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Avoid Illiquidity

Wednesday, June 18th, 2014

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.


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 Value That Investment Advisers Deliver

Saturday, June 14th, 2014

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.

Book Review: Effortless Savings

Saturday, June 14th, 2014

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.




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.)

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.

Post 2500: What is the Aleph Blog About?

Thursday, June 12th, 2014

Every hundred or so posts, I take a step back, and try to think about broader issues about blogging about finance.  Tonight, I want to explain to new readers what the Aleph Blog is about.

There have been many new followers added to my blog recently,  through e-mail, RSS, and natively.  This is because of this great article at Marketwatch, which builds off of this great article at Michael Kitces’ blog.

I am humbled to be included among Barry Ritholtz, Josh Brown, and Cullen Roche, and am genuinely surprised to be at number 4 among RIAs in social media influence.  Soli Deo Gloria.

What Does the Aleph Blog Care About?

I’m writing this primarily for new readers, because I’ve written a lot, and over a lot of areas.  I write about a broader range of topics than almost all finance bloggers do because:

  • I’m both a quantitative analyst and a qualitative analyst.
  • I’m an economist that is skeptical about the current received wisdom.
  • I like reading books, so I write a lot of book reviews.
  • I’m also a skeptic regarding Modern Portfolio Theory, and would like to see it discarded from the CFA and SOA syllabuses.
  • I believe in value investing, in both the quantitative and qualitative varieties.
  • I believe that risk control is a core concept for making money — you make more money by not losing it.
  • I believe that good government policy focuses on ethics, not results.  The bailouts were not fair to average Americans.  What would have been fair would have been to let the bank/financial holding companies fail, while protecting the interests of depositors.  The taxpayers would have been spared, and there would have been no systematic crisis had that been done.
  • I care about people not getting cheated.  That includes penny stocks, structured notes, private REITs, and many other financial innovations.  No one on Wall Street wants to do you a favor, so do your own research and buy what you want to own, not what someone wants to sell you.
  • Again, I don’t want to see people cheated, so I write about  insurance.  As a former actuary, and insurance buy-side analyst, I know a lot about insurance.  I don’t know this for sure, but I think this is the blog that writes the most about insurance on the web for free.  I write as one that invests in insurance stocks, and generally, I buy the stocks because I like the management teams.  Ethical, hard working insurance management teams do the best.
  • Oddly, this is regarded to be a good accounting blog, because as a user of accounting statements, I write about accounting issues.
  • I am a skeptic on monetary and fiscal policy, and believe both of them tend to sacrifice the future to benefit the present.  Our grandchildren will hate us.   That brings up another issue: I write about the effects of demographics on the markets.  In a world where populations are shrinking in developed nations, and will be shrinking globally by 2040, there are significant economic impacts.  Economies don’t do well when workers are shrinking in proportion to those who are not working.  (Note: include stay-at-home moms and dads in those who work.  They are valuable.)
  • I care about the bond market.  There aren’t that many good bond market blogs.  I won’t write about it every day, but I will write about i when it is important.
  • I care about pensions.  Most of the financial media knows things are screwed up there, but they do not grasp how bad the eventual outcome will likely be.  This is scary stuff — choose the state you live in with care.

Now, if you want my most basic advice, visit my personal finance category.

If you want my view of what my best articles have been, visit my best articles category.

If you want to read about my “rules,” read the rules category.

Maybe you want to read some of my most popular series:

My blog is not for everyone.  I write about what I feel most strongly about each evening.  Since I have a wide array of interests, that makes for uneven reading, because not everyone cares about all the things that I do.  If that makes my readership smaller, so be it.  My blog expresses my point of view; it is not meant to be the largest website on finance.  I want to be special, even if that means small, expressing my point  of view to those who will listen.

I thank all of my readers for reading me.  I appreciate all of you, and thank you for taking the time to read me.

As one final comment, I need to say this.  I note people unfollowing my blog at certain times, and I say to myself, “Oh, I haven’t been writing about his pet issue for a while.”  Lo, and behold, after these people leave, I start writing about it again.  That is not intentional, but it is very similar to how the market works.   People buy and sell investments at the wrong times.

To all my readers, thank you for reading me.  I value all of you, and though I can’t answer all e-mails, I read all e-mails.

