the investment department of a medium-sized life insurer.  17 years later, I worked for a notable hedge fund.  23 years later, I started my own firm.

Now, there were some spillover benefits for serving the church.  I have served on various boards of my denomination, chairing some of them, but my knowledge of finance has been a benefit to many of them, and I have been able to prevent a wide variety of errors.  Even this week, a Christian group in western Pennsylvania reached out to me regarding a “too good to be true investment,” and I told them it was likely a fraud.  There are ways that we can serve the church with such knowledge.  Brothers and sisters that I know come asking for advice, and I do not turn them down.

Now, all that said — no, it is probably not worth your time to learn about active investing.  I wrote two articles a while ago taking both sides of the argument:

Decide what you want to emphasize in your life and service to God.  The church benefits from a few “numbers guys” (as some refer to me in my denomination), but it doesn’t need a lot of them, if the group trusts them, and they are wise and upright.

Should you move to active investing, and are there some alternatives that would allow you gain some of the benefits of active investing, without costing you a lot of time?

I don’t think you have to move to active management — you might move to some sort of tilt on you passive management, though.  Over the long run, tilting to value stocks and smaller stocks has been a smart idea.  Cap-weighted indexes have most of their assets invested in behemoths that like Alexander the Great, have “no more worlds left to conquer.”  Investing a disproportionate amount passively in mid- and small-cap stocks can be a wise idea, as can passive investing with a value bias.  Two sides of the issue:

But, maybe wait a while before you add some mid- and small-cap value index funds… valuations are relatively high for small and mid-cap stocks at present.  I have a hard time finding truly cheap stocks at present.

Where to learn about active investing?

As for books, you could look through my book reviews, and scan for the word “value.”  You could visit the website; I have to admit I am impressed with what Jacob Wolinsky has done — it is the “go to” site for value investing.

You can also read the letters of notable value investors — Buffett, Klarman, Marks, and more…

How should I invest if I want to buy a house in the Bay Area in 5-10 years, and how does that differ from investing for retirement?

Let me tell you a story.  My congregation is near DC.  My congregation asked me to manage the building fund, and for years, I beat the market, but DC area real estate still appreciated faster.

At the same time, many congregations in the denomination, had received buildings for low prices, or virtually free, but those were mostly in rural areas.  So at prayer meeting in January 2009, after losing a large amount of the building fund, I asked God to drop a building in our lap, as I could not see any way that I would ever do it through my investing, good as it was.

Two months later, we bid on a short sale for a house with a church use permit.  We had the assets free and clear for it, and closed in May 2009.

Here is my point to you: geographically constrained markets like the Bay Area — there is no good way for the liquid stocks and bonds to keep up with real estate price increases. Buying a house in the Bay Area is a tough matter, and it might make sense to match assets and liabilities.

You might want to try to buy real estate related assets in the Bay Area — not sure how you could do that, but it would be the investment closest to funding what you want to own.

As for investing for retirement 40+ years from now, maintain a posture of 70-80% risk assets, and 30-20% safe assets.  I have been 70/30 most of my life.  Optimal is 80/20, but I take more idiosyncratic risk, and 70/30 just feels better to me.  My investments are more concentrated, and the cash levels out the jolts.

Do I have a track record that is publicly available?

Yes and no.  I send it to those who inquire after my services, but I will send you a copy after I publish this.  I’ve done well, but I know that it might be due to chance.  That said, my clients get the same investments that I have, so my interests are aligned with them, aside from the fee they pay me.  I have no other compensation from my investment management.

What to do when Valuations are High?

Thursday, July 10th, 2014

A letter from a reader:

Hi David,

What would you recommend for a long only equities portfolio?

I too think the market may be overheating, but as always, it’s impossible to tell when the party will end. I would have said the same thing last year this time as well.

This is what I am doing now:

  1. Cash is presently 16% of my portfolio.  I let that fluctuate between 0-20%.  I try to be fully invested during crises, and build up some cash when valuations are extended.  16% means valuations are high, but they could get higher — we aren’t at nosebleed levels.
  2. I have more invested in foreign companies than I normally do.  Around 40% of the portfolio is in foreign companies, which are at present undervalued relative to similar US companies.
  3. Emphasize companies with strong balance sheets, in industries that will not go away.
  4. I own cheap stocks.  The median valuation of the stocks that I own is around 10x earnings, and 1x Net Worth (Book Value).

This isn’t sexy, and if the market roars ahead, my clients and I will underperform.  But if there is a reason that emerges that causes the market to fall, my clients and I will do better than most.

