Category: Personal Finance

Improve the Position

Improve the Position

Posted on by David Merkel

It’s hard to take a loss.? But taking losses is necessary to avoid even larger losses.

This is prompted by Barry Ritholtz tweeting to me a piece he wrote 3 months ago called, Take The Loss.? Good piece, worth a read.

What I suggest to you today is that there is a better way to manage portfolios.? Ignore the cost basis — the price at which you bought it.? Instead, focus on improving the economic value of your portfolio.

It is hard, really, really hard to choose the best assets.? I? can’t do it. It is easier to choose assets that are better than the ones you currently own.

This assumes that you have a reasonable way of estimating the value of assets.? When I was a corporate bond manager, it was easy, because I had a large number of rules to help me estimate the proper yield tradeoffs, perhaps more than most managers had at the time.

  • Discount vs Par vs Premium bonds
  • Differing maturities
  • Special covenants
  • Deal size
  • Secured, senior unsecured, junior unsecured, trust preferred, preferred stock
  • Implied credit betas of different industries (take more/less risk when you want to)
  • Spread tradeoffs needed for capital requirements and likely default/capital losses
  • Holding company vs operating subsidiary
  • Public bond vs 144A vs private placement

There are probably more, but they aren’t coming to me now.? It is generally easier to estimate the tradeoffs with fixed cash flow streams with a maturity than unlimited life instruments where any cash flow back to you is uncertain.

Thus equities are squishier, where you have to compare valuation, industry trends, use of free cash flow, company quality, etc., to determine what is more valuable.? This is a much harder game, but one that can be played with discipline to good effects.

It is a lot easier to do swaps in equity portfolios than to to try to create the current optimal portfolio.? It is much easier to make comparative judgments (these are better) than absolute judgments (these are the best).

Other things equal, can you:

  • Improve the cheapness of your portfolio?
  • Improve the quality of your portfolio (unless you are in a period where leverage is expanding dramatically, and the opposite will pay off for a time)?? This applies both to balance sheet and accounting quality in earnings.
  • Improve your industry allocations?
  • Own management teams that use cash flow more effectively, and are more shareholder oriented?

Always trade for what is better, and ignore the price where you bought the assets.? It doesn’t matter what you paid; that is a historical artifact.? Trade for better securities regularly, subject to transaction costs and other limits.

 

On Penny Stocks (2)

On Penny Stocks (2)

Posted on by David Merkel

Yesterday, I received a pitch in the mail for a penny stock.? They should put a big red X over my address, but alas, they don’t.

Now for all of my prior penny stocks that I have been written about, all have done horribly.

Now we have AER Energy Resources [AERN] which has done horribly, and does not file financial statements, having “gone dark.”? From a research note on the web, this is what they said:

Please be advised that VictoryStocks.com has been paid $1,300,000 by Sanaz Trading Inc. to perform promotional and advertising services for a one month profile of AER Energy Ressources Inc. which services include the issuance of this release and the other opinions that we release concerning AERN ? VictoryStocks.com has not investigated the background of Sanaz Trading Inc. the hiring company. Anyone viewing this newsletter should assume the hiring party or , affiliates of the hiring party own shares of AERN of which they plan to liquidate, further understanding that the liquidation of those shares may or may not negatively impact the share price. VictoryStocks.com has received this amount as a production budget for advertising efforts and will retain amounts over and above the cost of production, copywriting services, mailing and other distribution expenses as a fee for our services. As such, our opinion is neither unbiased nor independent, and you should consider that when evaluating our statements regarding AERN. VictoryStocks.com is owned by: FreePennyAlerts, LLC, 40 East Main Street, Suite 572, Newark, Delaware 19711. Questions regarding this release may be sent to Editor @ VictoryStocks.com.

