Reaching Consensus

September 22, 2019

by Steve Stofka

In the early 1980s, scientists at NASA raised the alarm that much of the protective ozone layer over Antarctica was missing. Newspapers and TV carried images of the “ozone hole” (Note #1). In 1987, countries around the world enacted the Montreal Protocol and banned the use of aerosols and chlorofluorocarbons (CFCs). There were some arguments and a few AM radio talk show hosts called the ozone hole a scientific hoax. However, most of the world reached consensus. There will always be crackpots who ride backwards on their horse and claim that everyone is lying about what lies ahead.

Compare those days of yesteryear with today. We have a wide array of media and information outlets. People who can’t make change are self-proclaimed experts on climate change. The Decider-in-Chief can’t reach consensus with himself for more than a day. A slight breeze changes his opinion. Intentionally or not, he has become the Anarchist-in-Chief.

The younger generation is quite upset because they will have to live with the consequences of climate change. The fat cats who make their money proclaiming climate change is a hoax will be dead. Next week there’s a climate summit at U.N. headquarters in NYC. A lot of young people demonstrated in cities around the world this past Friday to let the world know that they are concerned. That’s consensus.

What happened to us in the past thirty years? It’s tougher for us to reach consensus about guns, immigration, climate change, women’s rights, and health care to name a few. Let’s turn to a group of people whose job it is to craft a consensus. In a recent Town Hall Supreme Court Justice Neil Gorsuch pointed out that the nine justices reach unanimous consensus on 40% of the 70 cases that they decide each year. Only the most contentious cases make it to the Supreme Court. 40% unanimity means they agree on many principles. 25-33% of their cases result in a 5-4 decision. Those are the ones that get all the attention. The nine justices who currently sit on the Court were appointed by five different Presidents over the past 25 years. Despite the changing composition of the Court over the past seventy years, those percentages of unanimous decisions and split decisions have remained the same.

Let’s turn to another issue concerning consensus – money. Specifically, digital money like Bitcoin. Some very smart people believe in the future of Bitcoin and the distributed ledger concept that underlies digital money. In this podcast, a fellow with the moniker of Plan B discusses some of the econometrics and mathematics behind Bitcoin (Note #3). However, I think that pricing Bitcoin like a commodity is a mistake.

I take my cue from Adam Smith, the father of economics, who lived during a time and in a country with commodity-based money like gold and silver. Unlike today, paper money was redeemable in precious metal. However, Smith did not regard gold or silver as money. To Smith, the distinguishing feature of money is that it could be used for nothing else but trade between people. Money’s value depends exclusively on consensus, either by voluntary agreement or by the force of government. Using this reasoning, Bitcoin and other digital currencies are money. They have no other use. We can’t make jewelry with Bitcoin, or fill teeth, or plate dishes as we can with gold and silver. The additional uses for gold and silver give it an anchoring value. Bitcoin has an anchoring value of zero.

When people lose confidence in money, they lose consensus over its value. Previous episodes of a loss of confidence in a country’s money include Zimbabwe in the last decade, Yugoslavia in the 1990s, and the sight of people pushing wheelbarrows of money in Germany during the late 1920s.

Like gold, Bitcoin must be mined, a process that takes a lot of electricity and supercomputers but does not give it any value. Ownership in a stock gives the owner a claim on the assets of a company and some legal recourse. Ownership of a digital currency bestows no such rights.

In an age when we cannot reach consensus on ideas like protecting our children at school or the rights a woman has to her own body, we seek consensus with others on more material things like Bitcoin. We seek out information outlets which can provide us with facts shaped to our perspective. When facts don’t fit our model of the way things should be, we bend the facts the way water bends light.

John Bogle, the founder of Vanguard, died recently. He was an advocate of investing in the consensus of value about stocks and bonds. Now we call it index investing. That’s all an index is – a consensus of millions of buyers and sellers about the value of a financial instrument. There are several million owners of Bitcoin – a small consensus. There are several thousand million owners of SP500 stocks. That is a very large consensus, and like a large ship, turns slowly in its course. A small ship, on the other hand, can zip and zig and zag. That’s all well if you need to zig and zag. Many casual investors don’t like too much of that, though. They prefer a steadier ship.

I do hope we can move toward a consensus about the bigger issues, but I honestly don’t know how we get there. In 2008, former President Obama called out “Si, se puede!” but quickly lost his super-consensus in Congress. “No, you can’t!” called out the new majority of House Republicans in 2010. We’ve gotten more divisive since then. Journalist Bill Bishop’s 2008 book “The Big Sort” explained what we were doing to ourselves (Note #4). Maybe he has an answer.

In the next year we are going to spend billions of dollars gloving up, getting on our end of the electoral rope and pulling hard. Our first President, George Washington, was reluctant to serve a second term. Hadn’t he given enough already? In our times, each President looks to a second term as a validation of his leadership during his first term. There’s that word again – consensus.

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Notes:

  1. Images, video of the ozone hole in 1979 and 2018 from NASA.
  2. We the People podcast from the National Constitution Center
  3. Discussion of bitcoin on this podcast
  4. The Big Sort by Bill Bishop

Saving Simplicity

November 25, 2018

by Steve Stofka

Many individual investors understand the importance of saving something for retirement. In decades past, workers with mid to large companies were covered by defined benefit pension plans. The term “defined benefit” meant that a worker could expect certain income payments in retirement that would supplement Social Security. The “wizard” that made those pension payouts was hidden behind a curtain. Two employees working for the same company at the same job for the same amount of time were entitled to the same pension payout.