I take more risk when the market is in the tank, and less when everyone thinks things are great.  This is particularly true when policymakers like the Fed are triumphant over high valuations, and low yield spreads.

This is a time to take less risk, in my opinion, but not a time to take no risk.

On Fixed Payment Annuities

Saturday, July 5th, 2014

Before I start, thanks to all those who e-mailed me over my “sorted weekly tweets.”  I am likely to continue doing them.  That will start next week, because I have had a flood of new clients, and other obligations.

On Fixed Payment Annuities

How often do you run into articles in quality publications talking about annuities that will pay a fixed sum over your life, or over your life if you live past a certain age?  Not often, right?  Right.  Well, today I got two articles on the same day:

Longevity insurance is an important topic, and everyone should consider getting an income that they can’t outlive.  That said, there are two problems with this:

  • Inflation, and
  • Credit risk (will the insurer survive to make the payments?)

It is possible to buy inflation-protected annuities, but at a cost of a lower initial payment.  With credit risk, consider what the state guaranty funds will cover in insolvency, and realize that any payments over that amount could be lost due to insurer insolvency.  If you have a large payment, only buy from strong insurers.

Then there are the deferred fixed payment annuities.   You are 50 years old, and you want a payment stream that kicks in when you are 80, should you live so long.  You can buy a lot of income that far out, which will help you if you survive, subject to the same two main risks: inflation and credit risk.  I am not aware of any deferred inflation-adjusted payment annuities.

Now, you can think of your annuity as a replacement for long-dated fixed interest bonds.  A portfolio of fixed payment annuities, cash, maybe some commodities/gold, and stocks could be very stable, balancing the risks of inflation and deflation, and of high and low real rates.

There is the added benefit of the regular income which is useful to average people, who are okay with budgeting, but really don’t understand investments.  Just beware inflation and credit risk.

One more note: most insurance agents will never suggest immediate annuities to you because when you buy one, that’s the last commission the agent ever gets.  They would rather you buy a deferred annuity, where they can gain another commission when the surrender charge period is up, and roll you to a new product.


Longevity insurance is good, but be sure you avoid credit risk, and have other assets to compensate for potential inflation risk.

Asset Value Illusion

Friday, May 23rd, 2014

Are some Baby Boomers retiring because the current value of their assets is high?  This article from Bloomberg gives an ambivalent answer to the question.  Personally, I don’t know the answer to that question, but I can answer a related question: In the current market environment, where interest rates are low and stock valuations are high, should Baby Boomers accelerate their retirements?

The answer is no.  Here’s why: in retirement, you aren’t earning income from wages.  You need income to be able to pay for expenses.  If interest rates are low and stock valuations are high, you won’t be able to create much income relative to your assets.

It’s like owning a long bond that you intend to buy and hold for the income.  Do you care that interest rates have fallen, and the value of your bond is above where you bought it?  No.  It doesn’t give you any more income.  If you sold it, where would you reinvest to get more income at equivalent risk?

Let me digress: rather than looking at asset values, look at anticipated cash flow streams.  Have you grown you anticipated cash flow stream?  In a bull market, many look like geniuses, but if it is only due to a rise in valuations, it means that the cash flow streams are unchanged.

I realize this is a harder way to look at the markets, but for those that have managed the interest rate risk at life insurers, this is the way the best do it.  Have you created a higher income rate over the funding horizon?  That is true improvement of the economic position.

Don’t merely look at the current value of your assets.  That is an illusion of the true value in terms of income.  Think of it this way.  Say that you have surpassed your prior peak assets of 2007 recently in 2014.  Now look at the income you could have purchased in 2007 (use the long bond as a proxy — 5%), versus what you could buy today — 3.4%.  The ability to generate income is reduced by 30%+.

You might argue that the long bond is the wrong proxy — too long, too safe.  I would argue that the safety is necessary.  If you want to take more risks in fixed income, go ahead, but that is an option.  As for length, the length is close to what is needed, but if you used 20-year bonds, the argument would not change.

Final Notes

You might think you have a lot of money, but how much income can it generate?  Are you protected against inflation? Deflation? Credit risk?  Don’t assume because the asset balance is high that you are necessarily better off, because you might not be able to earn as much income off your assets.

