As we were driving down the highway Monday evening, back from our oldest daughter’s symphony concert at U-MD, my wife and I began talking about teaching children about money.  We homeschool, so we have to consider a lot in training our children for the real world.

Some of my children have an interest in the market, some don’t. Personalities differ, but you want to give them some core knowledge that everyone can use. There have been people in our home school get-togethers who when they find out I am an investor, they ask “Do you know of any good books on the stock market for kids?” Lamely, I suggest the out-of-print book by Ken Fisher’s son, Clayton, which is pretty good, but I didn’t think it was definitive.  One has complained to me about the Stock Market Game, which seems to teach speculation, not investment.

That’s true of most stock market contests — the only exception I can think of was the Value Line contest back in 1984 . I managed to place in the top 1%, but not high enough to win. That contest forced you to pick 10 stocks from ten different groups for six months. The stocks were sorted by price volatility deciles, so you had to pick some volatile stocks and tame stocks. The stocks were equal weighted, and there was no trading. Great contest — I would love to run something like that. I have suggested it to The Street.com, but no dice. Hey, maybe Seeking Alpha would like to try it! Nominal prize money, but there would be bragging rights!  (Abnormal Returns, this could work for you as well…)

My wife tells me to think about it. Well, today, as I’m going through my personal e-mail, I run across a note from the Home School Legal Defense Association promoting the National Financial Literacy Challenge. Timely, I think. They are having a competition based off of the national standards published in 2007 by the Jump$tart Coalition for Personal Finance.

So I look at the standards, and I think, “These are pretty detailed… how can you turn this into a usable curriculum?”  I print them out and read a little bit of them to my wife Ruth, who says, “Typical for those that set standards, and aren’t teachers; you can’t work with that stuff.”  My wife was a high school teacher, and despite that hindrance, she still homeschools well.  But she knows the troubles that come to public school teachers as mandates come down from on high.

She asked me, “What would you recommend, then?”  I thought about it and said that the personal finance book that I reviewed recently, Easy Money, would be a good book for high school seniors to read.  It’s not a complex book at all.  Afterward I would discuss it with them.  She asked me why I hadn’t done that for our older two children and I said, “It was published after they went to college.  I’ll ask them to read it this summer.”

For investing, I still think that Buffett’s Annual Reports are understandable to most teens.  Marty Whitman is easy to read as well.  But I always liked Ben Graham, and I think The Intelligent Investor is accessible to the average teenager.  Good investing is not complex… but often we make it so.

Full disclosure: if you enter Amazon from my links and buy anything, I get a small commission.  It is my substitute for the tip jar, and it doesn’t increase your costs at all.

1) Liberty Mutual buys Safeco?  Pays 1.75x book, and 11x estimated earnings?  Mutual companies have limited access to the credit markets, and have no equity to pay with, so it is mainly a cash deal.  They must have had a lot of cash lying around — might we wonder why they might not have enhanced policyholder dividends instead?  This is not an economic use of capital in my opinion. Kudos to those who owned Safeco — it was cheap, though in the negative part of the underwriting cycle.

I know this diversifies Liberty Mutual geographically and from a line of business standpoint, but I don’t expect there are a lot of costs to take out here. Intellectually, it is harder to grow organically, but at this point in the underwriting cycle, it is definitely preferred to acquisitions.  There are no equity investors in Liberty Mutual, but I would not lend them money on a trust preferred or a surplus note at present.  There are better places to put money at interest — remember, acquirers usually underperform.

But for those with a RM subscription, check out Cramer.  Off of Safeco, he likes Chubb.  Okay, I like Chubb too.  Great company, and cheap.   I prefer Allstate, HCC, or Safety, and if I wanted to speculate, maybe Affirmative.  Lots of cheap P&C names out there, but it is the wrong side of the underwriting cycle — premiums falling, losses coming in unabated.

2) I don’t get fundamental weighting on bonds.  With bonds, the best one can do is get paid interest and principal, if one is buy-and-hold.  With stocks, a buy-and hold investor can do better in the long run by buying better earnings streams (value), rather than accepting market value weightings.  With bonds, there is no such upside, so I don’t get the fundamental weighting, except perhaps in foreign currency denominated bonds, and using purchasing power parity, which is still a weak tool.  I wouldn’t go there.