In summary: the Aleph Blog is about ethics and competence.  I want to do what is right, and do what gives the best investment performance, in that order.


Sorted Weekly Tweets

Saturday, May 24th, 2014

Market Impact 

  • Giving Yourself an Investing Makeover @jasonzweigwsj describes Guy Spier & his efforts 2b a more rational investor $$ May 24, 2014
  • The Bearish Signs Junk Buyers Reject in Stoking ’14 Rally BBs beat CCCs amid a falling Russell 2000 index $$ #odd May 23, 2014
  • Penny Stocks Like Latteno Foods Rally, Fueling Big-Dollar Dreams Fascinating 2c this amid a pullback in small caps $$ May 23, 2014
  • Buffett Too Rich for Buffett Is Sign Bargains Are Gone I’m still finding some cheap stocks but they r unusual $$ $SPY May 23, 2014
  • For Sale: 20% Stake in Hedge Fund. Terms: Complicated. “You don’t want to be wearing someone else’s underwear.” $$ May 23, 2014
  • Boomers Cash In as Bull Market Aids Exodus From Workforce Asset illusions delude Boomers who think they r rich $$ May 23, 2014
  • Wall Street Finds New Subprime With 125% Business Loans The businesses would get better rates on Prosper $$ #dumb May 23, 2014
  • Debt Rises in Leveraged Buyouts Despite Warnings Debt makes financial systems less flexible; depend on fixed pmts $$ May 21, 2014
  • Chasing Yield, Investors Plow Into Junk Bonds Yields have never been lower 4 CCC-rated debts $$ May 21, 2014


Rest of the World

  • What China Property Crash? Economists See Growth Bump Economists c new empty buildings & mark up GDP $$ $FXI #FTL May 23, 2014
  • Putin’s Singapore Dream Costs Crimea Banks and Burgers Singapore is not so much created by laws but by ppl culture $$ May 23, 2014
  • Russia, China Sign $400B Gas Deal After Decade of Talks The infrastructure must b created 2 make this work; not ez $$ May 23, 2014
  • Brazil World Cup Win Risks Stock Drop in Boon to Rousseff Brazil wins, Rousseff win odds rise, stocks will fall $$ May 23, 2014
  • BlackRock Has Cut Portugal Bond Holdings Over Past Couple of Weeks Some Emerging-Market Debt > Euro-Zone Bonds $$ May 23, 2014
  • Norway Loses Reputation as Stable Investment as Firms Recoil Tax 2 highly & businesses run away $$ May 21, 2014
  • It’s a Good Time to Globalize Your Stock Portfolio Many foreign companies r trade cheaper than US stocks $$ $SPY $EFA May 21, 2014
  • UK House Prices Rise to Record High in April B sure 2add wealthy foreigners buying in London as investment/hedge $$ May 19, 2014
  • Bank of England’s Mark Carney Highlights Housing Market’s Threat to UK Economy 100% of all UK mtges r short-dated $$ May 19, 2014
  • Good Time To Be A Farmer In China? China aggressively pushing crop insurance, & larger scale agriculture $$ $FXI $SPY May 19, 2014


  • Without Keystone XL Economic & public health costs of forgoing a new oil pipeline $$ {Sound of oil train derailing} May 24, 2014
  • Secrecy of Oil-by-Train Shipments Causes Concern Across the US Butane, propane & ethane should be removed b4 shpng $$ May 23, 2014
  • Oil Nations Put Out Welcome Mat for Western Companies If u make the cost of drilling2high, fewer bbls get produced $$ May 19, 2014


US Politics & Policy

  • How Timothy Geithner failed his stress test When @rortybomb & I agree on something, that is notable $$ #housingbubble May 23, 2014
  • Meet Jessica Rosenworcel, the FCC Swing Vote Marches to her own drummer, willing to cut deals 4 the greater good $$ May 23, 2014
  • How to Turn Homes Back Into Piggy Banks Housing Personal Savings Acct & Equity Principal Tax Credit; elim mtge ded $$ May 23, 2014
  • NJ Gov. Christie under fire for cutting pension payments to state workers Definite mistake; cashflows compound $$ May 23, 2014
  • BlackRock’s Fink Says Housing Structure More Unsound Now GSEs took too much default risk pre-crisis, returning $$ May 21, 2014
  • GOP’s Business Wing Sends Tea Party a Chilling Message Business fights small government GOP candidates $$ May 19, 2014
  • Why Republicans Should Take Rick Santorum Seriously Represents the middle class populist part of the GOP $$ May 19, 2014
  • California’s Drinking Problem California does not have enough water for Ag, Industry, People, w/o right incentives $$ May 19, 2014


