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What you don’t know can hurt you; Fear of the unknown is the #1 issue in people’s lives December 17, 2014

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As regular readers know, my background is in social psychology. Applying what I understand on how our minds’ work to financial matters lead me to several different strategies which include using equity indexed universal life policies to help fund retirement income.

The other day I received this e-mail note from a client:

I wanted to send you word that since I rearrange my retirement plan over the past two years, I am now riding out this stock market crash with little panic. I have moved most of my money into a combination of real estate, discounted real estate notes, and an EIUL.

I feel like I understand the risks at play, and how people all around me must be panicking like crazy due to this giant drop in oil prices. I feel like I can see the systemic risk you have been preaching about for years, for which mutual funds were supposed to be our savior. And yet, look at them now!

Thanks for helping me build REAL net worth.

This client has constructed a financial profile that allows him to sleep well at night.
This is perhaps the best financial advice I can give: Construct your personal financial situation in such a way as to allow you to sleep well at night. There are no guarantees in this world. But there is one thing I have discovered over the years; we are our worst enemies. Let me explain. Our brains are hardwired to take action in the face of perceived danger. When that saber tooth tiger entered our cave, the survivors were the ones that ran or used weapons to fight. Those that quietly, serenely, surveyed the situation were eaten. Fight or flight or freeze? The reaction to extreme stress creates real physiological changes. Transfer this known psychological reaction and its encouragement of action to our current financial world. The data is clear that people react to the ups and downs of the stock market in similar ways that are not good for their accounts. They buy high and sell low. What should they do? Nothing. Back in pre-history doing nothing gets you eaten. In the financial world doing nothing has proven to be the only way to do well over the long run.

How hard is it? Really hard. While I watch my energy stocks go down, my entire being was screaming sell….sell….sell. I went back and re-read Warren Bufffet to settle me down. But as I tell my clients when they ask, can you sleep at night when your portfolio of stocks [or mutual funds] goes in free-fall? Because if there are any doubts, then you don’t need to be in the equities market. The ability to resist your brain is very difficult and takes a certain personality.

Now, the above client might not have a set of financial strategies that work for you. But, you need to find strategies that work for your situation and personality. Nothing less will end up in disaster as the current data on personal wealth indicate for the vast majority.

Does an EIUL work for you? Maybe? Real Estate? Mutual Funds? Stocks? Bonds? Discounted Notes?
Figure it out, because your financial life depends on it.

Have a Merry Christmas and Happy New Year!

My Energy Stocks?????? December 2, 2014

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The market has destroyed all my energy stocks. Some people would point this out as a failure, but fortunately I am of the Warren Buffett ilk, that doesn’t particularly worry about short term variations, even dramatic ones like just happened.

In fact I even did what some people would call stupid and sold my HCN in order to buy another oil rig stock; NADL.

SDRL announced a solid quarter of results and then dropped the bomb. They suspended their dividend. If I was dependent on that dividend it would be a disaster. But, fortunately, I have done my homework and know that their dividend policy is not predicated on maintaining a dividend, but the dividend is considered a sharing of profits for its owners. So, in this market, where oil has gone down significantly, and there are questions about its ability to get good day rates for its rigs, I understand why they decided to withhold the cash internally and use it to pay off debt and buy back stock.

The ironic thing is that the analyst kept opining that the day rates for their rigs had gone down into the mid $400,000, but they have announced 5 contracts that range from around $500K for 4 in Brazil [2 new and 2 extensions] for 3 years and one other at over $620K. The company also mentioned that several tenders for rigs are out there and they expect to be able to get the next few available rigs contracted over the next year.

What did the market do with all this info? They killed the stock which now sits below book value and below a P/E of 2. But, like Buffett suggests, I have a 10 year plan with this stock and didn’t react to the bad news.