3) I don’t get Bill Miller.  I’m a value investor.  I like companies that trade at modest multiples of book and earnings.  I agree in principle with the concept of deferred performance that he mentioned in his quarterly letter:

My friend Jeremy Hosking, who has delivered around 400 basis points per year of excess return over two decades at Marathon (in London), corrected me recently when I spoke about our underperformance. “You mean, your deferred outperformance,” he said. I thought it a clever line, but it contains an important point. For investors who are trend followers, or theme driven, or who primarily build portfolios around forecasts, or who employ momentum strategies, price is dispositive. When they do badly, it is because prices moved in a direction different from what they thought. For value investors, price is one thing, and value is another. When prices move against us, it usually means that the gap between price and value is growing, and our future expected rates of return are higher.

With stable, cheap businesses, this definitely applies, but as you step out onto the growth spectrum, it no longer applies.  Check out the beginning of the letter, he is only 41 basis points ahead of the S&P 500 on a ten-year basis.  At this rate next year, he might be behind the S&P over ten years.  Quite a flameout for one who was so lionized.  Could he be fired?  Yes, but not by Chip Mason.  They are too close.  If one succeeds unconventionally, there is less tolerance for failure, because they weren’t sure why it worked in the first place.

4) I’ll take the opposite side of this trade.  Financial literacy is a good thing, and most people would be better off knowing more about finances, so long as they can mix it with humility.  I’m a professional, and I think humility is a key virtue in handling money.  As I say in my disclaimer:

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, or in my writings at RealMoney 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.

People who are educated will still make mistakes with their money, but they will make fewer mistakes on net.  Hey, I’ve paid market tuition, and it is painful.  But boy, I learned a lot, and I don’t repeat mistakes often.  (Repeating mistakes sometimes is bad enough… )

Full disclosure: long SAFT (not SAF)

I’m an actuary, but not a Pension Actuary. I don’t understand the minutiae of pension law; I only know the basics. Where I have more punch than most pension actuaries is that I understand the investing side of pensions, whereas for most of them, they depend on others to give them assumptions for investment earnings. I’ve written on pension issues off and on for 15 years or so. I remember my first article in 1992, where I suggested that the graying of the Baby Boomers would lead to the termination of most DB plans.

I am here to recommend to you the book Pension Dumping. It is a very good summary of how we got into the mess we in today with respect to Defined Benefit [DB] pension plans. Now, much of the rest of this review will quibble with some aspects of the book, but that does not change my view that for those interested in the topic, and aren’t experts now, they will learn a lot from the book. The author, Fran Hawthorne, has crammed a lot of useful information into 210 pages.

The Balancing Act

One of the things that the book gets right is the difficulty in setting pension regulations and laws. In hindsight, it might have been a good idea to give pensioners a higher priority claim in the bankruptcy pecking order. But if that had been done, many companies might have terminated their plans then and there, because of the higher yields demanded from lenders who would have been subordinated.

She also covers the debate on the “equity premium” versus immunization well. Yes, it is less risky to immunize – i.e., buy bonds to match the payout stream. Trouble is, it costs a lot more in the short run. With equities, you can assume that you will earn a lot more.

She also notes how many companies were deliberately too generous with pension benefits, because they did not have to pay for them all at once. Instead, they could put up a little today, and try to catch up tomorrow.

Things Missed

• · Individuals aren’t good at managing their own money. Even if a participant-directed 401(k) plan is cheaper than a DB plan in terms of plan sponsor outlay, the average person tends to panic at market bottoms and get greedy at market tops. DB plans and trustee-directed DC plans are a much better option for most people. That said, most people prize the illusion of control, and will not choose what is best for them.
• · Technological progress was probably a bigger factor in doing in the steel industry, and other unionized industries, than foreign competition. Nucor and its imitators did more damage to the traditional steel industry than did foreign competition. With commodity products, low price wins, and Nucor lowered the costs of creating steel significantly.
• · In the analysis of what industries could face pension problems next, she did not consider banks and other financial institutions. Most of those DB plans are very well-funded. Why? They understand the compound interest math, and the variability of the markets. But what if the current market stress led to financial firms cutting back on their plan contributions?
• · She gets to municipal pensions at the end, and spends a little time there, but those face bigger funding gaps than most private plans. Also, she could have spent more time on Multiple Employer Trusts, where funding issues are also tough, and plan sponsor failures leave the surviving plan sponsors worse off.
• · She also thinks that if you stretch out the period of time that companies can contribute in order to fund deficits, it will make things better. In the short run, that might be true, but in the intermediate term, companies that are given more flexibility tend to get further behind in funding DB pensions.
• The book could have spent more time on changes in investing within DB pension plans, which are drifting away from equities slowly but surely, in favor of less liquid investments in private equity and hedge funds. How that bet will end is anyone’s guess, but pension investors at least have a long time horizon, and can afford the illiquidity. My question would be whether they can fairly evaluate the skill of the managers.