I only ran into that scam because I Googled Lone Star Gold [LSTG], and that popped up.? Lone Star Gold is a negative income negative net worth stock.? A promoter for Lone Star Gold snail mailed me, complete with handwriting and excess staples, but the horrid disclosure in teeny tiny type was this:

IMPORTANT NOTICE AND DISCLAIMER: This paid email advertisement by XXX (hereafter “XXX” does not purport to provide an analysis of any company’s financial position, operations, or prospects and this is not to be construed as a recommendation by XXX, or an offer to sell or solicitation to buy or sell any security. Lone Star Gold Corp. (hereafter “LSTG”), the company featured in this issue, appears as paid advertising. Mermaid Finance Ltd has paid $1,768,000 for the dissemination of this info to enhance public awareness for LSTG. Although the information contained in this advertisement is believed to be reliable, XXX makes no warranties as to the accuracy of any of the content herein and accepts no liability for how readers may choose to utilize it. The information contained herein is based exclusively on information generally available to the public and does not contain any material, non-public information. Readers should perform their own due-diligence before investing in any security including consulting with a qualified investment advisor or analyst. Readers should independently verify all statements made in this advertisement and perform extensive due-diligence on this or any other advertised company. YYY has received twenty thousand dollars for this and related marketing materials. YYY/XXX also expects to receive new subscriber revenue, the amount which is unknown at this time, as a result of this advertising effort. YYY and XXX nor any of their principals, officers, directors, partners, agents, or affiliates are not, nor do we represent ourselves to be, registered investment advisors, brokers, or dealers in securities. XXX is not offering securities for sale. An offer to buy or sell can be made only with accompanying disclosure documents and only in the states and provinces for which they are approved. Research and any due diligence was conducted by an outside researcher for this advertisement. More information can be received from LSTG’s website at www.lonestargold.com. Further, specific financial information, filings and disclosures as well as general investor information about publicly listed companies and other investor resources can be found at the Securities and Exchange Commission website at www.sec.gov and www.nasd.com. Any investment should be made only after consulting with a qualified investment advisor and only after reviewing the financial statements and other pertinent corporate information about the company. Many states have established rules requiring the approval of a security by a state security administrator. Check with www.nasaa.org or call your state security administrator to determine whether a particular security is licensed for sale in your state. This advertisement is not intended for readers in any jurisdiction where not permissible under local regulations and investors in those jurisdictions should disregard it. Investing in securities is highly speculative and carries a great deal of risk, which may result in investors losing all of their invested capital. Past performance does not guarantee future results. The information contained herein contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21 E of the Securities Exchange Act of 1934, including statements regarding expected continual growth of the featured company. Forward-looking statements are based upon expectations, estimates and projections at the time the statements are made and involve risks and uncertainties that could cause actual events to differ materially from those anticipated. Forward-looking statements may be identified through the use of words such as expects, will, anticipates, estimates, believes, or by statements indicating certain actions may, could, should, or might occur. Any statements that express or involve predictions, expectations, beliefs, plans, projections, objectives, goals or future events or performance may be forward-looking statements. In accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, the publisher notes that statements contained herein that look forward in time, which include other than historical information, involve risks and uncertainties that may affect the company’s actual results of operations. Factors that could cause actual results to differ include, but are not limited to, the size and growth of the market for the company’s products and services, regulatory approvals, the company’s ability to fund its capital requirements in the near term and the long term, pricing pressures and other risks detailed in the company’s reports filed with the Securities and Exchange Commission. XXX is a trademark of YYY. All other trademarks used in this publication are the property of their respective trademark holders. XXX is not affiliated, connected, or associated with, and are not sponsored, approved, or originated by, the trademark holders unless otherwise stated. No claim is made by XXX to any rights in any third-party trademarks.

Each promoter paid more than a million bucks.? Given the light level of trading in the stocks, and the low share price, the promoters were trying to do a significant pump-and-dump.? Personally, I think it would be really tough to squeeze over $1 million off of these tiny horrible companies, but maybe I don’t know the revenue model so well.

As I frequently say, “Don’t buy what someone want to sell to you.? Buy what you have researched, and what you think has value.”? Ignore penny stocks, with all of the ads that are on the web.? Short them if you dare.? These are horrible companies; any stock that has someone paid to promote it is a sell.? Sell, sell, sell!

This could not be simpler, so ignore the touts that promote penny stocks.? Short them if you dare, “the market can remain insane longer than you can remain solvent,” as Keynes said.

Penny stocks are for losers who dream of great gains.? They get the losses that they deserve.

