More books; more futures?

I’ve been reading a new book “Ahead of the Curve” by Philip D Broughton. This is fun for me because it gets me back into the habit of reading at least 2 books at a time. This allows me to continue with whichever I’m in the mood for when I next start reading.

“Ahead of the Curve” is the story of Broughton’s stint at Harvard Business School. So far so good. I’ll be reading it and Snowball interchangeably for a while.

I’ve been pondering a couple things. I’ve wanted to obtain a Master’s in Financial Engineering and/or Risk Management for a few years now. I’ve been resisting the MBA (not to be confused with the NBA :). Now, at least today, I’m wondering if obtaining an MBA wouldn’t be so bad.

On another note, I almost signed up for an futures account.  The legalese scared me away from completing the application.  I’m interested in having the ability to trade SPY futures.  I’ve spent time exploring the use of options to hedge my exposure to SPY (and, indirectly, VTI) as well as gain income from covered SPY call writing.   The idea of incorporating  futures into the mix is appealing to me.

I am someone who prefers to learn by doing.   Here are some of my concerns…

  1. Hitting the wrong button and entering a futures position I did not want to be in.
  2. Misunderstanding a particular futures commitment (100 shares or 200 shares?).
  3. Being responsible for liabilities in excess of the amount held in the futures account.
  4. Liquidity concerns.  (What is the volume?)
  5. Concern about the unknown unknown.

Thus while I conceptually understand futures, I have gaps in my intuitive and practical understanding of them.  I hope to mitigate these gaps in a couple ways:

  1. Talk with (or exchange email with) folks familiar with futures trading.
  2. Read and research more about futures.  I’ve already started this process.

Until then my present will have no “futures”.

Happy investing!

Holidays, Snowballs, and Deals

I’ve been enjoying my Christmas break and doing some reading.  I’ve been reading “The Snowball: Warren Buffett and the Business of Life” by Alice Schroeder.  I’m only to page 65 of this 838-page tome (plus additional notes pages) but I’ve already been sucked in. The book was a gift, but not to me, and I’m hopping on a plane tomorrow, so I’ll have to buy myself a copy to finish it.

Speaking of books, I was reminded of another great “investing” book, “Negotiate This!” by Herb Cohen. It didn’t meet my top-8 list only because 1) It isn’t, strictly speaking, an investing book 2) I liked the number 8 and couldn’t manage to bump a book off in it’s place. Needless to say getting a good deal through shopping for great values (as Warren does) or through negotiating great deals (as Warren also does). Regardless, consider picking up “Negotiate This!” and help improve your personal bottom line.

It’s dinner time, so goodbye for now. Merry Christmas and Happy Holidays!

Mortgage this! If you can.

Last week the Fed shocked me a bit by lowering its target rate to “0 to 0.25” percent. Wow!  I had expected the target to be lowered from 1 percent to either 0.5 or maybe even 0.25.  The fact that zero is part of their new range did surprise me.

The next day some folks I knew were on the phone with credit unions and banks trying to snap up mortages rates as low a 4.5%.  These institutions were advertising rates as low as 4.5% for 30-year fixed mortgages on their websites that morning.  But several unfortunate outcomes occurred:

  1. They filed the online application but the return call from the bank to finalize and lock in the rate did not come in time (2:00pm or 3:00pm).
  2. Calls to lenders were not being answered nor returned.
  3. Provisions to existing loan customers were revoked that day (e.g. the option and promise to re-lock in a 30-day period for a cost of 25 basis points was removed without notice).

I read about some lucky re-financers who did get the amazing morning rates, but none of the people I spoke with in person were able to secure the morning’s web-advertised rates.

I have a couple takeaways from this mini-refi frenzy. The first is a question, “What ever happened to service in financial service?”  The second is more practical: that with the rate cuts and other potential Fed action, that it is again worth exploring mortgage refinancing options… despite the pain and inconvenience that is increasingly part of the process.