Summary

This book describes the motives of all of the parties in DB pension issues very well, and why they tend to lead to DB plan terminations. There are possible solutions recommended at the end, but in my judgment they might save some plans that are marginal, but not those that are sick. If you are interested in the topic of pensions, buy the book, and if you buy it through the links above, I get a small commission. (If you buy anything through Amazon after entering from a link on my site, I get a small commission. That’s my tip jar, and it doesn’t raise your costs at all.)

As I sit here, my taxes are done, all except for one K-1 that is very late, to put it mildly.  My taxes are complex, but my rule is that I do my own taxes.  If I can’t figure out the code, then I am probably doing something that I don’t understand the full economics behind it, and I should avoid it as a result.  Besides, it keeps me up with trends in the tax code that I might not truly grasp.  Surprises this year included the form for HSAs, and a credit  for promoting domestic production.  I also learned some of the intricacies in accounting for the sale of S corporation stock.  Not fun, but I learned something, and that is good.

It does motivate me to write a piece on tax reform, though.  I don’t fit neatly on the political spectrum: I’m a libertarian on economics, and a conservative on social policy (though conservative really isn’t the right word). Tax reform means different things to different people; let’s consider what it means to conservatives and liberals.

What does tax reform mean to conservatives?

• Eliminate the estate tax
• Eliminate the double taxation of dividends
• Eliminate the marriage penalty (actually should be a goal of liberals, and not conservatives, but hey…)
• Flatten the tax rate structure
• Preferentially tax income classes that aid in capital formation
• More taxation at the state level, less at the federal level
• Carve out exceptions for political allies that support your broad agenda

What does tax reform mean to liberals?

• Roll back the Bush tax cuts
• Keep the estate tax
• Increase the progressivity of tax rates
• More taxation at the federal level, less at the state level
• Preferentially tax wage income at lower rates
• Carve out exceptions for political allies that support your broad agenda

To me, both of them miss a dimension of the problem.  The main problem is how we define income, not the rate at which we tax income.  Both liberals and conservatives support areas in the tax code that allow for deferral of taxation.  To me, that is a core problem in the tax code.  Taxation should be roughly proportionate to the good that a taxpayer is deriving from society.  As a proxy for that, it should be proportional to his increase in net worth, whether the increase in net worth is liquid or not.

I will use Warren Buffett as my example.  Because he rarely sells stock, his taxes are deferred both personally, and at Berkshire Hathaway.  His net worth keeps going up, and the Treasury doesn’t get a piece of it.  Then he has the nerve to show up on Capitol Hill in favor of the estate tax, a tax of which his estate will pay little, because he has given most of it away.

My view is that people should be taxed like traders, on the increase in their net worth, at the same rate, regardless of where the income comes from.  Taxes would be paid on a mark-to-market basis.  There would be no more tax deferral IRAs or 401(k)s, and even pension earnings would get taxed inside DB plans.  Life insurance and annuities would lose their tax breaks.  Even charitable endowments would be taxed.  Private equity would get taxed off of “phantom income” at a 15% compounded rate, i.e., a private equity fund with $100 million in equity would have to pay taxes on $15 million of phantom income, at the fund if 15% distributions are not made to shareholders.  Truing up would occur at the dissolution of the fund.

Another key component here would be that there would be no separate tax accounting basis — the IRS would use GAAP.  What you report, is what you get taxed on, with the exception that firms that are heavily indebted to avoid paying taxes would get taxed on phantom income, the same as private equity.  Also, all like-kind exchanges would be taxed.  Even real estate would follow the property assessor, and income taxation would occur on the increase.

