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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.

The insidiousness of the market; My awakening October 30, 2012

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I have often mentioned that in the mid 1990’s, I was awakened to the wrongness of the financial advice being sold to consumers at the time. Not much has changed about the advice since then, just some tweaking around the edges. That in itself it pretty amazing considering how bad that advice has turned out to be. But, I never took the time to lay out how the process took place for me. So I thought I would write a few posts on it starting with today.

It seems counter-intuitive now, but what started me questioning was the great bull market that was at the end of its legs at the time. The market was going up with double digit returns every year, or so it seemed, and it felt really good. That is perhaps one of the insidious things, how good and smart it makes you feel when the market is going up. But, as I looked at my account, and projected into the future the numbers that were coming up seemed to good to be true. So, I started to really look at the history of the market, I mean really look at it. And I realized that there has to be a negative mirror to current results. Reversion to the mean, a mathematical truism would have to rear it’s ugly head at some time.

Now a quick reminder, I had bought into the mutual fund story of diversifying, owning the American economy, etc. So, what the market was doing, was what my accounts were experiencing. Then the tech stocks started their incredible climb into a bubble. People’s expectations were off the chart, sometimes so high as to be laughable. Classic bubble behavior. And then it hit me; variation was the enemy. Not only did the great years mean that lean years were coming, but great years were screwing with your psychology making it difficult to imagine any reversal of fortune. So not only were you betting against a sure thing [reversion to the mean], but when it came you would not be prepared. I noticed old folks of the time were still putting their money into certificates of deposits and always thought they were crazy for doing so. But, I took the time to talk to some. And what I found out was they remembered the great depression and the aftermath. They had seen this behavior before. I started to read about Warren Buffett and his philosophy on investing, which made me question some basic tenets like diversification. I read about great historical figures in investing with their made and lost fortunes. It seem to all came down to how to deal with that enemy, variability.

My first move was to transfer as much of my investments to Warren Buffett as I could at the time [my 401K was tied up with a company I was working for]. I spent several years doing this, cashing in investment, selling real estate, etc. I was convinced that he was the logical person to manage my money at that time, so I bought as much BRKb as I could. Since I had 30 years until retirement age, I hadn’t totally figured out the variability puzzle at that time, but I figured I had time while Warren invested my money to figure it out. Interestingly, I also bought some bank CDs, but I knew that the interest rates were not going to get me anywhere.

So, my first realization was that variability of the market was an insidious and dangerous factor to acquiring an abundant retirement. How I learned to tame it, will come later in my story. First there were some other hard learned lessons described in upcoming posts.

A golden oldie from last year! June 4, 2009

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Since I am on the road and unable to write new posts I thought I would give you some golden oldies.  This from about 10 months ago.

Why do you hate mutual funds so much?

Yep, you guessed it, I get this question a lot.  In fact, sitting on my porch with some neighbors espousing the philosophy of the Shafer Wealth Academy, I got it asked in a much nicer way.  So I thought I would answer it directly for the readers.

There are three reasons:

1.  Diversification sucks.  There I have said it.  There is an open secret in the investment world that diversification is for suckers or at least for folks that will never capture wealth.  You see, mutual funds were invented as a marketing strategy.  After academic finance disclosed you could reduce risk (variance) by diversification, astute Wall Street companies knew they could market this to average folks.  Previous to mutual funds and the idea of diversification the average person felt that investing in the stock market was akin to gambling and shied away from it.  But those folks in Wall Street knew a good marketing opportunity when they see one and ran with it.  Diversification reduces the variance to a point where the likely outcome is single digit returns.  Single digit returns are fine if all you want to do is beat inflation, but it will never create wealth.  What started as propaganda aimed at getting average folks to own stock has turned into common advice that is demonstrably wrong.  Every wealthy person from Warren Buffett to Donald Trump when being honest tell us that concentration is the way to go.  Diversification before we obtain wealth is a fear based strategy.  People think by diversifying, when things go badly, they can hang on to some of their wealth.  Unfortunately, diversification is a block to building wealth, so they are protecting themselves from a loss that means nothing.  Since fear keeps most folks from building wealth, when they hear diversification can protect them, they jump at it.  Its a perfect fit for a fear based environment. Not that fear is a totally wrong emotion to have for the middle class.  After all this is a group that is experiencing the economic changes most acutely.