There is a ton of financial action in recent weeks.  I’ve been slow on the blogging, and I’m sorry. I’ve got plenty of excuses including the holidays, but I’ll spare you the details. I’ve got a ton of things to explore and will do what I can in the next two weeks to blog about  a number of things that are on my mind including more on interest rates, TARP, the automakers, huge currency moves, the economy, and even “Fishing with NNT”.  Happy

Madoff with the Money

I’ve been following the Madoff money scandal with interest, but with limited surprise.  The only real surprise for me is the scale: $50 billion is big.  I am much less surprised that the regulators missed it.  For example, they missed Enron too.    It is also not surprising that big money investors were taken in.  The “keeping up with the Jones” competition is also a real phenomenon some members of the super rich.

History is replete with examples of wealthy individual who succumb to financial scams.   Look at John Law in 1700s France, for example.  He was an adroit visionary and scammer.  Check out Ponzi himself whose name is now synonymous with such cons.  It is with some satisfaction that I wrote about him and the dangers of unwary trust in this  August schemes and scams blog.  Another, less corrupt, but still costly debacle  that snagged experienced and wealth investors and companies was that of  Long Term Capital Management.

What I feel compelled to mention is a simple and wise maxim:  Diversify!  No matter how good an investment is (or seems to be) don’t risk putting your eggs in one basket.  Not one company’s stock, not one management company.  Secondly, it is simply unwise to invest a massive percentage of one’s portfolio in something so opaque as a hedge fund.

Let me clarify somewhat.  I don’t think it necessarily unwise to, say, invest 50% of entire investment portfolio with Vanguard index funds.  Why?  Because 1) index funds (such as the Vanguard Total Stock Market Index) are diversified — at least in terms of U.S. Stocks.  2) They are transparent… they are clearly invested in market-weighted proportions of the U.S. Stock market.   (Fine print: mostly, with some representative sampling of smaller issues).

The saddest thing I hear about folks who “invested” with Madoff.  Those who invested all, or most of their money.   Some of those sorry folks are likely to go from multi-millionaire to the poor house practically overnight.

The moral of this sad tale can be summed up in two words:  “Caveat emptor”.

  • Understand your investments.  (Be like Buffet… don’t buy what you don’t know.)
  • Part II: If you insist on buying something you don’t know, only invest a small amount (5% or less of your net worth).
  • Diversify:  Spread your funds to a reasonable degree.  This includes not putting all your money with one money-manager or fund.
  • Diversify.  There is arguably no substitute for some money in the bank.  E.g. FDIC insured deposits (subject to $100K, $250K limits per institution).

Green Power for the Econony AND Environment

I start with the assertion that the United States can make smart investments that are both green and ultimately profitable for the nation.  The single-most effective investment we can make now is to improve the transmission efficiency of electrical power distribution.  According to this grid efficiency article the U.S. loses a little under 8% of its energy in transmission and distribution (T&D).  An the loss in T&D is trending upwards.

The recent electrical outages due to the ice storm in the North East and comments from Duane regarding my economic stimulus article got me thinking about energy.  (During my day job I am an electrical engineer designing CPU’s.)  Our productivity on Friday was cut by half or more due to our reliance on systems on the East Coast that were impacted by the power outages.   Similarly, years ago, while working for Agilent Technologies our silicon wafer fab was shut down due to a local power outage, ruining millions of dollars of chips.  Simply put, I have seen power outages cost a single company millions.  Imagine the financial impact on, for example,  on all the companies in the North East due to the recent outage.

In a nutshell, a more robust grid is good for business.   Substantially upgrading and improving the U.S. grid would make it more robust and more efficient.   If  I were president-elect Obama, who probably isn’t reading this blog, I would issue the bold statement within my first 100 days:

I challenge the Congress, free enterprise, and the nation to improve the US power grid efficiency dramatically.  The goal I put forth today is to reduce transmission losses from 8% to 5% in the next 7 years.  The reduction of wasted power by 3% will result in less power generation by coal plants resulting in fewer emissions of pollutants such as sulfur dioxide and mercury and harmful particulates.  Further this will reduce CO2 emissions.

