I take a break from fiduciary exhortion to remind strangers of my morbid Aspect. The weak hearted, stomached, or minded ought to skip this fantasy. The ultimate image is beautiful only in efficiency and I pull no punches. I expressed a theory of execution long ago based on ‘mercy.’ Most executions foul because they concentrate on killing the body to suffocate the brain. Thus, let us attack the brain directly. For a long time, I concluded a grenade to the face would act quickest, in addition to being awesome. Movie executions are always dull affairs: the audience looks at the man strapped down go woozy and die. (Real lethal injection takes ten or so minutes. Let’s watch paint dry, eh?) But, the criminal’s family does deserve a corpse to unsettle them at a proper funeral. Just looking at a closed casket makes it an object by force. Much better to let children come to that conclusion from the waxy discolored skin and mom refusing to glance in. I’ll compromise and offer a method that saves face for us both.

Recall the Egyptian mummification ritual. They didn’t want people to rot, so they drained fluids and removed the bacteria laden offal (organs). I bet you remember the next part. If you don’t, a middle-schooler does. The next step is one of those facts the teachers tell to shock everyone awake and show, “hey, History is cool.” The priests slid a hook up the nasal cavity and dragged out the brain. I do not pretend that would shock the assembled lawyers, bailiffs, and estranged relatives less than vaporizing the whole head. It merely suggests an entry point.

I suggest the state officials apply local anesthetic to the sinuses, and then slide a power saw with a fork on the end up hiser nose. When the shmuck who drew the short straw turns it on, the reciprocating action of the spatula will scrape many parts of the brain at once. This ensures quick death because each sweep crushes memory sectors, motor sectors, and sensate sectors in the space of half a second (depending on motor speed). Five sweeps turns Timothy Macveigh into a man shaped accumulation of muscle and harvestable organs. Without prep, the procedure takes all of ten seconds; half are sliding the prong in and out. With a shorter suspense period and an obvious climax, perhaps the audience may actually achieve catharsis and closure.

Climax presents a social problem that explosive extinction avoids. Since the tool essentially stimulates the neurons (or possibly their connections) whilst being slid in, the convict will experience several types of activation. The prefrontal cortex renders a flash of memory or amnesia. The amydaglia could hemmorage all sorts of hormones that exacerbate massaging the Hippocampus. Shhe may spasm a bit depending upon the dilution of the anesthetic. On the upside, the last moment could be cross-sensory, hearing flavors or feeling the heat of a sound. That seems like good preparation for a great beyond that does not resemble Maya. But a truly novel experience before oblivion would be a nice, pyrrhic gift.

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Core Asset Classes

Domestic Equity

Stocks are what economists call equity. I admit the price fluctuations of stocks are rather occult to me; perhaps, because I willfully expect it to be more complicated than it is. Ordinary stock emphasizes voting rights; preferred stock emphasizes dividend entitlement. Obviously, daily fluctuations reflect the beat frequency of individuals (and mutual funds) trading their shares amongst each other. Good and bad news also present intuitive behavior. Because of improvements in assets and market share, we expect the value of the company to increase and so the value of its dividends. Sometimes though, the company’s employees fail and must liquidate or file bankruptcy. In that event a corporation first settles the claims of its creditors, then bondholders, and finally preferred then common stockholders.

My notes indicate Swenson next described the link between inflation and stocks. I do not remember exactly what happens when inflation increases. My unsold macroeconomic textbook says that the price increases as people hope to ride the train to the top. That seems reasonable and means stocks are no hedge at all.

Swenson is big on revealing the alignment of interests. By this, the potential investor knows whether the other people influencing the value of the asset will contribute or sap its value. Another author I value highly parallels this reasoning in identifying the consequence in governance depending upon whether a proprietor (king), employees (bureaucrats), or customers (tax payers) own the government. Which one a particular company imitates depends upon its ownership. A board of directors with a majority stake acts as proprietors and self-indulge. The mild conspiracy theory that corporations control legislation in their favor (to reduce costs to themselves) approximates a customer controlled government. But, a board of directors often does not possess a majority stake any longer and elected board members merely administer the company. James Dale Davidson describes the consequences in The Sovereign Individual thusly:

First and foremost, employee run organizations tend to favor any policy that increases employment and oppose measures which reduce jobs. As [Fredrick C] Lane put it, “When employees as a whole controlled, they had little interest in minimizing the amounts exacted protection and none in that large part of costs represented by labor costs, by their own salaries. Maximizing size was more to their taste also. A government controlled by its employees would seldom have incentive to either reduce the costs of government or the price charged to their customers. However, where conditions impose strong price resistence, in the form of opposition to higher taxes, governments controlled by their employees would be more likely to let their revenues fall below their outlays than to cut their outlays. In other words, their incentives imply that they may be inclined toward chronic deficits, as governments controlled by their proprietors would not be. (Davidson 122,3)

Stock options represent such a policy. Sometimes, a company rewards employees with company stock rather than money. In this fashion, it reduces the ledger since the employee will resist selling in hope of profit. To my understanding, some corporations do not buy back the stock from the market but inflate the supply.

Corporate philanthropy may indirectly benefit in good will. Some liberal investors created a trend toward favoring these companies, the ‘socially responsible’ school of investment. A concern for eventual return, though, finds a barrier of exclusivity. A million dollars donated to a public good elsewhere represents a million dollars the company has effectively squandered. The financial effect is real, opinion of the social effect remains the reader’s purview.

US Treasury Bonds

Every election features at least one proposition for a bond, a loan with taxpayers and others as creditors to the California government. The federal level also offers bonds, but with a much better risk profile. These, unlike every other bond, are not callable: the treasury has promised never to default on its bonds. This makes them the best bonds available, provided they fit the portfolio’s characteristics.

One factor in determining their value is the interest rate risk. As the duration of the bond increases, the debtor offers a greater premium rate in return. Recent events prompted the Federal Reserve board to reduce the lending rate, and thus the interest rate on bonds, to one percent. Obviously, this is a crap time to buy new bonds, no matter the duration. The makeup of the board influences this risk but is unknowable until it changes.

Despite the sometime danger of offering a poor return, bonds act as a strong diversifying asset. Once purchased, the bond represents a known return independent of conditions. This secures a segment of the portfolio’s principle against erosion.

We can purchase bonds on the primary or secondary market. The primary market matches the Treasury with creditors. Creditors trade with each other on a secondary market. For a time, I couldn’t figure out why someone would give away a sunk cost for less than the ultimate return. (Urgent cash flow obviously)  The Federal Reserve often combats inflation with lowered rates (as we well know). Thus, bonds are one step behind inflation. The secondary market acts as a futures market to the bond rate.

Because the federal government prohibits itself from calling the bonds, it can not act against the interests of the bondholder once sold. Whether the Reserve board keeps the rate up or down depends upon the ideological makeup of the board reacting to conditions.

Inflation Linked Bonds

The Treasury also sells bonds that maintain stable Real value. The technical quantity of the return may vary, but the worth will be equal in terms of inflated money. Investors with very short timescales can use this asset to staunch the bleed of a dry time. Again, the law forbids calling the bond.

Foreign Developed Equity

The rest of the First World’s corporations beckon as diversifying tools. While the business cycle plays universally, other locales march offbeat. Typically, this involves Canada, Europe, and Japan. Unfortunately, investing in other markets involves the bane of travelers everywhere: currency exchange. The markets could be as stable as America’s but the currency racket jacks up the risk anyway. I do not recall how the exchange rate reacts to changing inflation. Likely it works the same as it does for imported cars (in case you know how that works).

The foreign company has the same conflicts as domestic corporations do. Likely, a foreign investor ranks even lower in the pecking order in case of failure. The exchange rate represents the different tariff rates the respective governments set up.

Emerging Markets Equity

The rest of the world emerges, China and India’s popularity notwithstanding. The same dangers that foreign developed equity presents are here but more so. The currencies of these markets vary more often or present a greater cost. Company failure means the investment evaporates. (Nationalization means the investment evaporates.) Yet, the emerging corporation retains the same mystique of venture capital. Because of great opportunities for growth, the risk may bear a superordinary profit. This class of asset ought not represent more than five percent of a portfolio because the risk is so great.

