September 2009

Showing newest 13 of 32 posts from September 2009. Show older posts

5 Investment Managers You Should Learn From

Legions of investment gurus beckon us to follow, but is anyone really worth our time and money? The most popular investor in the world is Warren Buffett, but is he really our best example? As Clare of Money Energy asks, why do we seek to emulate Buffett, and not other spectacularly successful investment managers? Does he deserve his oracle status? While you may not agree with all the differing styles, let's examine him alongside other legendary investors:

Warren Buffett

He has been turned into the icon of the American Dream. With his humble demeanor and aw-shucks attitude, he buys quality business for less than they're worth, where the market dominance of the firm creates a "margin of safety" in the stock. His problem is that many of his investments are in declining industries, where he could have sold the businesses and reinvested in better firms (see Dairy Queen).

He learned investing from Ben Graham, who first wrote about this margin of safety. But over time, Warren evolved from buying decent companies for dirt cheap to buying great firms for a fair price. Fortunately for him, he is now the buyer of choice for closely-held businesses, which gives him the right of first refusal for deals inaccessible to most managers. Unfortunately, missteps like selling index puts near the market highs have slightly tarnished his sterling reputation.

Other than heading a large firm and his status the world's richest man for a time, what makes him so endearing? The public swoons over his image as a humble, down-to-earth man making simple buys that the average investor believes they can imitate. His main strategy, on its face, is quite simple, but 20% returns over 50+ years is by no accounts easy.

David Swensen

Next to Buffett, Swensen has one of the best reputations today. He has managed the Yale endowment since 1985, garnering compounded returns of 14.5% even after a 25% drop in the last fiscal year. He advocates passive buy and hold allocations in a retail investor's portfolio, going so far as to recommend his own lazy portfolio:

- 30% in Vanguard Total Stock Market Index (VTSMX)

- 20% in Vanguard REIT Index (VGSIX)

- 20% in Vanguard Total International Stock (VGTSX) or (15% inVDMIX and 5% in VEIEX)

- 15% in Vanguard Inflation Protected Securities (VIPSX)

- 15% in Vanguard Short Term Treasury Index (VFISX)

However, his success at Yale doesn't lie in passive buy and hold. He is famous for moving beyond normal stock and bond allocations into alternative investments, including hedge funds, private equity, timber, commodities, etc. He may still buy and hold his investments, but he has access to the best alpha-producing managers in the world, and takes full advantage of their availability.

He argues that average investors should not try to pick investments, as they are hopelessly outclassed by institutions with the best analytics, talent and strategies.

George Soros

In short, his strategy is to ride massive global trends, and then capitalize on his belief in Reflexivity. Reflexivity is the concept that faulty belief systems create unsustainable trends. When the belief pervades the great majority of market participants, a low risk trade can be made in the opposite direction of the trend.

He is interesting in that his great desire is to be remembered not as an investor, but as a philosopher and philanthropist, donating funds to encourage democracy in eastern Europe, and proclaiming his theory of Reflexivity.

He is most famous for "breaking" the Bank of England, betting against the pound because of a faulty policy. His other most notable accomplishment is founding (with Jim Rogers) and managing the Quantum fund to average returns of 30% from 1970-2000. His strategies are much harder to imitate than Buffett's, as he bets on currencies, stocks and bonds all over the world, requiring a diverse economic acumen far beyond any normal investment manager.

William O'Neill

He is the founder of Investor's Business Daily, and one of the first to marry fundamental and technical analysis into the same stockpicking strategy. He advocates buying newer stocks with high earnings growth and low debt, but only if they have leading price action during a bull market. His most valuable lesson is the maxim of cutting your losses at no more than 7-8%. He writes detailed selling rules for all possible scenarios because he learned firsthand that it's not the winnings that make a great investor, but knowing how to take a loss.

In order to be successful with his strategy, one must keep a watch list of suitable stocks, waiting for a stock to reach a buy point. This point is supposed to be the least risky price at which to buy. O'Neill's strategy is popular because it presents the possibility for large returns while limiting losses.