2.  Mutual funds are retail products so there is an extra hand (middlemen) between you and your investments.  Even the lowest cost mutual fund company has employees that must be paid, buildings that must be leased or bought and profit that is made.  Where does all this money come from?  Yes, your returns.  See how this all blends together.  In order to get diversification you need to buy mutual funds, which not only creates a profit center between you and your investment but also implicitly requires you to look toward others for financial advice.

3. The army of mutual fund sales people have no idea how to get wealthy because they aren’t.  Their participation in this propaganda machine, no matter what the initials after their name are, tells you they don’t.  The data is clear how people acquire wealth and/or financial independence and it is not by owning mutual funds.  Anyone that gives you that advice is wrong and ignoring the evidence.

A few words on why mutual funds are so popular.  I’m sure the denizens of Wall Street never imagined the success of mutual funds when they first designed them.  As it turns out they were ideally suited for the psychology of the middle class.  The middle class, especially during the last two decades of the 20th century, were looking for security.  Remember, previous to 1980, layoffs were non-existent, defined benefit pensions were what most people had, and retirement for most was usually less than 10 years before death.  Security for the middle class was the name of the game.  The economic insecurity of the early part of the century eventually got turned on its head, but this was just a temporary reprieve.  Education beget a good job, which brought economic security.  Enter an investment strategy called mutual funds, which offered as its main selling point security (even though this was false, it matters only what people perceptions were).  In other words, mutual funds fit right in to the way people thought about and approached their financial life.

Then the stability of the middle class was turned on its head in short order.  Layoffs became common place not only for industrial workers, but for middle management and technical workers.  Aerospace engineers became perhaps the first middle class victims of this change in the 1980’s.  The government along with Wall Street stepped in and created IRAs and 401Ks ostensibly to encourage retirement savings, but also to pump up their respective cash flows.   We are just now starting to see the results of this unholy trilogy (Wall Street, Government, Security Seeking Workers).  The noise has reached a crescendo about the lack of retirement funds for the current generation of retirees.  Yet, few question the strategy that brought us to this point??? And of course, the latest dependency;  home equity.  If you were depending on your home equity to fund your retirement, the bubble has now burst.

So there in a nutshell is why I rail against mutual funds.  It is an outdated investment strategy for the world we live in now.  Never was honestly sold.  And absent financial education as to the realities of the current economic climate, causes and will cause much financial pain at the exact time (retirement) that folks can least afford it.

Where the mutual fund strategy went wrong! April 1, 2009

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The latest Dalbar Inc. mutual fund study is out and it is not pretty.  Real losses with a 5-10-15 year look back from the end of 2008 and marginal gains [below the inflation rate] for the 20 year look back.  For those who aren’t familiar with these studies the study looks at actual data from the real investors and their actual rates of returns.  No theory here, just facts.  Before anyone tries to point out that these data points are in the bottom of a severe bear market, remember the highest 20 year rate of return since doing the studies has been less than 5%.  There are  a whole host of other financial products that have done as well or even better without the stock market risk.

Here is the real reasons the returns have been so bad for mutual funds;

1. The efficient market thesis which suggests diversification and index mutual funds for the masses is severely flawed;

2. Passive investing leads to massive mistakes because it lends itself to total emotional decisions;

3.  Diversification leads to lopping off the opportunity for oversized gains but leaves the investor with market [systemic] risk;

4. Mutual funds inside 401Ks as a form of compensation leads to people having way to much of their $$$ in the market and way too little in reserves; and

5.  The army of mutual fund sales people are recruited for there sales ability not their formal finance knowledge or experience so they had no clue what the side effects of having people put most of their money into mutual funds would be.

One final comment, there are still people out there that haven’t come to terms with the failure of this strategy and still insist that holding mutual funds for the long term is a viable strategy.  Buy and hold is not dead, just buy and hold mutual funds.  Given the last 20 years of returns in mutual funds anyone who is planning on retiring over the next 15 years better not be expecting to do it on the back of their mutual fund investing!

The Failures of the Financial Advice Industry! March 23, 2009

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Over the last couple of generations the financial advice industry has come to an almost universal set of beliefs about personal finance.  These beliefs, when it comes to risk management, are totally wrong according to the data we have had available for the last 30years.  It doesn’t matter if the financial advisor is a fee based planner, commission based, working for a equities based company or an insurance based company [they all carry complete lines of products now], jabbering on the internet, in the financial magazines, or cable networks or belong to the local Knights of Columbus or your kids baseball league, almost all of them prescribe the same theories of personal financial management.