Then eliminate all deductions, conservative and liberal ones, and you have a tax code that can operate at a low rate because the entire increase of wealth in the economy is being taxed, without exceptions.  Oh, and since the income has been taxed all of the way up, the estate tax is no longer needed.  It was needed when wealthy people could shelter their increasing net worth from taxation.

Objections to this Outlandish Proposal

• Would you really allow investment losses to reduce someone’s income to zero, or below?  Yes, though there would have to be some safeguards against people who disguise their hobbies to be businesses.
• This will kill investment; the economy won’t grow without tax deferral!  Nonsense.  Most tax deferral incentives don’t change the amount of investment, but just the forms that the investments go into.
• Without tax deferral, people won’t buy life insurance, annuities, and corporations won’t provide pensions.  To some degree, yes, but after the shock wears off people will invest for maximum advantage again, and with an eye toward what is best, not what is tax-favored.  With my proposal, I don’t care if people have pensions or savings.  It’s all the same.  Life insurance and annuities will be bought for risk reduction reasons, not tax reasons.
• This will kill private equity!  It won’t.  It may shrink it a little, but there are many advantage to private equity aside from deferral of taxation.
• But phantom income will require illiquid investments to retain liquidity for taxes, or require equity holders to fund taxes.  Guilty as  charged.  It changes the business model to that degree.
• This discriminates against the poor in favor of the rich.  No, it discriminates against the clever rich, who shield the increase in their net worth from taxation.  Taxes delayed often become taxes avoided in entire.  Poor people should pay some taxes.  They benefit from society a little, and taxes would give them greater interest in voting.
• If there’s no deduction/credit for JKL, then JKL will disappear.  Good, or, maybe I should say, yes, there will be a decrease, but if it is valuable, it will find its own level.
• This proposal is incomplete!  You haven’t considered a lot of other areas.  No doubt; there would be a lot to do here, should it ever see the light of day.  Let John McCain be a real straight-talking maverick, and adopt a proposal like this.  He could be a real conservative, while offending all of the “conservatives.”

I harbor no illusions here.  We have the tax code that we deserve.  Don’t blame the IRS.  Don’t blame the President or Congress.  Blame those who elected them, and those who failed to vote.  The politicians offer us favors from our own money, and we thank them for it, by re-electing them.  I know that my views of tax reform will never be enacted because it steps on too many feet.  Can you imagine how many accountants, attorneys and actuaries would be unemployed by this?  If they fought hard against TRA ‘86, just imagine how they would fight against this.  The politicians like fostering the illusion that they create our prosperity, when in reality, they take a share of it.  A proposal like this, that makes taxation more immediate, and more transparent, would make people more concerned about where their taxes go, because they would feel it more acutely.

And then, after all of this, we should move election day to April 15th.  Let the voters feel acutely what the politicians have decided for raising revenue, and they will render a better verdict.

I received this in the mail on Saturday:

ABC logo

March 31, 2008

Dear Investor,

I am writing to tell you that my firm is in very good financial condition. Normal market conditions would not require this correspondence. But I understand that many people are deeply concerned about the stability of their brokers at this time.

I have always tried to earn my clients’ trust by running the firm conservatively, with clients’ interests in mind. Today, 75% of the Company’s assets are in cash or cash equivalents and we have no debt. In addition, we have no investments in collateralized debt obligations or similar instruments. As a matter of policy, we do not carry positions or make markets.

Throughout the years, in making decisions about my business, I have always put the safety of my clients’ assets first. This is one of the primary reasons my firm clears on a fully disclosed basis through DEF LLC (DEF), a GHI company. DEF clears our clients’ trades and is in custody of their accounts. Their name appears with ours on monthly statements and confirmations. As of December 31, 2007, DEF had net capital in excess of $2.1 billion which exceeded its minimum net capital requirement by more than $1.9 billion.