Build the Buffer

Build the Buffer

Posted on by David Merkel

When young couples come to me and say, ?What should we do financially??one of the first things I say to them is something like, ?Build the buffer.?? You should have 3-6 months of expenses saved up.

I sometimes phrase it like this: use the stoplight rule.

  • Less than 3 months expenses in the savings fund? Red light. Defer all discretionary expenditures.
  • 3-6 months expenses in the savings fund? Yellow light. Some discretionary expenditures allowed, so long as you don?t dip back into the red light zone.
  • More than 6 months expenses in the savings fund? Green light. Discretionary expenditures allowed, so long as you don?t dip back into the red light zone.

For what it is worth, the same rule works well with congregational and other nonprofit budgets, for nonprofits without a significant endowment.? It balances mission needs, and donor giving.

But let?s take another look at the buffer, and why you might like to have it bigger.? Consumer finance charges really eat into the incomes of many people.? What if your buffer was so big that you could:

  1. Pay your insurance premiums in annual installments?
  2. Buy your next car without financing it?
  3. Pay off your credit card bills in full each month?
  4. Ask for a discount for cash when buying big ticket items?? (You?d be surprised.? I drove quite a deal with my orthodontist for my wife and eight kids. I?m the only one that hasn?t had braces.)
  5. End the escrow account on your mortgage?
  6. Pay tuition bills in full, rather than a payment plan?
  7. Take advantage of financial crises, and extend credit at tough times?? (I am still receiving 13% from a business associate that I lent money to in March of 2009, with warrants.)
  8. Retain cash in your corporation to reduce financing costs?
  9. Not worry about the minor disaster that recently hit?
  10. Raise your deductibles on your Auto, Home and Health insurance premiums to save money?
  11. Receive discounts on services that you want to receive, by getting a discount for buying years ahead?
  12. Fund your 401(k), IRA, HSA, whatever, to the fullest?
  13. And more?

Even when Fed policy is insane, the low rates do not apply to the masses, aside from GSE-supported lending.? In this environment, Fed policy starves liquidity in traditional lending to send it to the government, and related entities.

So, even though you can?t earn anything by saving, there is still the advantage of receiving a discount for full cash payment up front.? That doesn?t change, and because there are so many with bad finances, that discount is still valuable to businessmen who don?t want to deal with the costs of bad credit.

Now be wise.? When you use your liquidity to buy ahead, plan to replenish the buffer.? Don?t do everything at once; note the limitations of your liquidity, and act accordingly.

This is basic stuff, but I see many neglecting it.?? Incidentally, the same rules apply to small businesses.? Being well-capitalized has advantages.? Take advantage of vendor finance discounts where you can.? Seek discounts for prompt cash payment wherever it makes sense.

I?m not saying be a miser and hoard cash.? I am saying there is a happy middle ground where you have enough cash to meet most contingencies and normal needs, and use the remainder to further long term goals and whatever you enjoy.

PS ? I write this by the light of four candles as I continues to wait for power to be restored.? The candles illuminate my keyboard.? I will post this in the morning.

Book Review: The Era of Uncertainty

Book Review: The Era of Uncertainty

Posted on by David Merkel

 

Many fundamental investors have been shaped by Peter Lynch.? Invest from the bottom up.? Analyze companies, not the economy. Time spent on analyzing the economy is wasted time.

This book takes the opposite approach.? If you understand the economy, and think you know how GDP growth and inflation will go, you have a better chance of choosing the right industries and outperforming.

Like my methods of investing, he looks to understand where we are in the business cycle.? After that, look for good companies that exploit the tailwind.

I became familiar with the main author in the mid-2000s, when he worked for ISI Group.? I appreciated his approach to the markets, which was similar to mine, as the bubble grew, and he and I warned about it.

Think of it this way.? If you had been reading the main author in mid-2006, and had listened to him, how much better off would you be now?? Considerably better off and I offer many warnings over at RealMoney.com before the crisis emerged.

The book will help you understand the sectors and factors in the market that affect returns, and what elements lead those returns.

Beyond that the book expresses skepticism over many of the current economic policies of the US and other governments amid the overindebtedness of much of the world.