Richard Dennis

It is very understandable if you have not heard his name before. Dennis traded his account from a few hundred dollars to $200mm. He is famous for creating the "Turtle Traders," a group of trend-following traders that he taught from scratch to become successful investment managers. He would trade any asset classes, but created rigid technical buy and sell rules that he followed religiously, trading breakouts in the direction of the current market trend. While his technical strategy was fairly simple, it required discipline that was very difficult for most people. He himself suffered large losses when he diverged from his strategy.

Are you willing to backtest strategies and follow the proven ones even when they underperform the market, in exchange for fantastic returns in the long run? Learn from Richard Dennis.

Conclusion

Regardless of style, you can learn from each of the above investors. Each is a master of their own style, a style that fits their personality and strengths completely. Buffett could never follow Richard Dennis, and Swensen could not be a George Soros. If you find an investment style you are comfortable with, stick with it at all costs.

A word of caution, though. How much of your life are you willing to devote to investments? If you are not willing to live and breath the markets, don't even think about global macro. If your emotions get the best of you, stay away from Richard Dennis. The easiest to follow would be Swensen, who as a master asset allocator does not trade individual assets, but instead works to diversify and find the best managers.

Do you think it is possible to emulate the masters, or is it purely luck that has made them successful? Are there any other managers that you believe are better than those above? Can any average person become a great investor?

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This post was featured in the Best of Money Carnival #19

Optimism Wins in Investing

Pessimists are often right. But that doesn't mean they are the most successful investors. Fear can prevent you from thinking objectively, and as we all know, crawling into the fetal position never helps anyone. As the investment truism states, "discipline trumps conviction."

David Merkel at the Aleph Blog writes some of the most thought provoking posts you will read, and if you don't learn something new in each post, you aren't trying. Here, he talks about not letting his economic view prevent him from investing in the market:

I told him (Cody Willard) about a hedge fund friend of mine who let his bearishness drive his macro bets over the last four years. The only thing that has bailed him out is that his analysts are really good stock-pickers… their fund has been in the plus column despite being an average of 25% net short, but not positive by much.
I tie my hands when it comes to asset allocation policy. After determining what I think the neutral policy should be for someone that I advise, I allow myself to tweak it by no more than 10% to reflect my overall levels of bullishness or bearishness. This keeps my emotions from taking over, and protects me and those that I manage for.
Besides, absent a major war on home soil, or a Communist takeover, markets have a tendency to eventually bounce back. (even if the bounce takes 25-odd years, as in the Great Depression). The question is whether one’s asset allocation is conservative enough to be around for the “bounce back.” So, it generally pays to play along with the optimists in the long run. Or, as Cramer has said, the bear case always sounds more intelligent. That can trap bright people who let legitimate fears of something that may happen a ways out get treated as a clear and present danger.

David is a value investor. He tweaks his portfolio mainly by the character of the business he invests in, currently tilting towards defensive companies. He also does not let the amount of cash in his portfolio get too high, by. While this is not a common strategy, it is very valuable to note that one cannot hide fearfully in cash, because in the long run, stock market returns will leave you behind.

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Cash on the Sidelines - Debunked

Do you think that all of this cash still on the sidelines is bullish for the market? That when investors deploy all the funds in money markets, the S&P 500 will be driven much higher?

Barry Ritholtz at the Big Picture takes umbrage at this, showing that money market funds increased their assets even as stock indexes climbed in the late 90's and again in the 2005-2007 runup.

His evidence:

Via Ritholtz.com

Julian Robertson - Interview from CNBC

As far as investment minds go, Julian Robertson is certainly up there with Buffett and Soros. He ran the hedge fund Tiger Management Corp. until 2000.

His primary investment theme deals with inflation and rising interest rates. For more information on this, visit the exceptional Market Folly blog. He also has much to say in the video about the risks to the US if Asia pulls back from financing our spending rampage.

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Even Rabbis Teach Diversification

Did you know that Rabbis teach diversification? In the Talmud, which is over 1500 years old, it was advised for a person to divide their assets into thirds:

One third invested in business

One third kept liquid in currency and coinage

One third in land and property

What does this mean to you? It means that keeping your assets and return streams diversified has been time tested and it works. In those days, those three methods encompassed pretty much all of the means of investment.