Real Estate

Real Estate represents the single greatest investment a majority of Americans shackle themselves to. Of course, most restrict themselves to a single home. Only the luckiest get to rent a second home and battle as landlord. Investors have another option, buying REIT stocks. REIT acronyms real estate investment trust. A corporation buys some commercial property (office space, malls) and rents it out. Swenson here explained the risk and return characteristics; but, I do not remember them. I suspect the market runs its own cycle on a beat pattern related to certain classes of businesses.

I admit I do not remember content for this chapter which finished describing prices and inflation, alignment of interests, and market characteristics. I also feel like I present a poor presentation of his clarity, mostly because the Tustin library’s copy remains abroad. To somewhat compensate, I offer a link that I found at the time to support the argument.

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Two months before I could fund my IRA, I read five books about investment: This isn’t your Parent’s Retirement, Yes you can get a Financial Life, S&P Guide to Personal Finance, How to Make Money in Stocks, and Unconventional Success. I unreservedly recommend David Swenson’s Unconventional Success to anyone who has or will invest hiser savings. He treats the subject comprehensively without over-elaborating. To display why, I modeled the rest of this article after his book. I use his chapter and section headings as they appear in the text. I shall simulate his argument and reasoning as well as I remember it. Ten or so months have elapsed since I originally read the book. Also, I forbear explaining some elements to speed publication of this article. Where relevant, I reference the other authors’ advice.

Before I imitate his organization I must clarify who David Swenson is. My mother invited me to an investing seminar four years ago that unfortunately hid a sales pitch. I do maintain one memory from the spiel: don’t believe anyone’s financial advice unless shhe is a millionaire. I do not know his personal net worth. Instead, I cite Wikipedia’s entry about him:

David F. Swensen has been the Chief Investment Officer at Yale University since 1985. He is responsible for managing and investing the University’s endowment assets and investment funds, which total about $22 billion. Realizing an average annual return of 17.8 percent on his investments over the last ten years,[1] Swensen has added more than $16 billion to Yale’s coffers, and his consistent track record has attracted the notice of Wall Street portfolio managers.

Sources of Return

Fundamental Investment Principles

Investing our money in banks and CDs serves for a liquid store of money. However, an investor trades easy exit for an increase in return. Equity (stocks) offers the greatest return over the lifetime of an individual. As long as the portfolio remains independent of liquid demands (ie before you retire), it should be biased toward equity assets.

However, any particular stock will exhibit idiosyncratic behavior. Relying on any particular stock involves an inordinate risk compared to the stability afforded by diversification. Often this advice limits itself to buying stocks of companies of different industries. Swenson considers this unhelpfully narrow since, in aggregate, most companies in a single economy will approximate the performance of the whole. The best strategy involves diversifying the types of assets you invest in. That way bonds can keep the mean up even if real estate underperforms (or whatever).

Market Timing

The truism has been altered (by an author I have forgotten) to “buy lower and sell higher.” The day-trader lives by that creed in trying to time sales and purchases to reap a large return. Unfortunately, you have no chance of exploiting this aspect any more than you can beat the house at gambling. Brokers encourage the gullible with real-time quotes because we pay a commission every time. Frankly, without dedicating sixty hours each week to research, an individual investor plays with someone else’s loaded dice. Far better, in this case, to concentrate on the long time frame to allow slower returns to accrue.

Security Selection

The first thing I worried about when I decided that sipping at my credit union’s CDs was too inefficient was which stocks I should buy. I knew to trust virtually no one but allowed myself to defer some judgment to the January issue of Fortune 500 magazine that recommended thirty different stocks and five mutual funds. Soon after, I began reading these investment books and saw my fallacy. Remember diversification? It flatly contradicts the concept that security selection has any appreciable return value commensurate to its risk. Leave stock selection to professionals to beat their wallets against. All boats rise with the tide anyway.

This isn’t your Parent’s Retirement agrees somewhat. The author presents a list of seven mutual funds of the different sizes (small, large cap) and orientations (growth, balance, and value) and tells the reader to invest in those exclusively until shhe has deposited one million dollars. Only then should the dutiful student dare venture into individual securities (and he provides a hundred item list).