At the end, rather than saying, “This is what you should do,” the book asks what your views are, and says if you believe in “such and so” as an economic future, this is what you ought to do.

I liked the book a lot.? I think it is of value to most fundamental investors.

Quibbles

None

Who would benefit from this book: Most fundamental investors could benefit from this book.? If you want to, you can buy it here:?The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground.

Full disclosure: The publisher sent me a copy of the book for free.

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.

Take Prudent Risk

Take Prudent Risk

Posted on by David Merkel

This post is for average 401(k) investors.? I’m going to let you in on a secret that is not so secret, but does not get talked about much.? It’s a simple idea as well, and would be common sense, if sense were common.

401(k) investors tend not to change their allocations often, except to panic when things are going bad, or arrive late in bull market, and buy near the top.? In general, if you don’t have a lot of investment knowledge, it is good to come to a place where you “set it, and forget it.”? Remember, those with no experience are far more prone to the errors of fear and greed than most experts are.? Those arrive late to a rise or a fall in the market, and say, “Look what I have missed out on,” or ‘Look at how much I have lost,” are going to make the wrong move again and again.

There are temptations as an investor to not diversify.

  • “I’ll just hold all my assets in a money market fund.? I don’t want to lose anything.”? Money market funds preserve value at best.? They won’t help you build value.
  • “I’ll just hold all my assets in gold.? I don’t want to lose anything.”? Gold preserves value at best.? It won’t help you build value.
  • “This manager is the greatest.? I’m putting it all on him.”?? Sadly, managers have hot and cold streaks.? Many people join in near the end of hot streaks.? The quote I heard this from was a professional in 1999, deciding to invest all his money with Bill Miller.? Bad timing.
  • “Stocks win in the long run.? I am investing only in stocks.”? If you have a really long time horizon, and you are certain that your nation will not go through a revolution, or something close to it, that will work.? Otherwise, you are taking a risk.

There are more, but I think you get the point.? In most of life, those who do the best are the ones that take prudent risks.? Prudent risks are where the likely rewards outweighs the likely risks.

Think of it: in business, the guy who never takes risk does not do well.? The guy who takes huge risks blows up frequently, and does not do well on average.? The guy who takes moderate, prudent risks tends to do well.

The same is true of bond investing.? Those who invest in bonds of medium risk (BBB/Baa) tend to do best, those that play it safe or risk it all do less well.

The same is true of stock investing.? Stock investing is risky by nature, and in general, those who take less risk tend to earn better returns over time.? Ignore the canard: more risk, more return.? It ain’t so.

So what would I do if I were a 401(k) investor facing a limited menu of choices?

  • Put 60-70% in conservative, value-oriented stock funds. (US and Foreign)
  • And 25-35% in moderately risky bond funds. (US and Foreign)
  • And 5% in cash.
  • And rebalance yearly.? Do it after you complete your taxes, or something like that.

Avoid complexity.? Even if the plan offers a wide number of choices, winnow it down to a few funds, say five at most.? Over the long run, your investments should prosper, because you are doing things that few investors will do, and enjoy? returns from bearing risk successfully.

The Costs of Illiquidity — II

The Costs of Illiquidity — II

Posted on by David Merkel

I thought it was bad enough to try to dissuade people from buying life contingent cash flows.? Now I get to talk about Non-Traded REITs.

This is the first time I heard about them.? Doing a little digging, there is controversy around them.? But let’s talk about the benefits first:

  • You receive a high and steady income.
  • The stated value of your holdings remains stable, thus insulating investors from the chaos of the market.
  • Professional management of commercial real estate is now available to small investors, with high returns.

But then there are the limits:

  • Liquidation through the sponsor is limited.? (Dated, but gives you some idea…)
  • You likely can’t cash out in full except through illiquid secondary markets where you take quite a haircut.
  • If the underlying real estate does not do well, your income will shrink or disappear.
  • You have little data on how the underlying real estate is doing.? Is the dividend they are paying coming from income or return of capital?