These are some variation of save, invest in mutual funds for the long term [usually 30-40 years], term insurance [and maybe permanent insurance when it can be afforded], pay down debt including your mortgage, and as you get older reduce your risk by moving from equity funds to mixed funds to bond only funds.

The truth is that we have much evidence on how this strategy fails most folks who try to apply it to their lives.  As I pointed out in my book,  there has been very few in the industry that has bothered to look at the reams of data pointing out this failure. 

Here is the main issue.  The mainstream theory is that younger folks can withstand market downturns that will attack their mutual funds because they have much time before they will use the funds.  The reality is totally different, younger folks have less reserves to withstand job losses, and the other events that happen to us that force us to use our reserves for everyday living.  The other issue of course is that older folks for the most part are trying to play catch up with their money and buy into the idea of staying in the market as long as they can to maximize their returns.  This is also the result of faulty strategies that assume folks will invest for 30-40 years when in reality folks only really invest with any money for 15-25 years.  The younger set generally are busy saving for a home, stabilizing their careers, starting a family, dealing with an economic climate that puts the worker last in line for business profits.  Little is left for investing after all that and what they do invest is periodically needed to get through to the next job, career, place, etc.  The older set, didn’t get their financial house adequately arranged to have a base that will carry them if all else fails and are making decisions based on fear rather than sound thinking.

Knowing all this does it make sense to advise folks to invest most of their money in mutual funds inside tax deferred wrappers where there are hefty penalties to get to ones money?  Now I have blogged on why I dislike mutual funds before, but not directly about the risk folks are taking on by investing in these funds.

Has anyone had their companies’ 401K advisor, a personal financial advisor, cable TV talking heads or any of the financial magazines discuss the risk of locking your money away into a 401K/IRA or the fact that when you are most likely to really need it, a layoff for example it is likely to have gone down considerably [recessions create stock market drawdowns and well as increased chance of layoffs]?  Has any of them told you that about every 10 years or so there is a 40% drawdown in the stock market  that you need to be prepared for?  Has any of these advisors talked to you about when it is appropriate to take on risk and when you need to manage it down?  Or do they just show you those charts with an average return of the stock market of 10-12%?  Do they send you to their fancy websites that have lots of useless information on it?

Here is the reality.  There is only a short period of time when folks should be investing the majority of their funds into equities.  And when they do this they should not be investing into mutual funds which don’t reduce the systemic [market] risk, but do reduce your opportunities for double digit returns.   When investing in the stock market you should not be looking for what is the best risk/return ratio [i.e. asset management], but what is the best pure return you can get.

When you start your investing life, you should never invest more than 50% into the stock market.  The younger you are the less should be invested into the stock market.  The time to invest a larger amount is when you have significant reserves to get you through the tough times whether its market downturns or layoffs or sickness or any other combination of events that will occur.  Young people with families generally don’t have these reserves.  There are many products that can be used to create those reserves, of which I have spoken about in the past.  Now I not talking about 6 months of basic living expenses as adequate reserves, but 2-3 years of true living expenses in a conservative environment that if all else fails will provide for you.  When you have that accomplished then you can start investing higher percentages in more aggressive ways.  I have posted before about these types of investments too.

So here is the bottom line.  Early in life you create your financial base in financial products that are fairly liquid and don’t have negative returns.  After you have created that base you slowly increase your percentage going into higher risk investments, searching for the best pure returns you can find.  Because you have your base established, you can afford the mistakes you will make and the downturns that will happen.  Evidence is that you will get better at investing and find a place to make those double digit returns that will drive your wealth upward rapidly.  Success will come to you as long as you keep your base growing, account for taxes, and improve your investing accumen over time.  Investing in mutual funds inside a 401K/IRA is exactly the wrong thing to do [with the possible exception of gaining a company match] throughout much of your adult life.