In fact, I bought another small rig company, NADL. I got in really low [even though it has continued to go down since I bought it]. It also suspended its dividend. SDRL owns 70% of it and it is backed by the same Billionaire that owns 25% of SDRL. It is now priced as if it was going into Bankruptcy. I think that is highly unlikely. It is a small position for me at this time. It announced its best quarter results ever. But, it has the outstanding deal with Rosneft, which failed to close due to sanctions. It has until May to close that deal. It announced it is getting the proper permissions from the Europeans to close that deal that was signed before the sanctions went into effect. There is obviously big questions mark surrounding that deal, but if it doesn’t go through I believe they will find contracts for those rigs elsewhere. The current price is around 1.5 PE and they don’t have as much debt to deal with as SDRL.

That leaves AWILCO. Interestingly, they declared the same dividend as the last couple quarters. They have solid contracting until 2016 and the money to do their maintenance on the two rigs in 2016. Despite an excellent quarter the price got hammered too.

What that leaves us with is that the market has decided that no offshore rig companies are going to survive past a couple of years or if they do they will be unable to create profit. This is, of course, contrary to the evidence out there. Off shore projects are being started all over the globe, from the GOM to West Africa, to the North Sea, Southeast Asia, Brazil, etc. If these projects are postponed or eliminated, then over the next few years our demand for oil would surpass supply by a good bit. Just can’t see that happening. We are already seeing the NA fracking production starting to show cracks. But that is for another post.

Bottom line, this is a painful time for energy stocks, but the market is downright hysterical about them now. My intentions, the fundamentals, etc. haven’t changed. I believe it might be a couple of years for this to turn completely, but it will come.

Berkshire Hathaway Q3- 2014 November 18, 2014

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As regular reader know, BRKb has been a large mainstay holding of mine since the mid 1990s. Of recent changes, I have sold BRKbs in order to move into some high yield dividend stocks. But, it still remains over 40% of my portfolio.

The last quarter went well for Berkshire. It now holds over $62B in cash. Operating profits rose substantially to $4.72B a rise of 29%. It lost a little over $100M on derivatives and investments that included writing off almost $700M on an investment in Tesco Plc, a British grocer. I guess everything Buffett touches doesn’t turn to GOLD!

While total earnings for the quarter ran 9% lower than the 3rd quarter of 2013, overall for the first 3 quarters of the year earnings are up 8%. Cash flow from operating activities was up 16% from last year for the 3 quarter. A stunning success.

By any accounts a good quarter and a good first 9 months of the year.

After the quarter was announced BRK bought Duracell from Proctor and Gamble. The net price was $2.9B with the deal giving back $4.7B in P&G stock and P&G recapitalizing Duracell with $1.8B in cash.

By using all its P&G stock in the deal it avoided over $1B in a tax liability. The original stock was part of the Gillette deal years ago and had appreciated tremendously.

However, Buffett still sits on a ton of cash. What to do with it?

In its equity positions in addition to the aforementioned P&G disbursement it upped its GM ownership by 21% to 40M shares. It got rid of its Deere position. Slightly upped its positions in IBM, Wal Mart, Visa and Master Card. Also took a stake in Express Scripts with 449K shares.

Still making me lots of money. Thanks Warren!

Energy into the Future October 27, 2014

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Let me start off the post stating two facts:
1. I don’t invest/speculate for short term movement, but take Buffett’s advice to invest as if you are throwing the stock into a drawer for 10 years.
2. No one has ever been able to predict oil prices in the short term [less than 3 years]. Just look at the oil price predictions from 1 year ago if you don’t believe me.

Production

I will start off with a few facts and then go into my opinion. World-wide almost all wells are producing less oil than they were. So we have a world wide per well decrease in production for the last decade that is increasing. This is true if we are talking the Saudi’s, North Sea, or even tight oil which has the highest depletion rate by far. So in order to increase oil production there must be an increase in wells drilled. No getting around that fact.

Over the last years there has been thousands of new oil wells drilled in North America because of the improvement in technology in fracking tight oil. But tight oil wells have a depletion rate as high as 40% for the first year alone, so in order for them to increase production NA shale oil players need to dramatically increase well drilling going forward. This is unsustainable as the best plays are drilled first and the lesser plays are starting to be drilled now. In order for their to be a decade long increase in production in tight oil, there either has to be several major discoveries the size of the Permian Basin and/or a dramatic increase in the technology. Neither are likely in my mind.