Long-dated, illiquid assets exist for two reasons:

  1. To illustrate high yields to non-knowledgeable investors.
  2. To pay large commissions to those that sell them.

It’s hard to tell which of those are more important, but this is another reason why I continue to talk about illiquid investments, and why most people should avoid them.? It is much easier to cheat people when there is no liquid market available to validate what is happening with the investment.? It is not that Non-Traded REITs protect investors from volatility, as much as they hide volatility from investors.

Large commissions on investments are only possible when there is a lock-in where surrender charges pay off the commission.? Where there are large commissions, misguided investing is more likely.

Look, I could set up 10-year stock trusts.? I will tell you what I will invest in, but since you have no withdrawal rights, you’ll have to wait 10 years for liquidity.? That does not sound like a better investment than going to Vanguard.? But many don’t go to Vanguard because they will not do their homework.? Should we begrudge those who sell to the fools that will not do their own homework?

I wish that we could.? Hey, the SEC is going after them.? Why not?? It is a reply of the limited partnership era of the ’80s.? Illustrate high returns — deliver capital losses.? I could not get why my first boss bought his limited partnerships, because of the losses taken in the era.

It follows the paradigm for illiquid investments — Offer high yields, suck in money, pay high yields, and if things go bad, deliver large capital losses.

With publicly traded REITs low yields have returned better then high yields.? The attempt to generate high yields requires a strategy where everything must go right.? That doesn’t work.? The low yield strategy does work, because there is more flexibility to manage, and raise payouts only after strategies have succeeded.

It is the same for Non-Traded REITs.? They offer high yields after paying high commissions.? Those high yields rely on capital gains on the properties.?? Relying on capital gains is poison.

I will say it plainly: unless you are an expert who knows more than the seller, avoid buying illiquid investments.

Closing notes

There are many well-dressed people in this business.? But none discuss the scandal surrounding it.

This an example of those that prey upon small investors to get them to invest in non-traded REITs.

This is a growing area of investment, as people seek yield.

Pricing of Non-Traded REITs is controversial.

Here’s an example of a Non-Traded REIT that failed.

Look, my view is that that value of liquidity is usually underrated.? Liquid investments allow you to shift when opportunity favors such a move.? Whether you are ready for such a move is another matter, but whether you are ready to give up liquidity should require a similar degree of thinking.

I would not invest in Non-Traded REITs, the protections are lower than comparable investments.? Avoid illiquidity.

Cash Versus Valuations

Cash Versus Valuations

Posted on by David Merkel

From reading your blog, it isn’t clear whether you are a value investor or a valuation based investor. When you wrote that you would sell something only if you had a better opportunity, it sounds different from a traditional value investor (buy at a discount to fair value and sell when it approaches fair value, all assuming you can determine a fair value that the market is not properly recognizing). That is, perhaps you have x% in equities, split among a variety of holdings, and you are generally keeping an eye out for new opportunities, so that when a stock become really attractive, you will sell your least attractive (from a future returns perspective) holding in order to fund the new purchase.

Elsewhere, though, you wrote about the benefits of holding cash.

Perhaps you could write a post clarifying how these might relate. If you have cash, you don’t need to sell something (potentially good, or you wouldn’t have been holding it in the first place) in order to buy when a good opportunity comes along. When do you deploy cash (change the % of equity vs cash or bonds) rather than swapping equities? Or raise it? Do you have a macro view that governs when to increase/decrease your equity exposure? Or would you consider selling stock to “buy” cash (ultra short duration fixed income) as a “better investment opportunity”?

Are moves like this more selling driven (i.e. time to lighten up on equity, or this stock has gone up to a level of very low future returns)? Or are they buying driven (i.e. ABC is a great opportunity at this price, how should I pay for it? Cash or swapping out a position?)? Or is it just a complicated circumstance based mix?

Thanks for considering these issues.

ps I really appreciate the honesty and integrity you appear to bring both to your investing and your writing about investing.

pps Do you index at all? Or only hold individual securities?

This reader asks some interesting questions, and I want to give him some answers.

First, I am a value investor — I try to buy equities that have a margin of safety, with some potential for positive surprises.? I don’t buy securities where the balance sheet is weak.? But I have a more expansive view of value, because I am willing to buy into industries that have good growth prospects relative to their valuations.? In 2002, my biggest sector was technology.? Today, with big company technology so cheap, it is my third largest sector.