Can investors make money, build wealth? December 17, 2008

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Kinda of a wierd question from my perspective, but it seems to be the fundamental question of today’s investor psychology.  When many are questioning every investment activity, calling for a depression, or just doubting everything, we need to understand the answer to that question.  The answer is absolutely YES

If you can peel your brain away from short term thinking for a moment, you can begin to understand this point.  No matter what your investment strategy is, no matter how much capital you have at risk, if you understand what you are doing and can manage your emotions then the investment world is open to you.

Can you do it with fundamental analysis and a  buy and hold strategy in stocks? Yes (ex. Warren Buffett, Graham, Peter Lynch)

Can you do it with a trading philosophy in stocks?  Yes (Seykota, Selengut)

Can you do it with currency arbitrage, stock options? (Soros, Buffett)

Can you do it with investment real estate (Trump, Zell)

You can do it with as many different strategies as their are.  You choose the risk and the strategy what is right for you.  All I know is that people don’t build real wealth investing in mutual funds or annuities. They don’t build wealth investing in savings account or CDs.  They rarely build wealth being an employee and investing in the company 401K.  So why do the majority of people invest in the above things?  You tell me!


Who should you behave like; the middle class or the wealthy? October 14, 2008

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When it comes to our financial lives, who should we look to guide our behavior?  That is the question 10 years ago I asked myself.  Since my goals included having enough money to retire comfortably, the obvious answer was the wealthy.  Yet, many folks continue to insist that copying the behavior of the middle class is the way to go.  Yet, the middle class is in real trouble.   I have posted the current financial results from the data many times before.  Here they are again; for the 55-64 age group average retirement accounts have $83,000 in them.  Less than 35% of these folks have a defined benefit pension coming their way.  80% of this age group has a total net worth less than $300,000 of which more than one third is in the form of home equity.  Currently, 90% of retirees are dependent on government payouts for their basic living expenses.  The average person will spend 17 years in “retirement age.”  How long will that $83,000 last? 

That is where the middle class is right now.  Do you want to end up there too?  If you do mimic the middle class’s behavior.  What is that behavior?

Invest primarily in mutual funds, certificates of deposit, and savings account.  Pay off your mortgage as soon as you can.  Pay attention to fees, making sure you don’t pay any.  Be a passive investor.  Be a life time employee.  Panic when things happen you haven’t taken the time to understand or plan for.   Avoid risk.  Listen to the advice from Wall Street, Big Insurance, financial planners who are not wealthy and the banks, especially if the salesperson is sitting in a fancy office.

I posted on how the wealthy really invest here.  Quickly summarized it is real estate, niche businesses, individual stocks and cash value life insurance.  They are generally owners not employees and active investors not passive investors.  So which road are you on; the road of the middle class or the road of the wealthy?

Why EIUL’s might outperform mutual funds! October 11, 2008

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Several months ago I posted on equity indexed universal life insurance products (EIUL) versus mutual funds on this and at Bawld Guy’s real estate investment blog. There are always critics of this product that want to compare fees between the products.  No doubt, EIULs have fees, many times more fees than low expense mutual funds like Vanguard.  But, these folks miss the point.  It is all about the strategies employed.  Now, is a good time to talk how the basic strategy makes a difference.  EIULs have guaranteed rate of return, usually 2%.  They also have ceilings, like my favorite EIUL has a 30%/ two year ceiling.  But more importantly, they never go negative.  In other words any year the underlying index is negative, your EIULs cash value remains the same.  Let’s look how this factor can benefit you in down years like this year.

If you had $300,000 in a mutual fund at the peak of the market in April, and it got the S & P 500 market return (remember this is impossible since even Vanguard mutual funds have expenses and fees) it would be worth somewhere around $168,000 today.  If you had cash value of of $285,000 (lets pretend the extra fees and the cost of insurance cost you $15,000) in a EIUL, it would be worth $285,000 today.  You would need a 79% rate of return to get back to your $300,000 in your mutual fund.  You need to get a 70% rate of return to catch up with the EIUL!  That’s right, a EIUL never gives a negative return.  Looking at the historic rates of return, I doubt you will ever catch up with a EIUL, fees and all!  Remember, we have a bear market, on average every 6 1/3 years that averages a 31% decline.  We average 2-4 down years every decade! My EIUL has a two year 30% ceiling, so you would need to outperform that by more than 70% and still overcome other future down years!