In addition, when you do business at ABC, your account receives coverage from the Securities Investment Protection Corp. (SIPC) as primary protection for up to $500,000, including a limitation of $100,000 for cash. SIPC coverage is required of all registered broker-dealers. Since most “cash equivalent” money market mutual funds are considered securities under SIPC, investments in money market mutual funds held in a brokerage account are protected by SIPC along with your other securities to a maximum of $500,000. Of course, there is no protection that will cover you for a decline in the market value of your securities. You may visit www.sipc.org to learn more about SIPC protection.

Furthermore, DEF has arranged for additional protection for cash and covered securities to supplement its SIPC coverage. This additional protection is provided under a surety bond issued by the Customer Asset Protection Company (CAPCO), a licensed Vermont insurer with an A+ financial strength rating from Standard and Poor’s. DEF’s excess-SIPC protection covers total account net equity for cash and securities in excess of the amounts covered by SIPC, for accounts of broker-dealers which clear through DEF. There is no specific dollar limit to the protection that CAPCO provides on customer accounts held at DEF. This provides ABC clients the highest level of account protection available in the brokerage industry to the total net equity with no limit for the amount of cash or securities. And, unlike many other brokers, there is no “cap” on the aggregate amount of coverage for all of our customers’ assets. You may access a CAPCO brochure about “Total Net’ Equity Protection” at ABC.com [deleted]….

If you are concerned about the status of your assets at another brokerage firm, you might consider moving them to ABC. It is easy to transfer assets. If you have friends who are concerned about their brokers, you might consider referring them to us. We continue to offer free trades for asset transfer and referrals. If you have questions about anything in this letter, please feel free to call us at 800-xxx-xxxx from 7:30 a.m. –7:30 p.m. ET, Monday-Friday. Once again, thank you for your trust and your loyalty.

Sincerely,

President and Chief Executive Officer of ABC

I used to do business with ABC, and I presently do business with GHI. Both of them are good firms, doing business on a fair basis for their clients. To me, it is interesting to use financial strength as a marketing tool.

On another level, how many people actually check the solvency of their brokers before doing business with them? On a retail level very few, if any. On an institutional level, that’s a normal check for sophisticated investors.

That said, I would be surprised to see any major retail brokers go insolvent aside from those with significant investment banking exposure. Even there, accounts are segregated, and client cash typically has the option of being in a money market fund.

This is not something that I worry about in investing, but if I were worried about my broker, I would make sure that my liquid assets over $100,000 were in a non-commingled vehicle, most likely a money market fund.

What of Excess Insurance?

Now, I will add just one more note in closing. CAPCO is a nice idea, but I am always skeptical of small-ish insurers backing large liabilities with a remote possibility of incidence. There aren’t that many AAA reinsurers out there, and I am guessing that Berky is not one of them. Buffett does not like to reinsure financial risks, aside from municipal debt. That leaves the AAA financial guarantors — Ambac, MBIA, Assured Guaranty, and FSA (though I am open to a surprise here). I’m guessing it’s the first two, and not the last two. CAPCO is owned by many of the major brokers, but in a crisis, CAPCO has no recourse to its owners, but only to its reinsurers, should that coverage be triggered. The recent financial troubles have led S&P to place CAPCO on negative outlook, mainly because:

Standard & Poor’s assigns a negative outlook when we believe the probability of a downgrade within the next two years is at least 30%. The revised outlook reflects the challenging environment for broker/dealers and their parents. Deterioration in their credit quality and risk-management capabilities could affect CAPCO’s financial strength. In the past couple of months, Standard & Poor’s has revised the outlook on several of CAPCO’s members’ parents to negative. Also, the ratings on a couple of members are on CreditWatch with negative implications, which means there’s the potential for a more imminent downgrade. The capital of CAPCO’s members and–in some cases–their parents is an important resource for mitigating CAPCO’s potential payments for its excess SIPC (Securities Investors Protection Corp.) coverage.

It would be interesting to know for certain the underwriters and terms of CAPCO’s reinsurance. I’m not losing any sleep over it, though… there are bigger things to worry about, my personal broker is well-capitalized, and I have less than $100K at risk in cash, and that is in a money market fund. So long as accounts remain segregated, risks are small.