There has been much discussion on the majors moving to fracking tight oil, but that is really limited to two domestic majors, Chevron and Exxon with Exxon seemingly waiting to pick up some leases out of bankruptcy. Shell and BP have recently stated that they are ramping up their offshore drilling. And of course the nationals are for the most part dependent on offshore to ramp of their production. The truth is that for oil companies, they need to do everything they can to keep production up whether its onshore, fracking, or offshore. If they don’t then oil production will go down as their existing oil wells deplete.

Consumption

Worldwide consumption of oil products continues to increase. This is on the back of China/Asia increasing GNP and India increases in GNP. China GNP went up last quarter 7.2% [higher than most predicted], while India went up 5.5% [again higher than expected]. USA went up a little over 4%. Europe stayed flat and might be going into a recession while Japan also remained flat. Worldwide the predictions is for a 3.5% GNP increase for 2015 [again look at how badly prognosticators did last quarter before you put any confidence in that number].

Hear is my prediction: Worldwide consumption of oil will continue to increase for the foreseeable future.

So this is a pretty simple equation for me. Consumption will increase, while production will continue to need more wells drilled to keep up with the world-wide consumption. Can NA shale oil drilling keep up with the increased demand and the lowering production of existing wells world-wide? No not even close.
World wide consumption was 90.4M barrels a day in 2013. Likely to be in excess of 93M in 2014. Increase in USA production from 2013 to 2014 is expected to be around 1.5M barrels a day. OPEC can manipulate its production over a fairly tight range to account for short term variations, but many believe the Saudi’s [largest OPEC producer] is running pretty close to full bore.

Now add in that companies have to plan out 5-10 years in advance to create production level. So they need to have big drilling projects starting now to maintain their production. Where will they get this oil? They have to go to the biggest reserves which are mostly offshore.

Nothing I have seen over the last year has changed any of that analysis. Not the drop in oil prices over the last few months, not the increase in production in NA tight oil.

What we are seeing is folks trying to predict something that they can’t [oil production and consumption and oil price]. It is all just noise. Barring a world-wide depression consumption will increase. The oil has to be drilled to produce. The major oil companies will drill where there is oil whether it is in NA or offshore.

Buffett’s Investment Philosophy Simplified September 30, 2014

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When the market is going up, every one is a genius. But, to really understand how great investors do it, you need to look at their long term strategies.

Warren Buffett’s Strategy is simple to understand and very difficult to do:

1. Identify well managed companies;
2. Analyze their medium term outlook by understanding if they have a “moat,” meaning an enduring advantage over others in their same business;
3. Look at their books to make sure they have a business model that makes sense for the business they are in;
4. Calculate a fair price for that business;
5. When the price is at or below that fair price buy; and
6. Hold until the moat is gone, management disappoints, or some fundamental change in the economic environment causes you to reevaluate the business.

Easy as pie!

Here is the kicker, the vast majority of people will react to price movements, especially extreme price movement. If the companies stock starts to tank they will panic and sell. Buffett has the psychological makeup to stick to his analysis ignoring the market emotion. Since he has done his own due diligence he has the confidence to ignore the chatter out there. He also knows that most of the analyst that work for the major brokerage firms are relatively young and inexperienced. There is also the reality that in some incidences the brokerages own accounts tend to work opposite what their own analyst are saying, so they are buying up cheap stock as their own analyst are saying sell and they are selling when their own analyst are saying buy [with an appropriate short time lapse to not be too obvious about it].

Due to technical reasons the market is even more volatile than it was back in the day which puts even more pressure on folks who think they are missing the real reason a stock is going down that the insider’s know.

Bottom line, for me, is that I have found having stocks that pay a good to great dividend gives me the ability to ignore the market chatter [along with re-reading Buffett!]. That dividend carries me through a stock drop or a general bear market. Understanding how one of the greatest investor in history thinks about investing is a gift that continues to give.