US Monetary Policy

  • New Faces Behind Fed Dots Seen Roiling Markets as Forecasts Move Y publish estimates if u don’t want us 2read them $$ May 23, 2014
  • Bubble States Underemployment Rates Haunt Yellen Monetary policy is impotent w/debt defation; Fed on wrong track $$ May 23, 2014
  • New Faces Behind Fed Dots Seen Roiling Markets as Forecasts Move Y publish estimates if u don’t want us 2read them $$ May 23, 2014
  • Yellen Adds Disadvantaged to Full-Employment Definition Alas, monetary policy is weak when dealing e/employment $$ May 21, 2014
  • Fed’s Rate-Change System Up for Revamp The Fed is lost. The Fed is lost. The Fed is lost. The Fed is lost… $$ $TLT May 19, 2014


Companies & Industries

  • Google Developing Tablet With Advanced Vision Capabilities Will b interesting 2c what new apps get developed $$ $GOOG May 23, 2014
  • Planting Corn at Warp Speed Using High-Tech Tools Astounding application of technology transforms planting seed $$ May 23, 2014
  • Golf Market Stuck in Bunker as Thousands Leave the Sport Costs 2 much $$ takes up 2 much time, but growing in Asia May 23, 2014
  • Family Dining Offers Barometer of Middle Income Ugly valuations means stocks will fall if sales don’t rise 4%/yr+ $$ May 23, 2014
  • Silicon Valley’s Laundry-App Race Long article on the efforts to turn laundry into a scalable attractive business $$ May 23, 2014


Personal Finance


  • Dueling Strategies for 401(k)s, IRAs and Your Other Retirement Funds Do what maxes long-term purchasing power $$ $SPY May 23, 2014
  • 40 Financial Things You Should Know by 40 2013 article, but I thought it covered the personal financial basics $$ May 19, 2014



  • New Study: Is No Degree Better Than A Liberal Arts Degree? Depends. It helps in getting some jobs, but not all $$ May 21, 2014
  • BBC News – ‘Biggest dinosaur ever’ discovered Interesting b/c it probably was once much warmer in Patagonia $$ May 19, 2014
  • Haverford Speaker Bowen Criticizes Students Over Protests Former Princeton President calls them “immature.” Bingo! $$ May 19, 2014



  • Overrated: Russia, China sign deal to bypass USD What matters is where u invest the proceeds from goods exported $$ May 23, 2014
  • Wrong: Investing: The herd isn’t always dumb Then explain y dollar-weighted returns underperform buy & hold $$ #panic May 23, 2014
  • Wrong: Cutting Off Emergency Unemployment Benefits Hasn’t Pushed People Back to Work We run unsustainable deficits $$ May 23, 2014
  • Wrong: Ikea Economics Lure Central Bankers Seeking New Tools Don’t try negative interest rates; will b a disaster $$ May 23, 2014
  • Wrong: The Retirement Apocalypse That Isn’t Coming I might buy this if we weren’t running large deficits $$ $TLT $SPY May 21, 2014


Retweets, Replies & Comments

  • ‘ @DGenchev I am analyzing the investors as a group, thus what % of the mkt cap is relevant. I go to EDGAR and copy XML files into Excel May 24, 2014
  • If I were doing your project, I would not have chosen any of your “governance experts.” I would have chosen a group… May 22, 2014


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.

Playing for Pennies, Risking Dollars

Friday, May 16th, 2014

I try to avoid investments where the upside is limited, but the downside is unlimited.  That’s the way I feel about junk bonds now.  Have junk yields been lower before?  No, we have eclipsed the time in 2013 when the junk market was in a yield frenzy, until Bernanke uttered the word “taper.”

There are a lot of desperate retirees seeking income, assuming it is free, and not merely a return of capital.  There are a lot of desperate people seeking certainty in investing and do not realize that dividends are a handmaiden of value, and not value itself.