Business can correlate to the stock markets of today; there are good times and bull markets, and slow times and bear markets. Over time you will have positive and significant returns, but you cannot be assured of good selling prices at all times. If you are investing in the stock market, make sure to understand that this money is for the long term, and not to be accessed at the slightest whim.

As for land and property, these were the fixed income of the ancient world. The prices kept up with inflation, and provided a steady income from farmers and sharecroppers. This was less susceptible to the vagaries of fate than business, but provided a return on investment over and above cash and coins.

Lastly, coins and currency provided the liquid part of the portfolio. What this means to you is to always keep a portion of your investments available for emergencies, in case you need immediate access. Interestingly, money has always been able to earn interest from banks, even in ancient times (Matthew 25:27). However, ancient bankers did not have FDIC coverage, so you risked the bank failing, such as during the great Roman banking crisis of 33 A.D. Unlike today, however, if you kept your coins under the mattress then, the currency would not have lost value to inflation, as the coins were minted from precious metals.

Remember, diversification has worked since long before your time, and will continue to work long after we are all gone.

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Judging Stock Values by Bond Prices

Have you ever wondered about the best way to judge the fair value of stocks? Now, there's no magic bullet for this, as stocks spend a lot of time trading at prices that diverge from the real economic data.

Nonetheless, there is a much better indicator for how stock prices should trade - the bond market. There are much fewer retail or short term traders for bonds than in the stock market. You don't hear about market manipulation in fixed income. The traders and investors in the bond market are much more driven by the real economic data.

For instance, in stock prices can be affected by dividends and share buybacks, as well as mergers and acquisitions.

Now, fixed income investors are affected by the same issues of fear and greed as equity investors, but they generally do not drive prices to extremes of exuberance or depression. If we believe that bond investors have a better grasp of the economy, what are they saying now? Via the Financial Times:

The corporate bond market is now priced for 2 per cent real GDP growth, not 4 per cent...what if the stock market were pricing in the same 2 per cent growth rate the corporate bond market is discounting? Answer: 842 on the S&P 500. So, if you’re asking us if we think we will see a 20 per cent correction in equities, the answer is Yes. Sure, there could be another 100 points left in the S&P 500 from here to the upside in the near term, but it is seldom wise to chase an overvalued market to the top unless you are gifted enough to know when to call it quits.

The next question, naturally, is where Baa spreads should be trading if they were to align with the 4 per cent real GDP growth implicit in equity prices. The answer is: 200bps spreads over Treasuries, or about 100bps tighter than they are today

To reiterate, the equity market is overvalued and carries too much risk right now.

Do you still want to jump in with your retirement portfolio to the stock market at these levels?

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Investment and Personal Finance Linkfest - 9/25

Check out this week's linkfest, it includes ways to bolster up your financial defense, by cutting out the little purchases so that you can start maxing out your investments.

Once you start investing, make sure you have the desire and the perseverance to succeed, or else you will find yourself in trouble.

Personal Finance

Make sure your finances have a solid defense for tough times (Suburban Dollar)

The best ways to handle your tax burden for retirement (Evolution of Wealth)

Start your retirement investing early, even if you don't have much. (Get Money Energy)

Little purchases sure do add up over time (ManVsDebt)

Top ways to focus and prioritize your finances to get the best results (Bible Money Matters)

Life lessons learned from immigrant parents (Wisebread)

Is college education worth the costs these days? (Sound Mind Investing)

Investing Links

Desire and perseverance are key in improving your investment ability (My 10,000 Dollars)

How to interpret the latest Fed statement (Aleph Blog)

How to get busted for insider trading, the easy way (The Reformed Broker)

Peter Schiff thinks gold is going to hit $5,000 in the next couple of years (Crossing Wall Street)

Economic Data

Home sales have increased for the 4th consecutive month (MyLifeROI)

Lots of people embracing the "Staycation" (Econompic Data)

Lower jobless claims are evidence of recovery (BespokeInvest)

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Play Where the Puck is Going to Be

Have you heard this Wayne Gretzky quote? - "A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be." This is every bit as applicable to retirement investing as it is in hockey.

Most investors live in the present and recent past, and not in anticipation. In psychology this is called Recency Bias. this causes investors to chase a market that is already gone. An investor will see the market going up day after day, and thinks "This is going to leave me behind, I can't miss out on this!" Then they chase and buy stocks, not remembering that they can't realize gains that have already taken place.