Changes in Family Finances Outlined in Federal Reserve Report September 17, 2014

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The Federal Reserve’s report of changes in Family Finances 2010-2013 documents the continuing startling financial condition of families in the US. Here are the top line numbers:
Median Family Income Fell 5% to $46,700. That is on top of a 8% decline in the previous 3 year period. So median family income has fallen 13% in the last 6 years.  Mean family income rose in the latest period 4% indicating a widening of the income differential between the top tier and the balance. This differential has been consistent over the last decade.
Median Net Worth also fell 2% to $81,200. Interestingly, is the median amount of net worth for those with income in the 80-90% category is only $288,000 a drop of 11%. For comparison the upper 10% has a median net with of $1,126,000 and the 70%-80% income group had a net worth of $161,300. So in reality the only folks who have a total net worth of over $1M are the ones making the top 10% of income [$223,000 of family income]. This is really bad news for the country as only 10% have the means to retire with a decent retirement income. Further driving home this point is the median net worth of 55-64 year olds of $165,900. Families in the upper middle class or between 75th and 90th percentile had a median net worth of $505,800 a 3% drop. For comparison the top 10% median net worth is $1.8M while the 50-75% grouping has a median net worth of $168K. Most of this net worth is in principal residences not retirement savings.

Roughly half of US families have retirement accounts and the median value is $49,200 [remember that the market just had a +32% year which should have pushed up 401K values significantly]. Roughly 15% of families own individual stocks with a median value of $27,000 and about 9% have mutual funds outside their retirement accounts with a median value of $80,000. About 20% have cash value life insurance with a median value of $8,000.

The mean level of retirement accounts [for some reason they don’t report median level on this measure] for folks in the 50-90% income level is $147K. No doubt the median level would be much lower. The top 10% of income earners have a mean retirement account level of $446K.

Some quick comments on debt; the debt to income level decreased to 107% from 118% indicating lower level of overall debt. The one area of debt that is increasing, and doing so dramatically is student loan debt.

Overall we see stagnating incomes outside the top 10%, and extremely low levels of retirement savings and assets among all those in the below 75% of income. And even up to the 90% income level strikingly unprepared folks for retirement.

Musings on oil since the price dropped September 16, 2014

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I have seen folks around the internet saying that we have a glut of oil now. Many are predicting that tight oil [North American Shale for the most part] production has created a situation where deep sea exploration/drilling will drop significantly. Since I am invested in a couple of UW drillers [SDRL, AWLCF] I thought I would re-examine my original investment thesis.

Prediction is usually a tough business but I did find some consensus on future demand. Most folks think the long term demand in the US, Europe and Japan will go down slightly. While the demand in China, India and the Middle East will increase dramatically.

FutureOilDemand

Overall the prediction is for a 19 million barrel a day increase. So if they are correct, where is this 19 million barrel a day habit going to come from? Many are assuming tight oil. But, how much shale oil is there being produced now? Less than 4 million barrels. So over the next 20 years can we assume that the amount of shale oil produced will go up by a ratio of 5 times?

The most successful company in the shale oil space is currently EOG. Here is what their CEO, Mark Papa has been saying. The most productive shale plays have already been picked over and we are close to our peak production for shale oil. He is not alone in saying this. But for the time being let’s pretend over the next 10 years we can double the increase in production that has happened over the last 5. The CEOs of companies already into shale oil production would call that unlikely, but let us keep with that prediction. So we increase production by 3 million barrels. And let’s say that shale oil finds lucrative areas in the rest of the world that mimic North America’s increase in production. So we are up to 6 million barrels. Where is the other 13 million barrels coming from?

Now let’s talk price. That is the other myth being thrown around. That shale oil production is cheap. The truth of the matter is that NA shale oil costs about $65 barrel to produce. That compares to $52 for deepwater and $56 for ultra deepwater production. So we see that overall costs favor going underwater except for the Arctic which costs $75. Of course, getting shale oil has proved to be faster than underwater which can take up to 3 years for exploration and drilling. But, for the most part current shale oil is not cheaper than going deep into the oceans. As to the economics at least two of the major oil service companies’ CEOs have commented on the bad economics of shale oil [Shell, BP]. Bottom line is that oil has gotten very expensive to get out of the earth and is getting more expensive by the day. Shale oil has no particular advantage over drilling under the water even at huge depths.