I do vary my stock holdings versus cash, but I limit my cash to 20% of my stock portfolio at maximum because I have been generally good at picking stocks over the years.? Cash is useful, but I try to vary it in proportion to valuations.

Take a look at my eight rules, they will tell you a lot.? One of my main ideas is that people aren’t good at making decisions when they have a big menu in front of them, but they are good at binary comparisons.? They can say, “This is better than that” with reasonable accuracy.

So most of the time, I do swap trades, trading things I like better for things I like less, much like a bond trader would.? When I am more bullish on the market, I add in an extra buy, and when I am bearish, I add in an extra sell.? But I stick with the essential idea of swap trades, because it forces the idea of the binary tradeoff.

That’s how I do it.? Now I wish it were working better for me over the last year, but I’m not worried because my methods have worked well for a long time.

PS — I never index.

Silent as Night

Silent as Night

Posted on by David Merkel

When I worked at a life insurer that was in the pension business, we would sometimes get asked to quote on business where termination of the existing plan would result in a surrender charge.? Now no plan sponsor would ever want to deliver a loss to participants — the effect on morale would be huge, so they would approach companies like ours and say something to the effect of, “If you pay our surrender charge off, we will invest with you.”

Not the happiest way to get business, but we reckoned that the fault was on the side of those that accepted the surrender charges in the first place.? We never did surrender charges on new business, but in order to get plan sponsors out of underperforming money managers, we would offer to pay off the surrender charge, at a price of a higher management fee plus a surrender charge.? We didn’t charge anything extra; we left our profit margin the same as with new clients.? We offered plan sponsors longer and shorter surrender charges, with correspondingly lower and higher annual fees.

As my friend Roy said, “We’re the good guys.? We’re out to save the world for 0.25% on assets plus postage and handling.”? But being “good guys” we helped hide the stupidities of plan sponsors, and to some degree, the cupidity of some mutual fund purveyors.

It also taught me a lesson.? When fees are deducted daily, no one notices.

You have read articles about how high mutual fund fees are, and you wonder why people buy them.? They buy them because they don’t look at the fees, and the fees get taken out quietly, night-by-night, imperceptibly.? They might also earn money from securities lending and soft dollar commission arrangements as well.? Their investors might reimburse some expenses also.

Now as for me, my business has just one source of revenue, my management fee as a percentage of assets.? I receive nothing else, and pay all expenses out of those fees.? It comes out once per quarter.? Savvy investors ask for direct billing, which I happily do, rather than deduction from the assets.

But it makes my cost to them very visible.? I am happy to live with that; I hope they are as well.

For those who use mutual funds, I suggest that you review the fees that you are paying. For those with 401(k) and similar plans, I suggest you look at the form 5500 documents behind your plan to see what you are implicitly paying.

Be aware.? In investments, charging through modest changes in the net asset value is the way most fees get siphoned off.? Big firms don’t like to talk about this, because it is their lifeblood.? You are your own best guardian, so review the fees of the firms that you entrust to invest your money.

Reparations

Reparations

Posted on by David Merkel

The current book I am reading is Lords of Finance: The Bankers Who Broke the World.? Great book, long book, and I am one-third through it.

Britain and France borrowed a lot of money from the US to fight WWI.? After the Allies won the war, they pushed the costs of the war onto the Germans, partly in an effort to defray their costs of repaying the US.? The Germans could not bear such a load, and it? led to renegotiations, hyperinflation, etc.

Germany needs to be thankful that eventually the victors gave up pressing their demands, and that after WWII, the Americans not only did not ask for Reparations, but sent the Marshall Plan to rebuild Europe.? Germany is not as merciful as America in the 1940-50s.

But Germany is not as generous toward the Euro-fringe as the the US was toward Germany.? Much as Greece and others cheated to get into the Eurozone, it is not as if intelligent people could not see the dodge.? The Eurozone was/is a political construct to unify Europe.