A similar case happened in 2008 and early 2009. The market fell more than any time in recent history, even more so than the tech stock crash at the beginning of this decade. My own mother asked me several times if she should move all of her savings into stable funds to avoid the downturn. Investors panic and sell off their stocks, because they just want all of the volatility to stop, and make the pain go away.

How Great Hockey Translates into Great Returns

The fact is, you need to play where the puck is going to be. Know that stock market returns after large declines are historically much greater than average. If you were the great investor of Gretzky's mold, you would have put more money into stocks, not less, when the market sank day after day as if it would never recover.

You need to have a plan to invest. When the market has rallied 50+% in the last few months, you need to take money out of stocks, not increase your stock allocations. Sure, stocks may continue to increase, but the biggest returns are over, and you will not get the 50% back. Would you rather buy stocks after they have rallied, or before?

In the end, you need to have a plan. What will you do if the market declines 20% from today's levels? What will you do if it gains 20%? If fair value is 880 for the S&P 500 per Jeremy Grantham (worth listening to), then right now when the S&P is at 1070 you should stay underweight on equities. If the market continues to increase, take some more stocks off the table and move them to safer assets. When the market declines to fair value and below, increase your asset allocation to stocks to equal or higher than your target percentage.

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Reflections on This Blog's 1st Month

In the last week, Retirement Savior finished its first month of posting. There are several things I have learned:

Building credibility with your audience and other bloggers takes time.
The blogging community is fraternal and seeks to help each other reach their goals. The bloggers I have met are quite helpful and are unselfish, kind people. I think that success in blogging follows these types of personalities.
Your blog needs a niche to succeed.
Blogging takes perseverance and drive, especially when the popular posts may not be your best ones, and your best material can languish.
You learn more by writing a blog than reading one.

What is our niche?

This blog's niche is to help the average investor achieve early retirement. The main topic this blog discusses is investing strategies to help you beat the market and achieve early retirement. The vast majority of personal finance bloggers advocate debt reduction and passive indexing. Some post a little about beating the market, but none have it as their main focus. They are much better than I at discussing debt and saving. And passive indexing is a very responsible action that the average person should implement if they do not want to tend to their portfolio like a garden (with continual care). If you venture outside passive indexing to achieve better returns, you need a guide. And through these waters is where Retirement Savior will lead you.

What has RS achieved in its first month?

The biggest accomplishment so far is a feature in Wolfram Alpha about my retirement calculator post. This has more than doubled the visits in the past few days, and has been a shot of credibility from an incredible search engine that could normally take quite a bit longer to earn.

I have written guest posts for Personal Dividends and Free Money Finance (to be published this Saturday).

The easy work of getting into the top 1mm in Alexa has been done (Just the 1 month average that is, hoping now that it stays). Moving up from here will take a lot of work, networking and patience.

I hope that you have enjoyed your visits to Retirement Savior, and that you will come back soon to see what is happening in this community. If you enjoyed this post, please subscribe to my RSS or email feed and have the latest posts sent straight to you!

Index Funds - When NOT to Use Them

Summary: There are still some mutual funds that outperform, and you can grow wealthier by using them instead of index funds.

You have heard here in the past, and from most of my counterparts, that index funds and ETFs are the way to go, and to do otherwise is a fool's errand. Index funds have lower costs, and will beat the majority of mutual funds over time.

There are myriad reasons why most mutual funds underperform. The fact is, mutual fund companies are primarily asset gatherers. They do not benefit from outperformance, unless it gains them assets. They only get revenues from assets under management, not their performance. Investors being the herding animals that they are, if a fund outperforms most years and then has a bad year, money will pour out of the fund like a leaky bucket. The CEO, being a good businessman (or woman), will recognize that the most profitable way is to try and immunize the fund from underperformance. The solution is to make sure that your fund keeps up with your competitors. For example, if the rival funds are piling into energy stocks, you had better have the same exposure, or risk being left out. In the end, funds mimic each other so that they don't risk losing clients.