Book Review: Clash of the Financial Pundits

Tuesday, May 6th, 2014


Josh Brown’s last book, Backstage Wall Street, was four books in one.  This book, Clash of the Financial Pundits, is three books in one.  The authors cover three things:

  • Punditry in history
  • How to understand modern pundits
  • Interviewing modern pundits

I will take them in that order:

Punditry in history

The book covers the following eras in punditry:

  • The Crash that Started the Great Depression
  • The South Sea Bubble
  • Joe Granville
  • Harry Dent, Charles Kadlec, Dow 36,000
  • Martin Zweig
  • Jim Cramer was right during the 2008 crash

Roger Babson warned people about how high the stock market was, while Irving Fisher talked about stocks hitting a “permanently high plateau.”  The South Sea Bubble had many in the 1700s media stoking the flames of speculation.  Joe Granville was hot stuff in the late ‘70s and early ‘80s, but was dead wrong the rest of the time.

Harry Dent, Charles Kadlec, and the crew that put together Dow 36,000 created their own sensational predictions which proved to be controversial and very wrong.  Martin Zweig was right about the 1987 crash, while Jim Cramer controversially was right during much of the 2008 crash.

How to understand modern pundits

Then comes the basic advice to help us weather the storm of advice that floods the media.  The main topics are:

  • How to use financial media intelligently?
  • Need for humility
  • Hedge fund managers that talk to the public
  • People who act certain attract belief
  • Wall Street maxims often contradict each other
  • Making predictions that are squishy (surprises lists)
  • There are no experts

Using financial media intelligently means limiting the intake, and limiting its effect on you.  We must be humble in what we understand and accept, and we should listen to those that are humble in what they say.

When hedge fund managers speak publicly, realize that they are speaking their own interests.  They may not be right.  Also, those who speak with certainty on TV tend to attract more belief than those who are more humble and nuanced.

There are many soundbites in financial television, radio and writing.  For every maxim, there is a counter-maxim.

There is an art to making predictions that can’t be falsified, such as surprise lists.  It would help us all if we all realized there are no experts in investing, and that even includes me.

Interviewing modern pundits

Jeff Macke, Josh’s Co-author interviews the following pundits:

  • Jim Rogers – former manager of the Quantum Fund, author of many books.
  • Ben Stein – speechwriter for Nixon, written a scad of books, etc.
  • Karen Finerman – founder, owner & head of Metropolitan Capital, on CNBC’s Fast Money
  • Henry Blodget – Internet stock analyst 1998-2002, and now the editor and CEO of The Business Insider, a business news and analysis site, and a host of Yahoo Daily Ticker, a finance show on Yahoo.
  • Herb Greenberg – wrote for the San Francisco Chronicle’s business section, for, and has appeared on CNBC many times.
  • James Altucher – Entrepreneur and blogger.  He contributes content in many journalistic outlets.
  • Barry Ritholtz – Writes for and his own popular blog.  Also writer of the excellent and early crisis book Bailout Nation.  Josh Brown works with him at their firm.
  • Jim Cramer – Former hedge fund manager, founder of, host of the show Mad Money which appears on CNBC.
  • Jeff Macke – Josh’s co-author, currently working for Yahoo Finance, who relates a tale of when he screwed up badly as a pundit.

These are good interviews, and it gives the readers an internal look as to what it is like to be in front of the media, particularly amid controversy.  Each of the nine interviews sheds light on being a pundit, but in different ways.

Jim Rogers has talked about macro issues, and with a varied track record in the short-run.  Ben Stein has said many controversial things over time.  Karen Finerman has the story of being invited onto CNBC’s Fast Money, and taking a sip from the firehose as the first woman, one with no TV experience, and surviving.

Henry Blodget goes through his errors in the Internet Bubble, and how he has found redemption in writing about finance.  Herb Greenberg, the consummate skeptic, describes what it is like to take unpopular positions versus popular stocks.  James Altucher oozes blood over much of what he writes, telling of his own failures and successes in excruciating detail.

Barry Ritholtz, skeptic par excellence, describes the attitudes of interviewers, and the limited range of thought they have.  He delights in giving them answers that trouble them, like, “I don’t know.”

Jim Cramer is perhaps the most controversial of all.  I have known him, albeit distantly for 15 years.  He is very bright, but falls into the trouble of making too many predictions.

And so it is for most pundits.  Amount of predictions is inversely proportional to their quality.

The last “interview” is where Jeff Macke relates a failure of his on CNBC, tells a story of how pundits are human.  They have stresses in their lives.  They make mistakes.  They are people, humans, like you and me.


This is a good book, and will educate average people regarding financial media.  You will see the financial media from an insider’s view. If you want that, you can buy it here: Clash of the Financial Pundits.