Wall Street has been very astute at reacting to every challenge to its mutual fund industry.  It has adeptly allowed people to focus attention on fees instead of the actual results of mutual funds.  Now, as people panic and pull their money out, it has a built in blame factor to further hide the failure of the mutual fund strategy from folks.  Already, they have cranked up the propaganda machine blaming individuals for the poor performance of their retirement vehicles!

Those of us who have EIULs are not afraid to look at our statements as they come in the mail, can you say the same!

On the market and other Friday notes. October 10, 2008

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From Investopedia---Capitulation: In the stock market, capitulation is associated with "giving up" any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling.

For those who are wondering it is now apparent that capitulation is what is going on at Wall Street this week.  When will it stop?  Don’t know!  But we do know that this is not a once in a lifetime occurrence.   Since WWII there have been 10 bear markets (greater than a 20% decline) in the S & P 500.  That averages out to one every 6 years or so.  The average decline was 31.5% in these bear markets.  Two (1973-74 & 2000-2002) were around 50%.  Currently we are at around a 41% decline.  This feels like it might be one of those 50% declines.  The point is that this is not unusual in any way unless it goes to -60%. 

The second point that this drop does not have a corresponding fundamental reason.  Bear markets are just as irrational as bull markets.  All those mathematicians who try to tell us the markets are perfectly rational are simply wrong, the markets have always been more emotional than based on fundamentals in the short run.  The long run they are correlated with profits, but bounce around irrationally on a day to day basis.

Here is a chart of the S & P 500 Index going back to 1950.  Looks pretty scary at the end, but that is a function of the scale.  In other words because of the growth the absolute numbers are much larger making it appear to be larger percentage drops at the end.  Changing it to a log base 2 scale (don’t worry about the math) allows our minds to make better sense of the proportion.

Now we see, that there are no unusual variations from this weeks drops!

However, the media does what it always does and makes it seem like the end of the world.

Here is a couple of sentence from my forthcoming book.

The truth is that several times a decade mutual funds drop over 20%. It was only 20
years between times that the S&P 500 dropped 50%. So we see big drops aren’t unusual for stock funds. Wall Street has sold mutual funds as a way to not have risk or at least avoid most of it. Now the truth is you must assume some risk in order to build wealth. Instead of that message, the message is that mutual funds diversification makes risk disappear. So is it surprising when individuals who are sold on an investment that has little risk, react badly when their funds lose value?

Yesterday, I pointed out that mutual fund outflows forces selling. Add in investor panic and you have the recipe for what has been happening! My best advice, build a plan that suits your personality and does not require unrealistic returns to find success.

Mutual Funds; Redux October 7, 2008

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By now all the people who own mutual funds are either in full scale panic or are trying their best to put it out of their minds and do what Wall Street advises; make no changes.  The mutual fund money managers however are not quite so lucky.  When there are large net outflows, as there are now, they have to sell to cover the redemptions!  So while Wall Street might advise not selling to its mutual fund owners, the managers don’t have that luxury.  The question is, of course, what to sell?  Index funds have to sell evenly to keep their ratio’s the same as the index they are mirroring.  So for them they sell all companies, whether they are doing well or not.  The managed funds tend to sell their losers locking in those losses.  After all if you were reading a mutual fund prospectus you might be alarmed to see banks and investment firms represented.  So out go the out of favor industries and companies, no matter whether they might be good investments at current prices or not!

For those of us who are not in mutual funds, we can make individual decisions based on the fundamentals of each company we own, and not lock in losses unless we think the something has changed to make these companies prospects poor going forward.

For me, I will make no changes, since both Berkshire Hathaway and my REIT are actually up since September 1 and I see nothing fundamentally changing the prospects of these two companies.

Having control of one’s investments should be what folks strive for.  I have friends who have sold their equity mutual funds in favor of bond mutual funds inside their retirement accounts.  This is the only choice they have other than to go to a cash equivalent.  However, as the data demonstrates this attempt at market timing will fail.  Unfortunately, their choices are limited inside that retirement account.

This is perhaps the worst factor in the current strategies most people employ.  I am not a big believer in 401Ks and IRAs for two reasons.  First, you will most likely end up paying more taxes in the long run than if you invested outside of the tax deferred accounts.  But more importantly to the current situation, you are limited to what you can invest in and have to pay hefty penalties to get at YOUR money.  And I don’t want anyone controlling my money, especially not the geniuses on Wall Street! They got their bonuses, and what did you get?