Moreover, I challenge the G7, Russia, China, and India to make similar strides in transmission efficiency.  For the developing world I’m asking the G7 to contribute $200 million to provide technical assistance and loans to transmission efficiency improvements.”

Greater efficiency means cleaner power.  For example, if the power produced by a coal plant loses 8% in transmission, and plant managers wish to supply a Megawatt (MW) to end users, it must supply 8.7% more to deliver that 1 MW.  Improving T&D efficiency (T&DE) reduces that excess to 5.26%, resulting in a  savings of 3.44%.  This means 3.44% less particulates, mercury, and SO2 sent into the air.

In essence, I’m suggesting we do for our power grid what President Eisenhower did for our roads.  Eisenhower spearheaded the creation of the U.S. Interstate System…  transforming a mishmash of local and state roads by integrating them with a backbone of fast, efficient federal highways.  I suggest Obama could integrate our mishmash of regional power tributaries and webs with a truly robust and efficient U.S. power backbone.

I’m suggesting we implement a plan to achieve these goals:

  • Upgrade our grid starting with the creation and upgrade of new interstate trunks featuring an increase in underground lines (versus overhead lines which are more vulnerable to weather.)
  • Make use, in part, of the railway system, the interstate system, and telecommunication systems to help find lower-impact right-of-way solutions.
  • Fund scientific research into power T&D including mechanical, material, civil, computer, and electrical engineering as well as physics.  Fund business, political, and legal study into T&D topics.

That is my 2 cents for now.  What follows are a few nitty gritty technical details I can’t help but add as footnotes:

  • Focus should be on high-voltage DC power transmission (>400KV).  DC presents several advantages including virtually eliminating 60-Hz phase-matching concerns.
  • Superconductors may continue to be evaluated as a portion of the program, but emphasis will be on more traditional conductors such as copper (blends, silver-plated) and aluminum which will be at the core of the initial implementation phase.
  • Power conversion is another key aspect… both AC-to-DC and AC-to-AC stepping.
  • Finally grid monitoring, load balancing, and other command-and-control function are the third key element.  Both advancing the infrastructure with existing technologies as well as researching future hardening, robustness, monitoring, and power-routing technologies are critical.

Favorite Investing Books

Here they are.  Read ’em and profit:

  1. The Black Swan. Nassim Nicholas Taleb (NNT).  Random House.
  2. Fooled by Randomness. NNT.  Texere.
  3. The Intelligent Investor (Revised Edition). Benjamin Graham (w/ Jason Zweig).  Collins.
  4. When Genius Failed. Roger Lowenstein.  Random House.
  5. Your Money & Your Brain. Jason Zweig.  Simon & Schuster.
  6. The Ascent of Money. Niall Ferguson.  The Penguin Press.
  7. All About Index Funds. Richard Ferri.  McGraw-Hill.
  8. Investments. (Textbook)  Bodie, Kane, Marcus.  McGraw-Hill.

The first three are must reads in my opinion (though #2 overlaps with The Black Swan.)  I can’t say enough about the first two, though I try.   The Intelligent Investor is the book on value investing, period.

If you want to understand today’s financial crisis, read #4, in addition to #1.  These books provide the blueprints and some solutions.  If only Greenspan, Paulson, Bernanke, etc, had listened.

#5 provides a much needed perspective into the reality of financial decisions and the emotions behind them.  This book confirms the wisdom of having a play money (Crazy Ivan) fund to give emotion an outlet and aid in maximizing overall portfolio objectivity.

#6 is an excellent history of money and how we got to where we are today in the financial universe.   #7 is the best read I’ve found about the ins and outs of index funds and ETFs.  Finally #8 is a surprisingly readable text and reference for those who want to know how the financial world thinks (Read it to understand, not slavishly believe).

Read (and re-read) these books and you’ll be light-years ahead of 90% of the financial advisors out there.