Now let’s talk politics. We know that spills in the ocean are devastating and create all sorts of risk. But,the shale oil fans simply aren’t dealing with the risks of transporting these tight oils. Every month of late we have had a railroad car issue transporting oil and pipelines have their own dangers. This is already driving up costs as the US government applies more stringent regulations on rail cars.

Getting oil of the ground to market is a dangerous dirty business that creates environmental disasters all over the globe. But, there are no practical alternatives on the horizon yet, and no political will to deploy alternative energy at a high rate anywhere but Germany.

Until we see both advancements in alternative energy and the political will to deploy them we are stuck with oil.

Given all this, does anyone really think we see the price of oil plunge?

Here’s a Deal For YOU! September 2, 2014

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I got an investment for you.
First you are going to invest in a strategy that has failed for 2 generations.
That strategy will have you investing in things you don’t have the time to possibly understand the details of.
You are going to be locked out of getting your money from that investment for as long as you work at your job or perhaps they will let you get at it and only charge you 10%.
You will defer taxes, but if you have any success at all with this investment you will end up paying more taxes than you deferred.

So are you ready to sign up?
You probably already are; its your 401K at work!

The truth falls on its sword in the face of the Wall Street Hype Machine September 2, 2014

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Sometimes I go out into the internet world to see what others are saying and advising. It’s interesting that the Wall Street hype machine, regardless of what people really feel about Wall Street gets reiterated all over the net. Now that we are 5 years into a bull stock market, and last year we saw over 32% rise, everyone thinks they know how to become a millionaire retiree. Yep, just keep putting money into that 401K and you will retire wealthy.

Every CFP or whatever letters they have by their name, almost every newspaper or magazine finance writer, all the mutual fund companies, etc. are out in force telling people just to keep buying those mutual funds. And that is repeated as gospel by folks on the various websites. You can’t go wrong!

Yet, the studies don’t change that illuminate that people aren’t becoming millionaires with their 401ks. No, they are just putting money into their 401ks/mutual funds now that they are at a high value. Guarantee, that will reverse itself after we get a correction. Happens every time, when the stock market goes down, people start to sell [many because they need the money when they lose their job].

And Wall Street loves it all the way to the bank. Never mind those pesky Dalbar Studies, never mind the government studies, never mind that people are having to work longer because they have few, if any savings. No, just stay on the program. Don’t know if this is “Alice in Wonderland” or “The Wonderful Wizard of Oz,” but folks who believe in the impossible will pay the price.

New EIUL from Minnesota Life August 14, 2014

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On Monday, Minnesota Life will introduce a new EIUL product, the Omega Builder. At first, I did not think it was going to be something my clients would benefit from. But, after an in-service this week, it is clear that for many of my clients this will be a great product.

It functions the same way as the existing Eclipse EIUL, with one difference. There is an income protection agreement. The agreement locks in a death settlement that is not simply a pay-out of the death benefit to beneficiaries. Instead the client chooses what percentage of the death benefit is paid out upon the death and the remaining amount is paid out over time [between 10 and 30 years]. There is a fixed interest rate paid on the un-paid out amount which adds to the overall total payment. Now, when I first saw this, I was not impressed that my clients would benefit as most of them are planning to use the cash value for living benefits in their retirement years.

But here is the kicker. Because the death benefit is not paid out entirely at death, the insurance costs that run in the policy are radically reduced [up to 50%]. This reduced insurance expense means that more of your premium is put into the savings side of the policy annually. And with more money getting interest credits every year, your cash value increases and the amount of cash you can pull out increases. The best part of this is that nothing changes on the top end. In other words, I can still minimize the death benefit down the same amount and stay within IRS regulations. The end result is up to 30% more distributable cash.

Minnesota Life has again placed itself on top of the EIUL ratings with this product. While, the Eclipse still remains one of the top performing products, a couple of other companies had products that had just as good of performance over the last couple years. With the Omega Builder, ML has created a space between it and the rest of the EIULs again.

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