Full disclosure: I received an advance copy of the book via NetGalley.

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.

Look to the Liabilities to Understand the Assets

Thursday, May 1st, 2014

There’s a puzzle of sorts in asset allocation, and it falls under the rubric of uncorrelated returns.  When a new asset class arrives, and it is small and few invest in it — lo, it is uncorrelated!

But then the word spreads, and more investors begin investing in the alternative asset class.  This has two effects:

  1. It drives up the price of the alternative assets, temporarily boosting performance, and
  2. It makes the asset class returns more sensitive to the actions of large institutional investors, such that the correlations rise with stocks and other risk assets.

How an asset is funded matters a great deal as to future price performance.  I often talk about strong hands and weak hands in investing, but I can make it simple:

  • Strong Hands — Well capitalized, little debt, and what debt there is, is long-dated.  Such people can buy assets and ride out storms, not worrying about mark-to-market losses.
  • Weak Hands — Poorly capitalized, much debt, and what debt there is is short-dated.  A storm will capsize them, making them forced sellers of the assets they acquired with debt.

Buffett understands this.  His insurance companies have relatively low underwriting leverage, but they benefit from high allocations to stocks.  He can own stocks because there is a core amount of liabilities that will fund the stocks that he owns.

Think of housing for a moment.  Asset prices were highest when the ability to use short-term low-cost financing was abundant.   Eventually, there was no demand for housing when prices would lock in losses for buyers who would rent the property out.

If an asset is owned by entities that have weak financing, there is a real risk of loss if the financing can’t be maintained.  You become subject to the credit cycle, which governs much of investing.  Invest when credit spreads are wide; don’t invest when they are narrow.

I know that advice is vague, but that’s a part of the game.  You have to adjust the riskiness of your portfolio to overall conditions, and resist trends, if you want to make money over the long run.

How people and other entities fund the assets that they own has an effect on the future price performance, because it affects how they might buy or sell.


I’m Not in This for Love

Friday, April 11th, 2014

Much as I appreciate those who like what I write at this blog, I don’t write to be loved.  I don’t write to be hated, either.  I am sensitive to what people think of me, but not to the degree that it changes what I write.

I may have nonconsensus views on:

  • The Federal Reserve
  • Gold
  • Social Security & Medicare (and their cousins around the globe)
  • The current Bull Market in Stocks and Corporate Bonds
  • Long Treasuries
  • and more…..

But I write what I write to disclose the truth.  I am an active equity manager, but I encourage people to use passive investing via index funds, unless they can find a manager who can reliably obtain outperformance.

I don’t blog for economic advantage.  If I wanted to do that, I could channel a wide variety of ideas on investing that are popular, but I know are marginal at best in terms of effectiveness.

Some friends of mine have told me, “Why don’t you write about companies that you own, or companies that look attractive to you?”

I’ve been burned by doing that.  For every ten that you get right, you get the same response from every one you get wrong.  As with most of the web, the complainers dominate.  That’s why I don’t trot out many individual stock ideas.  It’s not that I don’t have them, but I only share them as a group, not as a single idea, most of the time.


I’m here to tell the truth, even if it cuts against my own short-term economic interests.  Most of the time, I adjust my portfolio so that it is ready for everything, but sometimes I delay, because I know that changes in the market usually happen slowly.

I do not write to be popular.  I write to change the consensus, unlikely as that will be.  Finance is a perverse area of life where fear and greed take over.  And with academics, they have these lame models that are fit for Vulcans (maybe) but not humans (and certainly not Ferengi).

We need new models that reflect the fear-greed cycle, and make valuation a significant input in risk assessments.

I’m not in this for love; I only want to change the way that we view investment decisions.

This May Be Gold, But It Is Not Golden

Sunday, February 16th, 2014

I’ve done a number of articles on dollar-weighted returns in mutual funds.  There are rare cases where the shareholder base is smart, usually in value funds, where the shareholders add more money on declines, and lighten up when things are going too well.

Tonight’s target is the Gold ETF SPDR Gold Shares [GLD].  As with most volatile mutual funds, people tend to get greedy or panic.  They chase performance.  Consider this list of inflows and outflows from GLD. Cash flows are assumed to occur at mid-period.


Cash Flow































Versus a buy-and-hold investor, the average holder gives up almost 3% of returns via market mistiming.  Technicians may talk down buy and hold, but buy and hold usually outperforms the average trader.  This is similar to what my friend Josh Brown talks about in his article Flows Don’t Follow Value, They Follow Performance.  Very few investors are rational businessmen, estimating likely returns over their funding horizon.  Rather they chase past success, and flee past failures.