Tax Sensitivity

Large returns are meaningless unless you can keep them. The government suffers a few limited paths to escape windfall taxes. We can invest using a tax deferred account, like a traditional IRA, Roth IRA, or a 401(k) plan. A traditional Individual Retirement Account allows the individual to annually deposit 5000 dollars (as of 2008) into an account using money already taxed. When the retiree withdraws the money and potential profit at the age of seventy, it is not taxed. An exception exists; people can draw from an IRA to pay for a first house. The Roth IRA allows the tax payer to deduct the deposits from his income, but taxes the withdrawals later at the capital gains rate. The 401(k) requires an employer’s participation, so I did not research it.

Capital gains taxes present a thorn for the investor. If a citizen sells a security before a year and a day have elapsed, the difference constitutes ordinary income (or a deduction if a person suffers capital loss). However, selling after this period invokes the capital gains rate instead. Before 2003, this was 15%, but is now 5%. Dividends, unfortunately always manifest as ordinary income. This introduces a sometimes importune tax slap even as a mutual fund does badly and may have saved itself as a tax deduction. (as some complained this year)

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For some reason, the (server? blogspot?) did not keep the original post, so here it is again. Unfortunately, I lost the link below. Luckily for you, I noticed the graph did not show the vertical axis and corrected it.

I receive the Wall Street Journal in common with Rick, so I have opportunity every day to know how badly our country fares. Unlike most though, I almost welcome the recession. Almost only because I have completed my Stock Odyssey for the year and lament that I did not wait until now to invest. So I encourage you, who are not retiring today and likely have not invested at all, to get a toehold now before mutual funds start to recoup their losses and push up the average price.

Do as I did: fully fund your IRA this year while the return will be greatest. You are only taxed on its current value and brokers are generally forbidden to touch your money. The amount is not great, 5000, but that puts it within the means of my peers. I made the mistake of assuming the general worry in April (when I bought in) signaled the bottom was a month away. My paper loss today shows I was gravely wrong, but you are not inappropriately hopeful in expecting that the market is deeply discounted today.

Every investment book speaks of the ‘black magic of compounding interest.’ This is a sometime truth. If you leave money in a bank, they give a pittance in interest. The only way to live off the surplus involves entrusting the firm with several million dollars. Alternately, the advice turns to the growth in a dollar invested shortly after the Great Depression. [Find out the numbers later.] But, much of the increase comes from dividends reinvested into shares. The simplest means of reaping an increase in value is to snatch a patch when the market is well and truly down and sell later when the firms are in their cups, soon to recognize their hubris (2001). You have heard the expression before, “buy low, sell high.” Now is Low; now is the time to strike.

Perhaps, your thoughts run like my father’s: why invest now if American industry (and services) will not recover for two or more years? What if the companies I invest in fail and my money evaporates? Your logic, Nicholas, wouldn’t count for much then. I invest in ETFs, which do not represent a particular company. The concept approaches a mutual fund without any of its administrative conflicts of interest. Further, some already react to the opportunities I identify. Granted, any gains exist conditionally until after the quarter declaration of profits. This presents no problem. No one sweats the fourth quarter because the winter solstice celebrations encourage consumer participation.

Any broker will tell you all I have said above, which arouses my father’s suspicions. So, I unveil math in defense. I have kept track of not only the value of my portfolio, but three others as well to illustrate my argument (and other aspects I will explain another time). Behold:

The dark blue line represents most of the world market. I invested in ETFs that have most every stock in America, Eurasia plus some other Americas, real estate, and bonds. SPY is an ETF that tracks the S&P 500, I use it to test the marginal returns of diversity. (As you can see in the trends, they are mostly the same. The green line is a mutual fund that Fortune 500 magazine recommended in January as an exemplar purchase. The “undiverse” portfolio holds about eight single company stocks recommended in the same issue. The light blue line in the top right corner exists to mock us both. It represents the value of a portfolio with the same ETFs I chose, but purchased a week or so ago.

My portfolio: VTI, VEU, VNQ, TLH, IPE

Undiverse portfolio: ERTS; DNA; GE; PZE; GLD; POT; YUM; AAPL

While I hope you devote some time to searching for a suitable investment plan, I know this tirade concludes rather than informs. I will describe my own journey and tribulations in financial purgatory in subsequent posts. The sale, though, will end before I finish. I implore you to fully fund an IRA as soon as possible. The investment guide I (will) wholeheartedly recommend is Unconventional Success by David F. Swensen.

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