Also, financial advisors are more concerned with keeping their clients in the correct Morningstar style box for diversification than in creating the highest possible terminal wealth. That is why the best managers that go anywhere for returns are penalized by Advisor Joe, CFP who is only concerned with whether a fund can be labelled large value or large growth. Advisor Joe would much rather put you in a bloated, underperforming fund with a static mandate than an outperformer that disregards style boxes.

How can you profit by this? Look for these characteristics:

DO NOT USE massive, bloated funds. If a manager outperforms frequently, and their fund increases in size from a few hundred million to 10+ billion dollars, the fund is much less likely to outperform (i.e. Fidelity Contrafund). The smaller the fund, the better.
Look for funds that are not "closet indexers." If it performs like the benchmark index every year, disregard.
Find funds with a history of outperformance. The best managers, regardless of style, outperform over longer timeframes.
Select managers that are not concerned with fitting a particular style box and invest based on a theme, such as future inflation.

Do you want an example? Hussman Strategic Growth picks quality stocks that the manager (Hussman) believes will outperform. Then he hedges the portfolio (incrementally removing the stock market risk) based on his views of how cheap or expensive the stock market is at the moment. If stocks are cheap (based on historical average valuation) and the market has positive momentum, there will be little or no hedges on the portfolio. If stocks are expensive and the recent market action is poor, the portfolio will be fully hedged.

Another example is CGM Focus by Ken Heebner (underperformed in this bear market, but overall a good fund) that doesn't correlate highly to the stock market.

Just remember, if you want a solid portfolio without much effort, just use indexes and forget about it. But if are willing to put forth the effort, there are opportunities in mutual funds.

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Weekend Linkfest - 9/19

Here are some insightful articles from the week. What are your thoughts about these?

Investing

Don't listen to get-rich quick strategies, listen to those who tell the truth (Options for Rookies)

The Endowment Model isn't broken at all (Absolute Return + Alpha)

Buying calls to hedge your portfolio in a stretched market (Investing with Options)

90% of new money into mutual funds its not going into stocks (Fund my Mutual Fund)

Retirement

4 common mistakes with 401k's (Redeeming Riches, also Consumerist)

How to rollover a 401k to an IRA (Oblivious Investor)

Don't let saving for retirement leave you susceptible to emergencies (CNN Money)

Miscellaneous

Funniest blog name I just found - Punch Debt in the Face

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Calculate your Retirement Needs

Do you want to know ahead of time how much you will need for retirement? It can be extremely easy to make a rough calculation (if you have more time, you can check out the best retirement calculator on earth).

Business Week (via Div Guy) had an article where an investment strategist discussed asset to salary ratios. Basically, this is based on how much you think you will be making at retirement, and then using that figure to show how much savings you will need.

Hammond's calculations start with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years. He states corporate employees with higher income might need 60% from their 401(k)s, with Social Security filling in the extra 10% gap. The wealthier you are, the smaller the percentage of retirement income Social Security will contribute.

How will you know if your nest egg will cover 60% of pre-retirement income once you stop working? If you're 35 and plan to retire at 65, you need 2.1 times your salary to be on track. By 45, you had better have 3.6 times. At 55, the multiple rises to 5.4 times. And by the time you retire, you'll want it to be 7.7 times.

Of course, there are some assumptions built in to Hammond's formula. He assumes a 10% contribution rate, including any employer matching contributions; 4% salary growth, a bit ahead of inflation; a 6% return on investments; and a 25-year retirement period to finance, which would be paid for by purchasing a low-cost annuity at retirement. Those are relatively conservative assumptions—except, perhaps, the 10% contribution rate.

So let's work out an example:

You assume you will be earning $100,000 per year when you retire. Then according to Hammond, you would need $770,000 to retire on. That seems a bit low to me, especially if Social Security will be reduced in the 2040's (as noted in the letter sent to me from the Soc. Sec. office) by about 22%. But it's a good back of the envelope calculation tool, and one that you can update as you age.

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Market Most Overbought Since 1983

Via BespokeInvest, the stock market is above its 200-day moving average by more than any point since 1983.

I'm not saying this means SELL, but it sure does mean don't pile everything you own into stocks because you are scared the bandwagon has left you behind. Believe me, it has already left you, and you can't get it back.

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