Such has been true of the SPDR Gold Shares ETF.  Say what you will about the cheapness of large ETFs, people will still misuse them.  They will buy late in a bull phase, and sell late in a bear phase.

And so I say to all: Guard your emotions.  Be forward-looking.  Analyze likely value five years out.  Don’t make snap decisions out of regret.  Think about risk control before you buy shares, bonds, whatever.

Now, as a personal aside, it took me around eight years to learn to control my emotions.  Over the last 20 years, I have made at most a handful of errors reacting to bad market events.  I learned to analyze rather than panic back in the 90s.  It doesn’t mean that I am always right, but it does mean that I act.  I almost never react.

As for GLD, be wary about paper gold.  Is it really fully collateralized by audited gold in a warehouse?  There are lots of promises of gold being traded, but how much physical gold could you have delivered to you, should you want it?

That’s all for now.  Be careful in all of your investing; it is easy to err.

Sorted Weekly Tweets

Saturday, February 15th, 2014

Market Impact


  • Companies Squeeze 401K Plans From Facebook to JPMorgan This should not surprise, many companies shrink labor costs $$ Feb 15, 2014
  • Wells Fargo edges back into subprime as US mortgage market thaws Isn’t a problem now, problem comes w/imitators $$ Feb 15, 2014
  • Homebuyers Get Break as Loan Rates Defy Fed Tapering Housing & general economy weakened, so mortgage rates fell $$ Feb 13, 2014
  • Pension politics @felixsalmon points out how defined benefit plans r in general better 4 workers. Mind the PBGC $$ Feb 13, 2014
  • Colleges Raise Record $33.8B Exceeding US Peak in 2009 Donations always follow creation of unrealized cap gains $$ Feb 12, 2014
  • Some Lines Say Maybe the Stock Market Will Go Down @matt_levine correctly criticizes the 1928-9 $SPY graph overlay $$ Feb 13, 2014
  • 1929 Stock Market Crash Chart Is Garbage Unequal left & right scales make the relationship look tighter than it is $$ Feb 12, 2014
  •  When to Ignore the Investment Experts “When all the experts &forecasts agree — something else is going 2 happen.” $$ Feb 11, 2014
  • Comparing Economic Recoveries In 1984-2006, growth was borrowed from future by increasing debt levels-> #payback $$ Feb 11, 2014
  • Aluminum Lines Still Trouble the London Metal Exchange Aluminum inventories will b a prob, til short intrates rise $$ Feb 11, 2014
  • Top Anecdotal Signs of a Market Bubble Good piece, like one of mine: Watch the credit cycle $$ Feb 11, 2014
  • Ten Stocks to Own During a Market Correction Good list. I own a few of them. $$ Feb 11, 2014
  • Does trend-chasing explain financial markets? Partly. Difference between investment IRR and total return is big $$ Feb 10, 2014
  • “Security. Safety. Stability.” from @reformedbroker Gold is useful at certain points, but only when it is hated $$ Feb 10, 2014
  • Flows Don’t Follow Value, They Follow Performance @reformedbroker wrote this little gem. Learn & internalize it $$ Feb 10, 2014
  • Long Term Charts 2: Western Markets Since The Middle Ages Interesting charts from very messy data at Zero Hedge $$ Feb 10, 2014
  • Most Expensive Place to Find Out Who You Are @jasonzweigwsj : Your reaction 2 minor crisis shows yr risk tolerance $$ Feb 10, 2014


Companies & Industries


  • AIG Takes $832 Million Charge on Death Bets as Hedge Funds Gain Life settlements should b illegal $$ $MET $AIG $PRU Feb 14, 2014
  • To Stop the Coffee Apocalypse, Starbucks Buys a Farm $SBUX helps create a variety of rust resistant Arabica trees $$ Feb 13, 2014
  • Former BlackRock Manager Finds Billions on Rice Energy Few investment mgrs have operating talent; Daniel Rice does $$ Feb 13, 2014
  • Buffett’s Pal Munger Heads a Very Weird Company Growth of $DJCO thru investing leads 2 # of growing pains & 13F $$ Feb 13, 2014
  • Here’s Why the Biggest Cable Company in the Country Thinks It Can Get Bigger Feds tolerant of cable re antitrust $$ Feb 13, 2014
  • Why AOL ended up spending millions on ‘distressed babies’ $AOL chose 2b in healthcare biz 4 its employees & lost $$ Feb 13, 2014
  • 3 High-Yielders To Buy On The Pullback In total $SNH issues more stock than it pays in divs. Divs -> cap losses $$ Feb 13, 2014
  • Who is John Thompson? A look at Microsoft’s new chairman May have right stuff to protect new CEO from meddling $$ Feb 10, 2014