Now Germany and the rest of the core extends loans to the fringe at rates that they will not be able to pay back.? Now admittedly Greece has problems, but those are Greece’s problems.? If they are not willing to deal with abnormally early retirement, or tax evasion, that is their problem, and they should feel the effects of their idiocy.

But after reading the history of post-WWI Europe, I am less optimistic that imbalances can be easily addressed.? Better that Germany should support its banks, and let the fringe fail.? It would be the best solution for all involved, after all, currency unions have never worked without political union.

The analogy is not exact, but there is a lot of trouble trying to get other nations to go along when it means making capital outflows.? No one in the euro-fringe is ready to send any significant amount of capital abroad.

Personally, I expect this to end with a smaller Eurozone, minus the fringe.? Then the new Eurozone can fight over smaller issues.

My view is that the Eurozone will implode before China or the US implodes.? Personally, I think the US will be the last of the bunch — that’s? just the way of the US, DV.

My main point is to make clear that the instabilities of Europe need not affect the US much.? I invest money looking at the world as a whole, attempting to make money for clients.

 

The Costs of Illiquidity

The Costs of Illiquidity

Posted on by David Merkel

Liquidity is underrated.? What’s that, you say?? You are earning nothing on your slack cash balances?

Well, welcome to the club.? I am earning nothing there as well.? To earn money on short duration assets in this environment means taking risks, like Pimco does with its ETF with the ticker MINT.

Now, many will offer yield in an environment like this, but at a cost — a long surrender charge.? The long surrender charge hides the transfer of future yield to the present.

I am talking? about more than annuities here.? There are other illiquid investments being proffered today that offer a high “yield,” notably fixed payment streams from insurance companies that are life-contingent.

This is the deal:? There are some annuitants who would rather have a lump sum than a payment stream.? Some firms will buy the payment stream at a price attractive to them.? Then they try to sell the payment stream to an investor at a higher price, thus eliminating their risks on the annuitant prematurely dying.? But how good as an investor would you be at evaluating the risks?

  • You do realize that you aren’t buying a bond here — at the end you are not getting your principal back.? So what’s the yield? — it isn’t the annual payment divided by the purchase price because part of each payment is an uncertain partial return of principal.? Do you have your own actuarial consultant to calculate the yield, or are you blindly trusting the seller?
  • So you bought out the annuity of another person.? How certain are you that he will live a long time?? Why are you smarter than the seller regarding? his own life?
  • Unlike an annuity on your own life, the payment stream may end before or after you die — a classic asset/liability mismatch.
  • Is there any possibility that you will not get paid?? Is your contract illegal?? Have you retained your own counsel in the matter, or are you trusting the seller?
  • Do the IRS immediate annuity tax rules apply in this situation?
  • If you need cash, you will have a hard time selling this — one of the few potential buyers is the friendly guy that sold it to you.? The price spread between selling and buying is huge, and not in your favor.
  • You do realize that unlike an annuity on your own life, this is not judgment-proof.

There are all manner of illiquid investments offering yield, but almost all of them lock the investor up for a time.? Think of them as quirky Certificates of Deposit, minus the FDIC.? Particularly egregious are EIAs with long and high surrender charges.? (The agents are paid a lot to sell those.? Never trust an insurance agent who is receiving a large commission to sell you an annuity.? Note: if they won’t disclose the commission, know that it is roughly the size of the initial surrender charge.)

The Cost

Illiquidity means a loss of flexibility.? If your money is tied up during a fall in the market, you will not be able to take advantage of what could be a 30-50% return over one or two years when the market bounces back.? That is a lot to give up for a little bit of yield.? Personally, I prefer flexibility.

The costs of illiquidity are quiet.? The extra yield seems free until there is a need for ready cash, whether to spend or to take advantage of investment bargains.? Personally, I’ll take the loss of income, and keep the flexibility.

Also, avoid unusual investments that are hard to evaluate unless you have expertise greater than that of the seller.? Don’t buy what someone wants to sell you; buy what you have researched and want to buy.

PS — this is another reason why I encourage people avoid “sales loads” in investing.? Mentally, it ties your hands, because you want to recoup the load, or not incur the surrender fee.

 

Full disclosure: I have one client that owns MINT in his portfolio with me as a cash substitute.

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