1) Note to small investors seeking income: when someone friendly from Wall Street shows up with an income vehicle, keep your hand on your wallet.  One of the oldest tricks in the game is to offer a high current yield, where the yield can get curtailed through early prepayment (typically in low interest rate environments), or some negative event that forces the security to change its form, such as when a stock price falls with reverse convertibles.  Wall Street only gives you a high yield when they possess an option that you have sold them that enables them to give you the short end of the stick when the markets get ugly.

2) When times get tough, the tough resort to legal action.  Financial Guarantee Insurance contracts are complicated, and the guarantors will do anything they can to wriggle off the hook, particularly when the losses will be stiff.

3)  The loss of confidence in financial guarantors has not changed the operations of many muni bond funds much.  With less trustworthy AAA paper around, many muni managers have decided that holding AA and single-A rated muni bonds isn’t so bad after all.  Less business for the surviving guarantors, it would seem.

4) Jefferson County, Alabama.  Too smart for their own good.   So long as auction rate securities continued to reprice at low rates, they maintained low “fixed” funding costs from their swapped auction rate securities.  But when the auctions failed, the whole thing blew up.  There will probably be a restructuring here, and not a bankruptcy, but this is just another argument for simplicity in investment matters.  Complexity can hide significant problems.

5) Spreads were wide one week ago, even among European government bonds, and last week, as these two posts from Accrued Interest point out,  we had a significant rally in spread terms last week.  Now, credit can be whippy during times of stress, and there are often many false V-like bottoms, before the real bottom arrives.  Be selective in where you lend, and if the sharp rally persists for another few weeks, I would lighten up.  That said, an investor buying and holding would see spreads as attractive here.  When spreads are so far above actuarial default rates, it is usually a good time to buy.  I would not commit my full credit allocation here, but half of full at present.

6)  I don’t fear ratings changes, if that is the only thing going on, and there is no incremental credit degradation, or increased capital requirements.  But many investors don’t think that way, and have investment guidelines that can force sales off of downgrades that are severe enough.  Personally, I think Fitch is best served being as accurate as possible here; they don’t have as large of a base to defend, as do S&P and Moody’s.  So, if downgrades are warranted, do them, and then make the other rating agencies justify their views.

7) I have not been a fan of the ABX indices, and I thought it was good that an ABX index for auto ABS did not come into existence.

So what is a auction rate security worth if it is failing?  Par?  I guess it depends on how high the coupon can rise, and the debtor’s ability to pay.  It was quite a statement when UBS began reducing the prices on some auction rate securities.  Personally, I think they did the right thing, but I understand why many were angry.  A complex pseudo-cash security is not the same thing as owning short-term high-quality debt.

9) Then again, there are difficulties for the issuers as well, particularly in student loans.  Not only are costs increased, but it is hard to get new deals done.

10)  GM just can’t seem to shake Delphi.  In an environment like this, where liquidity is scarce, marginal deals blow apart with ease, and even good deals have a difficult time getting done.

11)  Regular readers know that I am not a fan of most complex risk control models that rely on market prices as inputs. My view is that risk managers should examine the likely cash flows from an asset, together with the likelihood of the payoff happening.  With respect to bank risk models, they were too credulous about benefits of diversification, as well as what happens when everyone uses the same model.  Good businessmen of all stripes focus on not losing money on any transaction; every transaction should stand on its own, with diversification as an enhancer in the process.

1) A lament for Bill Miller.  Owning Bear Stearns on top of it all is adding insult to injury.  Now, living in Baltimore, I get little bits of gossip, but I won’t go there this evening.  I think Bill Miller’s problems boil down to lack of focus on a margin of safety, which is the main key to being a good value manager.  During the boom periods, he could ignore that and get away with it, but when we are in a bust phase, particularly one that hurts financials.  When financials get hit, all forms of accounting laxity tend to get hit, making the margin of safety more precious.

2) Now perhaps one bright spot here is rising short interest. Short interest is a negative while it is going up, but a positive once it has risen to unsustainable levels.  What is unsustainable is difficult to define, but remember Ben Graham’s dictum, that the market is a voting machine in the short run, and a weighing machine in the long run.  The value of stocks in the long run will reflect the net present value of their free cash flows, not short interest or leverage.