US Politics & Policy


  • Runaway Drones Map Land, Film ‘Wolf,’ Knock Down People, FAA Gives Chase Drones r here 2 stay; time license them $$ Feb 15, 2014
  • Teacher Tenure Put to the Test in California Lawsuit Tenure has outlived its usefulness; older teachers can b lazy $$ Feb 15, 2014
  • Lincoln’s Foreign Policy in Today’s World Kept England & France from joining Civil War; otherwise pragmatic $$ $SPY Feb 15, 2014
  • What Would Lincoln Do? A clever man w/principles, who did not cease to be pragmatic pursuing 1 main goal – Union $$ Feb 15, 2014
  • Harvard Professor Attacking Google Thrives as Web Sheriff At some point, lack of disclosure will blow up on him $$ Feb 14, 2014
  • The $2.2B Bird-Scorching Solar Project Get used 2 idea: almost every form of energy imposes environmental costs $$ Feb 13, 2014
  • Obamacare Damage-Control Teams Seek to Calm Complaints Things r tough when u r trying to avoid media embarrassment $$ Feb 13, 2014
  • Billionaire Musk Gets Brownsville to Pay for SpaceX Like a football owner bargaining 2 get taxpayers buy a stadium $$ Feb 13, 2014
  • Snowden Swiped Password From NSA Coworker & it cost him his job. Snowden denies it; NSA is Not Saying Anything $$ Feb 13, 2014
  • Puerto Rico Legislators Amend Bill Calling for Bank-Deposit Shift Provincial govt’s attempt 2raid cookie jar stopd $$ Feb 13, 2014
  • Obamacare Will, in Fact, Encourage Employers to Cut Jobs As the employer mandate comes into force, jobs will b cut $$ Feb 12, 2014
  • Tea Party Scorns Republicans as House Lifts Debt Ceiling t-party can b “pure” as Dems raise ceiling w/few GOP $$ $TLT Feb 12, 2014
  • A Lame Duckish Calm Falls Over the Capital Parties in DC act as if the next event is the November elections $$ $TLT Feb 12, 2014
  • Obama Rewrites ObamaCare Another day, another lawless exemption, once again for business; WSJ bangs populist drum $$ Feb 11, 2014
  • The US Senate Again Insists on USPS Saturday Mail Delivery 2 timid; end Wednesday & Saturday delivery $$ $UPS $FDX Feb 11, 2014
  • US firms ‘paid effective tax rate of 2.2% in 2011’ More than a tax haven, Ireland helps insurers shave reserves $$ Feb 11, 2014
  • No Honeymoon for Janet Yellen QE withdrawal will bite, & what will become of all the deposits? $$ Feb 11, 2014
  • Please Hold Your Bernanke Applause Remember, when Greenspan left, he was viewed as a success, same as BB now $$ $TLT Feb 11, 2014
  • Sounding the Tax Alarm, to Little Applause IRS stiffs whistleblowers who often lose employability 4 being a tipper $$ Feb 10, 2014