There are a lot of desperate pension plans looking to make up for lost time, and hoping against hope, buying dividend paying and growth stocks, high-yield bonds, alternatives like hedge funds, private equity, etc., at the wrong time.

Those are the things you should buy when stocks are cheap and people are scared to death.  You sell them when people are confident, and valuations are high.

Valuations are high; not nosebleed high as in 2000, but high as in comparable to the peak in 2007.  Could things go higher?  Yes, but you are playing for pennies and risking dollars in the process.  Those with a value and quality discipline will likely fare better in the process, but markets are messy, and what actually happens will be a surprise.

Thus I would encourage you to consider the credit quality of your stocks and bonds.  What kind of shock could they withstand?  When yields are low, like they are now, the system is less resilient to credit crises.  Be aware, and be on your guard.


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.


On a Letter From A Younger Friend

Tuesday, April 29th, 2014

A younger friend of mine sent me an email asking for investment advice.  Here is the redacted version of it:


I’m not sure if you are aware of a blog called The guy who runs the blog retired in his late twenties just working a software development job. Granted, he was really fortunate to have graduated college and started his career in the dot-com bubble, but he didn’t have a really high-paying job by any means during that time. Anyways, his main strategy was saving 70-80% of his income and investing heavily into Vanguard index funds. He stopped contributing to his 401Ks early on and started putting the rest of his savings into taxable accounts with Vanguard (index funds) in order to retire early and withdraw his 4% from his portfolio every year for living expenses. I think it’s a pretty interesting blog and might be worth checking out if you had the time. I’d be really interested in your general thoughts about him and his blog and if you think he gives wise investing advice.

[Wife] and I both have IRAs ([Wife] has a traditional 401k and I have a Roth). [Wife] actively contributes to her 401k every paycheck and I think it has about $XX in it. I put the max contribution amount into my Roth every year, currently $XXXX, and it is at about $XX. I always hear it’s important to max out your tax deferred and tax free accounts before opening a taxable account. I think we’re at the point where I want to start investing in a taxable account. I like Vanguard and their low expense ratios and I know index funds outperform actively managed funds in the long-term.

 I was thinking about opening a vanguard taxable account and starting off small (5-6k) with my investments into VTSMX and VFWIX with a 50/50 split. Do you think this would be a wise move? I don’t want our money sitting in savings accounts and not even keeping up with inflation. I almost feel like it’s foolish not to invest as much as possible.

Anyways, looking forward to your response and thoughts on MMM and his blog.

Thanks Dave!

First, I want to commend you for making an effort to save and invest early.  Most people don’t do that, and it is a major reason why they never become financially secure.

Second, I want to thank you for introducing me to Mr. Money Mustache.  As one that has sported a full beard for the last 20+ years, I can appreciate the name.  He saved lots of money in his twenties, and invested it in stock index funds at Vanguard.  I am a Vanguard fan also, though I use them less often now, because my stockpicking has done well.

MMM reminds me of a more severe version of Dave Ramsey, minus the Christianity.  If you can deny yourself in the early years, work hard, keep expenses down, and build up a nest egg early, wow, do it.  Most people can’t do that.  You and your wife have already accumulated more than most have at similar ages.  Keep it up.  Having a bias against unnecessary spending is a good thing.  When my kids ask me why we don’t get new cars, I tell them that they run, and I will drive them until the cost of maintaining them is greater then the cost of buying and maintaining another car over the long run.

It is wise to avoid too much debt, and wise to pay it down early.  I have been debt-free for the past 11 years, including the mortgage.  Excluding the mortgage, 22 years.  It changes you, and frees you, because when you don’t have worries over paying debts, you don’t have the same degree of concern of are you going to run into financial trouble.

In inflation-adjusted terms, you are roughly as well-off as my wife and I were when we were your average age.  Good job, and keep it up.

Third, you are young, so investing 50/50 in US/Foreign Total equity index funds from Vanguard is fine, especially the Foreign part of it.  I say that because the US Stock Market is priced to deliver 5.5%/year returns for the next 10 years.  Foreign markets offer more return now.  When MMM was investing his savings the market was priced to earn 9-13% or so per year.