3)  Now, if you want the opposite of Bill Miller in the value space, consider Bob Rodriguez of FPA Capital.  Along with a cadre of other misfit value managers that are willing to invest in unusual long-only portfolios aiming for absolute returns while not falling victim to the long/short hedge fund illusion, he happily soldiers on with a boatload of cash, waiting for attractive opportunities to deploy cash.

4) Retirement.  What a concept amid falling housing and equity prices.  Though we have difficulties at present from the housing overhang, and the unwind of financial leverage, there will be continuing difficulties over the next two decades as assets must be liquidated and taxes raised to support the promises of Medicare, and to a lesser extent, Social Security.  My guess: Medicare gets massively scaled back.

5) I get criticism from both bulls and bears.  I try to be unbiased in my observations, because amid the difficulties, which I have have been writing about for years, there is the possibility that it gets worked out.  When there are problems, major economic actors are not passive; they look for solutions.  That doesn’t mean that they always succeed, but they often do, so it rarely pays to be too bearish.  It also rarely pays to be too bullish, but given the Triumph of the Optimists, that is a harder case to make.

6) Bill Rempel took me to task about a post of mine, and I have a small defense there, and perhaps a larger point.  Almost none of my close friends invest in the market. It doesn’t matter whether we are in boom or bust periods, they just don’t.  These people are by nature highly conservative, and/or, they are not well enough off to be considering investments in equities.  They are not relevant to a post on investing contrarianism, because they are outside the scope of most equity investing.  They are relevant to a discussion of the real economy, and where your wage income might be impacted.

7) To close for the night, then, a note on contrarianism.  When I read journalists, they are typically (but not always) lagging indicators, because they aren’t focused on the topics at hand. They get to the problems late.  But when I think of contrarianism, I don’t look for opinions as much as financial reliance on an idea.  Many opinions are irrelevant, because they don’t reflect positions that have been taken in the markets, the success of which is now being relied upon.  Once there is money on the line, euphoria and regret can do their work in shaping the attitudes of investors, allowing for contrary opinions to be successful against fully invested conventional wisdom.  But without fully invested conventional wisdom, contrarianism has little to fight.

I’ve written about “the lost decade” before at RealMoney.  A lost decade is where  the stock market goes nowhere, or loses money for ten years.  My purpose in doing so was to point out:

• That it is normal for lost decades to occur.  Stock returns are weakly autocorrelated.  Good years tend to be followed by good years, and bad years by bad years.
• Once a generation, you have to get a severe boom and a severe bust.  It is partly driven by monetary policy/financial regulation laxity, followed by tightness.  It is partly driven by the fear/greed cycle, because most people, even professional investors, chase performance.
• This has a chilling effect on retirement planning.  Recall my recent article on longevity risk.  In that article, I tried to point out the similarities for retirement investment planning between Defined Benefit plans, and an individual with his own unique retirement circumstances, typically with defined contribution plans.

I’ll amplify the last point, because the WSJ doesn’t do much with it.  Nothing kills a DB plan’s funding level worse then a protracted flat/falling equity market, and low bond yields (showing not much alternative for reinvestment).  Same for an individual financial plan.  If a DB plan has an assumed earnings yield of 8%, and the stock market earns zero, and bonds earn 5%, with 60/40 stocks/bonds, than plan earns 2% when it needs 8%.  The funding deficits grow rapidly, and corporations finally bite the bullet, and begin making contributions to their DB plan, cutting earnings in the process.

As for individuals, they should start to save more for their retirements after such a long bad market, in order to get their retirement funding back on track.  Oops, wait.  This is America.  We don’t save personally (particularly Baby Boomers), and our governments run deficits (even more on an accrual basis when we look at Medicare, Social Security, and other long-term inadequately funded programs.  Only our corporations save on net.

So, what to do?

• Save more.
•  Don’t materially increase or decrease allocations to stocks.  Things may be rough for a while longer, until excesses in the US financial system and in China are worked out, but positive returns will recur.
• Avoid investing in companies with large pension funding deficits.
• Avoid investments with high embedded leverage, whether individual companies, or ETFs.
• Be wary of investing in esoteric asset classes this late in the performance cycle.  They may do well for a while longer, but their time is running out.  (It could be one year or another decade.)
• Be ready for increasing inflation.  Even with the income giveup, it is probably wise to have bond durations shorter than the benchmark.
• To the extent you can, push back retirement, or plan that you will do it in phases, where you slowly leave the formal labor force.