Rest of the World


  • Putin is Playing a Game of His Own Not so fast. Russia has significant resources & influence in Eastern H’sphere $$ Feb 15, 2014
  • Boy’s Life Hanging on 8-Hour Trip Shows Why Venezuelans Protest Socialism is like a cancer that spreads til death $$ Feb 14, 2014
  • Let’s Watch Venezuela Destroy Itself Logical extreme of Socialism falls apart; pity that Chavez never lived 2c it $$ Feb 14, 2014
  • Chinese Join Winklevosses in L.A. Luxury Home Hedges Amazing what the wealthy will pay 4a fancy foreign retreat $$ Feb 14, 2014
  • Next crisis won’t come from the emerging markets Argues France, Germany, Britain, Australia & Canada-> 2 much debt $$ Feb 13, 2014
  • Mister Donut, Pan Am and Friendster Found Alive and Well Old brands never die, they just move overseas & make $$ $SPY Feb 13, 2014
  • Bank of England points to 2015 rate rise, blurs guidance More precision than 1 can know; the world is messy $$ $FXB Feb 13, 2014
  • Italy Pays Record Low to Sell 3-Year Debt at Auction Let the leverage build for the next crisis $$ Feb 13, 2014
  • Fink to Mobius Touting Emerging Stocks Fails to Stem Outflow A time 2 nibble, not a time 2 gulp $$ $EEM Be wary Feb 13, 2014
  • Greek Truckers Show Plight as Groceries Show Up Frozen Freeing up the labor market will work as attitudes change $$ Feb 13, 2014
  • Tunisians Bolt Doors Even After New Constitution Passed Constitutions cannot create cultural change; asks 2 much $$ Feb 13, 2014
  • Israel Desalination Shows California Not to Fear Drought When resources r tight there are incentives 2 create tech $$ Feb 13, 2014
  • London Walkie Talkie Owners to Shield Car-Melting Beam Reflective parabolic curve of building melts cars @ a spot $$ Feb 12, 2014
  • Rouhani Seeks Economic Fix as Iran Commemorates Revolution Will have to get the agreement of unelected true rulers $$ Feb 11, 2014
  • Argentina to Replace Bogus Inflation Index to Mend IMF Ties Argentina tries 2 find cheapest way out of this mess $$ Feb 11, 2014
  • Who Should Pay for Trusts that Go Bust? If China is smart, protect depositors, but let banks & WMP holders fail $$ Feb 11, 2014
  • Iceland Girds for Fight as Suit Targets Half $14B GDP Icelandic taxpayer will refuse the bill; UK will b stiffed $$ Feb 11, 2014
  • Mobius Says Emerging-Market Rout Near End as Valuations Lure I dunno, a 4% earnings yield premium seems small $$ $EEM Feb 11, 2014
  • Rehabilitating Portugal Long; Argues that a Greek-style bailout should b done, or Portugal will eventually default $$ Feb 11, 2014
  • Iranian TV Shows Rare Broadcast of Band Playing Music Christianity has always been easier on music than Islam $$ Feb 11, 2014


Work Trends


  • Sheep-Shearing Wells Fargo Banker Bridges US Income Gap Sells coffeemakers too; many in US work multiple jobs $$ $TLT Feb 13, 2014
  • Workers Shed Caution, in a Healthy Sign for Labor Market When workers r willing 2 quit, labor mkt is healthy $$ $TLT Feb 11, 2014




  • A Little Valentine’s Day Straight Talk Sage counsel 2 younger women if they want to get married: start early $$ Feb 15, 2014
  • The Sex Question Readers Want Answered Most Even Long-Married Happy Couples Ask, ‘How Can We Have Sex More Often?’ $$ Feb 11, 2014
  • Ten Ways You’re Probably Leaving Money on the Table Simple list of ways to save money for avg upper-middle class $$ Feb 11, 2014
  • Why Mom’s Time Is Different From Dad’s Time Husbands, u can win if u reduce chaos for your overburdened wives $$ Feb 11, 2014




  • US Scores Fusion-Power Breakthrough Bad news is Tritium very expensive @ $100K per gram; takes much energy 2 make $$ Feb 13, 2014
  • If Ocean Heat Pump Switches On, Expect to Feel It Speculative; we don’t understand climate or hurricanes well $$ Feb 11, 2014
  • Who is Steven Reisman? Meet Hip-Hop VIPs’ Favorite Lawyer, The Man With The $2 Bills Weird. Very, very weird $$ $SPY Feb 11, 2014
  • What Really Happened to Flappy Bird? Beware the success u wish 4? Also: Still a puzzle $$ $SPY Feb 11, 2014


Wrong, etc.


  • Skeptical: Blackstone-Fueled Single-Family Home Boom Lifts Chicago In past hi levels of investor ownership bearish $$ Feb 15, 2014
  • Wrong: Pros Panic, Retail Investors Stay Cool on Emerging Markets Too short a period time to judge $$ Feb 14, 2014
  • Wrong: Social norms: The indignity of no work New technologies will create new jobs & make the whole world better $$ Feb 13, 2014
  • Wrong: Warren Buffett is laughing at you for selling Poorly thought-out piece glues 2unrelated ideas together $$ $EEM Feb 13, 2014
  • Wrong: The #1 High-Yield Investment Of America’s Elite Spammy article that talks about REITs as if they r a secret $$ Feb 11, 2014