This brings up another point.  I don’t like earning nothing on my money, as it is with most banking and savings accounts, but sometimes that is the best option.  In September of 2000, the US stock market was priced to earn -2%/year returns for the next 10 years.  That was a time to throw stocks out the window.  I didn’t do that, and my value investing made money in 2000 and 2001, though I got whacked hard in 2002.

Not every moment in the market offers the same degree of opportunity to make money.  To the degree that you can, be ready to invest when markets have fallen, and things look bad.  If you want to be clever, after a severe fall invest after the S&P 500 is higher than its 200-day moving average.

But investing regularly to some degree immunizes market environments.  You will invest in good times and bad.  In the end, the discipline will benefit you.  You have saved, invested, and did not panic when things went bad.  You lived to prosper when things went good.

But, you might tilt your US assets to the US value index fund, and if Vanguard has a foreign value index fund, you might do that as well.  Value outperforms over the long haul, so do that if you can.  If small stock valuations weren’t so high now, I would tell you to look for small cap value, but I won’t, it doesn’t make sense now.

Fourth, yes, start the taxable brokerage account with your excess money.  I started mine at age 29, and the economic help it has been to me has been significant.  I would not have been able to start my business in 2010 if I had not done that.  Or survive the low earnings years 2008-2012.

Fifth, all that said, I have one more insight to add.  I’m sure that MMM enjoys his life and works, even though he is “retired.”  The Bible warns us about not wearing ourselves out to get rich, in Proverbs and Ecclesiastes.  Hey, it is nice to live off of a passive income, but the Lord made us to work six days, and rest on the seventh.  Work is an ordinary part of life even if you are managing your assets, and it is to be enjoyed.

What MMM suggests may be harder to bear than many people are capable of bearing.  We should appropriately enjoy life and not be misers.  The Larger Catechism in talking about the Eighth Commandment encourages us to enjoy what God has given us.  As we prosper, we should thank God for it, and enjoy it.

You have a wonderful wife, and that is reward enough.  But save and invest in good times and bad, and it will work out far better for you than those that don’t do so.

The Good ETF, Part 2 (sort of)

Friday, April 18th, 2014

About 4.5 years ago, I wrote a short piece called The Good ETF.  I’ll quote the summary:

Good ETFs are:

  • Small compared to the pool that they fish in
  • Follow broad themes
  • Do not rely on irreplicable assets
  • Storable, they do not require a “roll” or some replication strategy.
  • Not affected by unexpected credit events.
  • Liquid in terms of what they repesent, and liquid it what they hold.

The last one is a good summary.  There are many ETFs that are Closed-end funds in disguise.  An ETF with liquid assets, following a theme that many will want to follow will never disappear, and will have a price that tracks its NAV.

Though I said ETFs, I really meant ETPs, which included Exchange Traded Notes, and other structures.  I remain concerned that people get deluded by the idea that if it trades as a stock, it will behave like a stock, or a spot commodity, or an index.

What triggered this article was reading the following article: How a 56-Year-Old Engineer’s $45,000 Loss Spurred SEC Probe.  Quoting from the beginning of the article:

Jeff Steckbeck didn’t read the prospectus. He didn’t realize the price was inflated. He didn’t even know the security he read about online was something other than an exchange-traded fund.

The 56-year-old civil engineer ultimately lost $45,000 on the wrong end of a volatility bet, or about 80 percent of his investment, after a Credit Suisse Group AG (CSGN) note known as TVIX crashed a week after he bought it in March 2012 and never recovered. Now Steckbeck says he wishes he’d been aware of the perils of bank securities known as exchange-traded notes that use derivatives to mimic assets from natural gas to stocks.

“In theory, everybody’s supposed to read everything right to the bottom line and you take all the risks associated with it if you don’t,” he said this month by phone from Lebanon, Pennsylvania. “But in reality, you gotta trust that these people are operating within what they generally say, you know?”

No, you don’t have to trust people blindly.  Reagan said, “Trust, but verify.”  Anytime you enter into a contract, you need to know the major features of the contract, or have trusted expert advisers who do know, and assure you that things are fine.

After all, these are financial markets.  In any business deal, you may run into someone who offers you something that sounds attractive until you read the fine print.  You need to read the fine print.  Now, fraud can be alleged to those who actively dissuade people from reading the fine print, but not to those who offer the prospectus where all of the risks are disclosed.  Again, quoting from the article:

Some fail to adequately explain that banks can bet against the very notes they’re selling or suspend new offerings or take other actions that can affect their value, according to the letter.