Of course, you could be a good stock picker, but that’s not a common gift.  The choices are hard when we have a “lost decade.”  There’s no silver bullet; only ways to mitigate the pain.

Most of my friends don’t follow the economy or the markets that closely, so it has been interesting for a number of them to ask me recently, “Should I be worried about the economy?”  The answer isn’t a simple one.

Part of the answer depends on your line of work.  Stuff that’s economically necessary (utilities, staples, government, common services) will probably do okay, though there will be some slackening of demand at the edges.  For example, I visited  a hair salon recently, and asked how business was.  The answer was that customer numbers were unchanged, but that the average purchase level had dropped.  Even government positions, stable as they are will experience some pressure, because budgets have to balance, and tax revenues are starting to sag a bit.

Now if you work in an export-oriented sector, with the dollar down, you will probably do okay.  Demand for food, energy, raw materials, industrial goods, and some technologies will continue relatively strong.

But institutions that rely on credit risk, whether borrowing or lending, will have it tough.  During the boom phase, more and more bodies get added to service the cash flow.  At his point, bodies are coming out of banking, investment banking, real estate, homebuilding, etc.

You can also ask how well capitalized and profitable your current firm is.  This is not a time that rewards high degrees of leverage and short-term financing (unless you are very well capitalized). Volatility rewards firms that have excess capital; it is worth more when times are panicky.

Another part of the answer is how dependent you are on the need for continued external financing.  Can you meet all of your obligations, with some room for error over the next two years?  Do you have excess assets to aid you if you have a sudden crisis?

Finally, if you have investments, look them over.  Examine what investments are sensitive to worsening credit problems, and remove weakly financed companies from your portfolio.  You should have some investments that are inflation-sensitive, like stock in industries that have pricing power (precious few ), cash, TIPS, and foreign-currency demoninated bonds.  Now, carefully selected muni, mortgage and corporate bonds have value here, though don’t put on a full position at present.

In summary, it depends on your personal financial position, the firm and industry that you serve, and how much you have prepared to weather bad times in investing.  It’s not a pretty time as the leverage unwinds, but if you planned in advance for the possibility of trouble, then you should do adequately.

For most of my readers, this book may prove to be too basic, but we all have friends that are not “money people.” They don’t know how to take care of their finances, and they constantly get into money troubles. This book could be of help to them.

Now, as you can see from the picture, you can see that she refers to herself as, “The Internet’s #1 Personal Finance Expert.” I can’t vouch for that. I like to think that I am aware of a wide number of trends in investing and money management, and this was the first time I heard of her.

There were five main things that appealed to me about this book. First, it’s not a long book (173 pages in the main body of text), and it is simply written, so an average person not good with finances could make his way through it. Second, even though small, it is pretty comprehensive for the finances of an average person or family. Third, I think she gets most issues right for average people who have relatively simple financial problems. Fourth, it provides advice on where to get more data, without marketing herself directly. Fifth, it summarizes action points for each area of personal finance.

I do write about personal finance a little, but you will never get the detailed advice on cash management, budgeting, personal credit, hiring advisors, and shopping smart from me that you will get from this book. My contribution is a more savvy view of investing and insurance. On the latter topic, insurance, I thought she covered the bases well. (As an aside, she shares my bias against variable annuities.)

Now, was there anything that I wasn’t crazy about? I know she wrote a book on the topic, but I think it would have been worthwhile to briefly explain why keeping a high credit rating in this age is so important, because of the effect that it has on insurance premiums, and even employment, leaving aside how much you will pay in interest, and how onerous lenders and creditors will be with you if you ever make a mistake.

Now on investing topics, the book is good but not great. For the average person that doesn’t matter. For those wanting to take a step up, I would recommend The Dick Davis Dividend. She focuses on saving enough (most people don’t save enough), and asset allocation through passive investments. She is a little too bullish on real estate for my tastes. Someone following her advice in these areas will do better than most, if they have the discipline to avoid panic and greed.

But, leaving those quibbles aside, this is a solid book, and those following its advice will benefit.

Full disclosure: If you buy through Amazon.com on any of the books that I review through links on my site, I get a very modest commission.