Replies, Retweets & Comments


  • 10 miles west of Baltimore, MD, we got ~15 inches of snow over the last last 2 days. #snow #weather #pax $$ Feb 14, 2014
  • “I made this comment six months ago:… & then, I tipped the SEC. …” — David_Merkel $$ $DJCO Feb 13, 2014
  • “Administrative Services Only” plus individual stop loss protection is in general the smart way2…” — David_Merkel $$ Feb 13, 2014
  • “This is a common confusion in statistics — you can have a high correlation and a low beta. Second…” — Merkel $$ Feb 13, 2014
  • RT @Pawelmorski: Scary parallel my foot. Feb 12, 2014
  • @davidgaffen that would only be a temporary fix. I wrote this 3.5 yrs ago on the topic: The internet eats USPS Feb 11, 2014
  • @quakkelaar I miss you too. If you are ever near Baltimore/DC, let me know; we can get together, brother. Last few years have been hard Feb 11, 2014
  • RT @ReformedBroker: Please explain how the wording of this investment advertisement on the Washington Post site could be legal:… Feb 10, 2014
  • ‘ @quakkelaar Hail old friend. Yes, same old mistakes, b/c those wishing to retire are making the money sweat, until it rebels on them $$ Feb 09, 2014


An Expensive Kind of Insurance

Thursday, February 6th, 2014

Strategy One: “Consistent Losses, with Occasional Big Gains when the Market is Stressed”

Strategy Two: “Consistent Gains, with Total Wipe-out Risk When Market is Highly Stressed”

How do these two strategies sound to you?  Not too appealing?  I would agree with that.  The second of those strategies was featured in an article at recently — Inverse VIX Fund Gets Record Cash on Calm Market Bet.  And though the initial graph confused me, because it was the graph for the exchange traded note VXX, which benefits when the VIX spikes, the article was mostly about the inverse VIX exchange traded note XIV.

Why would someone pursue the second strategy?  Most of the time, it makes money, and since January 2011 we haven’t a horrendous market event like the one from August 2008 through February 2009, it makes money.

I would encourage you to look at the decline in the second half of 2011, where it fell 75% when the VIX briefly burped up to around 50.  But given the amazing comeback as volatility abated, the lesson that some investors drew was this: “Volatility Spike? Time to buy XIV!”  And that explains the article linked above.

You might remember a recent book review of mine — Rule Based Investing.  In that review, I made the point that those that sell insurance on financial contracts tend to win, but it is a volatile game with the possibility of total loss.  To give another example from the recent financial crisis: most of the financial and mortgage insurers in existence prior to 2007 are gone.  Let me put it simply: though financial risks can be insured, the risks are so volatile that they should not be insured.  You are just one colossal failure away from death, and that colossal failure will tend to come when everyone is certain that it can’t come.

But what of the first strategy?  How has it done?

Wow!  Look at the returns over the last few weeks!  Rather, look at a strategy that consistently loses money because it rolls futures contracts for the VIX where the futures curve is upward-sloping almost all the time, leading to buy high, sell low.

Does it pay off in a crisis?  Yes.  Can you use it tactically?  Yes.  Can you hold it and make money?  No.

Back to the second strategy.  People are putting money into XIV because they “know” that implied volatility always mean-reverts, and so they will make easy money after a volatility spike.  But what if they arrive too early, and volatility spikes far higher than expected?  Worse yet, what if Credit Suisse goes belly-up in the volatility?  After all, it is an exchange-traded note where owners of XIV are lending money to Credit Suisse.

Back to Basics

Do I play in these markets?  No.

Do I understand them?  Mostly, but I can’t claim to be the best at this.

What if I try both strategies at the same time?  You will lose.  You are short fees and trading frictions.

What if I short both strategies at the same time?  Uncertain. It comes down to whether you can hold the shorts over the long term without getting “bought in” or panic when one side of the trade runs the wrong way.

Recently, someone pinged me to speak to CFA Institute, Baltimore, where he wanted to talk about “not all correlations of risky assets go to one in a crisis” and pointed to volatility investing as the way to improve asset allocation.  Sigh.  I’m inclined to say that “you can’t teach a Sneech.”

I favor simplicity in investing, and think that many exchange traded products will harm investors on average because the investors do not understand the underlying economics of what they own, while Wall Street uses them as a cheap way to hedge their risk exposures.

There may be some value to speculators in using “investments” like strategy one for a few days at a time.  But holding for any long time is poison.  Worse, if you are accidentally right, and the world comes to an end — this is an exchange-traded note, and the bank you lent to will be broke.  That will also kill strategy two.

So, my advice to you is this: avoid either side of this trade.  Stick with simple investments that do not invest in futures or options.  Complexity is the enemy of the average investor.  I can understand these investments and they don’t work for me.  You should avoid them too.

PS — before I close, let me mention:

Good article in both places.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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