“My experience with ETN prospectuses is that they’re very clear about the fees and the risks and the transparency,” Styrcula said. “Any investor who invests without reading the prospectus does so at his or her own peril, and that’s the way it should be.”


The offering documents for the VelocityShares Daily 2x VIX (VIX) Short Term ETN, the TVIX, says on the first page that the security is intended for “sophisticated investors.” The note “is likely to be close to zero after 20 years and we do not intend or expect any investor to hold the ETNs from inception to maturity,” according to the prospectus.

While Steckbeck said a supervisor at Clermont Wealth Strategies advised him against investing in TVIX in February 2012, he bought 4,000 shares the next month from his self-managed brokerage account. The adviser, whom Steckbeck declined to name, didn’t say that the price had become unmoored from the index it was supposed to track.

David Campbell, president of Clermont Wealth Strategies, declined to comment.

Steckbeck, who found the TVIX on the Yahoo Finance website, doesn’t have time to comb through dozens of pages every time he makes an investment, he said.

“Engineers — we’re not dumb,” said Steckbeck, who founded his own consulting company in 1990. “We’re good with math, good with numbers. We read and understand stuff fairly quickly, but we also have our jobs to perform. We can’t sit there and read prospectuses all day.”

If you are investing, you need to read prospectuses.  No ifs, ands, or buts.  I’m sorry, Mr. Steckbeck, you’re not dumb, but you are foolish.  Being bright with math and science is not enough for investing if you can’t be bothered to read the legal documents for the complex contract/security that you bought.  I read every prospectus for every security that I buy if it is unusual.  I read prospectuses and 10-Ks for many simple securities like stocks — the managements must “spill the beans” in the “risk factors” because if they don’t, and something bad happens that they didn’t talk about, they will be sued.

In general I am not a fan of a “liberal arts” education.  I am a fan of math and science.  But truly, I want both.  We homeschool, and our eight kids are “all arounds.”  They aren’t all smart, but they tend to be equal with verbal and quantitative reasoning.  Truly bright people are good with both math and language.  Final quotation from the article:

“The whole point of making these things exchange-traded was to make them accessible to retail investors,” said Colbrin Wright, assistant professor at Brigham Young University in Provo, Utah, who has written academic articles on the indicative values of ETNs. “The majority of ETNs are overpriced, and about a third of them are statistically significant in their overpricing.”

So, I contacted Colby Wright, and we had a short e-mail exchange, where he pointed me to the paper that he co-wrote.  Interesting paper, and it makes me want to do more research to see how great ETN prices can be versus their net asset values [NAVs].  That said, end of the paper errs when it concludes:

We assert that the frequent and persistent negative WDFDs [DM: NAV premiums] that appear to be driven by uninformed return chasing investors would not exist to the conspicuous degree that we observe if ETNs offered a more investor-driven and fluid system for share creation. We believe the system for share creation is ineffective in mitigating the asymmetric mispricing investigated in our study. Hence, we recommend that ETN issuers reformulate the share creation system related to their securities. Specifically, we recommend the ETN share creation process be structured to mirror that of ETFs. At a minimum, the share creation process should be initiated by investors, rather than by the ETN issuers themselves, as we believe profit-motivated investors will be more diligent and responsive in creating ETN shares when severe mispricing arises.

Here’s the problem: ETNs are debt, not equity.  To have the same share creation system means that the debtor must be willing to take on what could be an unlimited amount of debt.  In most cases, that doesn’t work.

So I come back to where I started.  Be skeptical of complexity in exchange traded products.  Avoid complexity.  Complexity works in favor of the one offering the deal, not the one accepting the deal.  I have only bought one structured note in my life, and that was one that I was allowed to structure.  As Buffett once said (something like this), “My terms, your price.”

To close, here are four valuable articles on this topic:

So avoid complexity in investing.  Do due diligence in all investing, and more when the investments are complex.  I am astounded at how much money has been lost in exchange traded investments that are designed to lose money over the long term.  You might be able to avoid it, but someone has to hold every “asset,” so losses will come to those who hold investments long term that were designed to last for a day.


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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