Simple and Clear

The current government-sponsored bailouts disappoint to such a degree they are becoming self parodies.  Among the disappointments:

  • Very expensive.  Not billions, but trillions of taxpayer dollars are on the line.
  • Opaque.  Which companies have how much?  For what?  Under what terms?
  • Only marginally effective so far.  LIBOR is down somewhat, but is much lending really reviving?
  • Tops-down.   Rewarding failure, mismanagement, even incompetence and neglect of duty.

Rather than ladling trillions more into the same troughs, maybe we should consider a different approach that has the following properties:

  • Relatively inexpensive (billions not trillions).
  • Transparent, simple, and clear.  Can be explained in few sentences.
  • Bottoms-up.  Rewarding ordinary Americans who save and invest.

While there likely many ideas that meet these properties, here’s my stab at a legislative solution.

  1. Make the first $2500 of interest earned in FDIC-insured vehicles (e.g. savings accounts) in 2009 exempt from federal tax.
  2. The deductibility of investment losses against earned income would be doubled to $6000.
  3. U.S. Stocks (including ETFs) purchased in 2009 and held for over 18 months would be exempt from capital gains up to $20,000.  Additionally, after 12 months, dividends on such stocks would be tax-free up to $2500 per year… indefinitely.
  4. A simple $1000 stimulus rebate to everyone who paid taxes in 2008.

These measures would be retroactive to Jan 1, 2009 if the legislation passes after that date.  I believe these measures would be simple and effective.  They would result in more money for lending and turbo-charge the stock market.  The wealth-effect from increased stock market prices would spur capital investment.    A psychological boost would likely ensue as everyday Americans realize that the “bottoms-up bailout” is going primarily to themselves and their neighbors, rather than wall street and corporate board rooms.

Well, this is likely just some wishful thinking.  I hope it stimulates some different thinking.  I am ever hopeful for the USA, based on the character of our people and our tradition of creativity and entreprenurial action.

Mr. Tax Man

It’s December and a good time to start tax planning.  For example now is a pretty good time to realize investment losses by selling some stocks or mutual funds that have lost money (which haven’t).  Last I checked the amount of tax loss deductible from ordinary income was $3000.  Just be careful of the wash sale rule which effectively prohibits buying back a stock/etc for 30 days: wash sale.

Another thing to consider is mutual fund capital gain distributions.  There’s nothing fun about paying taxes on a distribution from a fund that has lost money.  It is often helpful to consider funds that have good tax management (index funds are often excellent at keeping capital gains distributions to a minimum.)  If a fund is about to dump an unwanted distribution on you consider selling it before the distribution date.

Finally 401(k), IRA, 403b, and similar accounts.  If you are not maxed out, consider upping your 2009 401(k) contribution.  You might also consider making a 2008 IRA contribution if your are not subject to income limits.

It’s what you keep

I recall something I read several years ago.  I’ll paraphrase…

If you’re going to pay for investment advice, start with good tax advice.

I was listening to an estate planning program on PBS while working in the garage. The speaker charmed his audience with anecdotes and analogies. His advice was decent enough:

  • Pay attention to the beneficiary forms for your investments.  Especially for 401K and IRA accounts.  These trump wills and have important tax advantages upon death.
  • Spouses should consider bequeathing some assets to  non-spouse heirs to benefit from the $2M estate tax exclusion. (Note: I’ve not fact-checked this amount).
  • Consider life insurance and annuities.   Life insurance for tax-free inheritance, annuities for the possibility of living much longer than you expect (say to 100).
  • If you don’t plan, guess who is likely to take most of the estate…. the government and the nursing home.

First, these are valid points.    Second, this type of planning ranks right up with dentist visits, cleaning the bathtub, and proctology exams on the fun scale.

Nonetheless I’ve seen first-hand the impact of helpful decisions (smart IRA beneficiary choices) and unhelpful ones (no will, hard-to-find financial information, social security snafus, nursing home challenges).

If you wish to leave the most to your grandchildren, heirs, charities, then estate planning is a must.  Boring, yes.  Important, yes!

Additionally, tax planning is helpful not just for the deceased, but for the your day-to-day life.  I’ll touch on that in my next blog.