In the past thirty years, companies have transitioned to a “defined contribution” plan. The company puts some defined amount in a tax-advantaged retirement account for the worker. Each worker can choose from a menu of investment choices. Two employees working at the same job for the same amount of time will have different amounts in their retirement account.

Workers now have choices, but with choice comes clarity or confusion. There are so many terms to understand. The distinction between an account, a mutual fund, an ETF and a security is unclear. An account at a mutual fund company like Vanguard or Fidelity might contain several types of securities. On the other hand, the same security might be held under two different accounts at Vanguard or Fidelity. No wonder some investors throw up their hands and wish that the wizard would have stayed behind the curtain!

I’ll try to clear up the confusion and create a top down hierarchy. People belong to the group of legal entities. Those entities can be account owners. An account owner has an account with an account holder, a financial trustee or custodian. Vanguard, Fidelity, or Charles Schwab are included in this group. Accounts come in two flavors, tax-advantaged and taxable. Accounts have securities. There are two types of securities, equity and debt, but for simplicity’s sake, let’s deal with that another time.

Let’s go down the hierarchy like a person might do with their family tree, only it’s going to be much simpler. Mary Smith is a legal entity. She is on the top line. Mary Smith is an account owner with Vanguard, Fidelity, and U.S. Bank. That’s the second line.

On the third line or level, Mary Smith has two accounts with Vanguard. One account is tax advantaged – a traditional IRA, Roth IRA, SEP-IRA, 401K, and 403B, for example. The other account is taxable. She has a tax-advantaged 403B account with Fidelity, and a tax-advantaged traditional IRA with U.S. Bank.

Each of those accounts holds one or more securities. That’s the fourth line. Here’s a chart of the hierarchy.

InvestHierarchy
The Vanguard IRA has two securities – a SP500 index fund and a bond index fund. The Fidelity 403B employee retirement account has one security – a balanced fund. The IRA account at U.S. Bank has just one security – the CD.

Each of those securities except the CD holds a basket of securities. That’s the fifth line, but let’s put that off to avoid complications.

There are two type of accounts: tax-advantaged and taxable. Tax-advantaged accounts include traditional IRA, Roth IRA, SEP-IRA, 401K, and 403B. All accounts incur a tax liability for income payments or capital gains – changes in the value, or principal, of the securities in the account. For tax-advantaged accounts, the taxes are deferred or forgiven (Roth IRAs) on the dividend income and capital gains.

Almost anyone can open an IRA, traditional or Roth. If you have not opened one up, think about it. Account custodians often waive a minimum deposit to open an IRA as long as you make an initial commitment to a regular contribution schedule.

Expectations

by Steve Stofka

December 3, 2017

What can I expect from my portfolio mix? Portfolio Visualizer has a free tool  to analyze an asset mix. We can also get a quick approximation by looking at a fund with that mix.
An investor with a 40/60 stock/bond mix might go to the performance page of Vanguard’s Wellesley Income fund VWINX. It’s 50-year return is close to 10% but that includes the heady days of the 1970s and early 1980s when both interest rates and inflation were high. The ten-year performance of this fund includes the financial crisis and is close to 7%.

An investor with a slightly aggressive 65/35 stock bond mix could look to Vanguard’s Wellington Fund VWELX, which has a similar weighting. It’s 90-year return is 8.3% but that includes the Great Depression and WW2. It’s 10-year return is – wait for it – close to 7%.

Two funds – a conservative 40/60 and a slightly aggressive 65/35 – both had the same ten-year returns. All it took was one bad year in the stock market – 2008 – to even up the returns between these two very different allocations. On a year-by-year comparison of the two funds we see a trend. During the two negative years of this fifteen period, I charted the absolute value to better show that trend. Also, compare the absolute values of the returns in 2008 and 2009. The collapse and bounce back was about the same level.

VWELX-VWINXComp

During this fifteen year period, the cautious mix earned 88 cents to the $1 earned by the slightly aggressive mix. Looking back thirty years, cautious made only 75 cents. In the past fifteen years, the difference between positive and negative years was important. In good years, cautious earned 20 cents less. But in negative years, like 2002 and 2008, cautious made 73 cents more by losing that much less.

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Personal Saving Rate

The savings rate is near all-time lows. We’ve seen a similar lack of caution in 2000 and 2006. As housing and equities rise, families may count those gains in their mental piggy bank. Asset gains are not savings. Asset prices, particularly equities, will decline during a recession. Jobs are lost. Without an adequate financial cushion, families struggle to weather the downturn. The rise in bankruptcies and foreclosures further exacerbates the downturn.
SavingsRate1998-2017

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Annuity

A good explanation of the various types of annuities.  The graphics that the author presents might help some readers understand the role of annuities, and the advantages of deferred vs. immediate annuitues.  I have also posted this on the Tools page for future reference.

http://www.theretirementcafe.com/2017/11/income-annuities-immediate-and-deferred.html

A Decade Of Change

June 25. 2017

This week I will review a decade of change to help illustrate a fundamental fact about investing:  most of us are clueless about the future because we are bound by comfortable habits of thinking.

Ten years ago this month, June 2007, Apple launched the iPhone. The touch screen was innovative but I found the keyboard had a lack of responsiveness. The ability to use the internet was cool but the connection was slow. There was no camera built into the phone. Cameras took pictures, not phones.  Apple did not introduce the App Store till July 2008 so users got whatever Apple thought they needed. Apple controlled both the hardware and software. People stood in line when the first phone was released because Apple people are a little bit nuts. The phone was suitable for geeks who had money to burn.  Or so it seemed.

Phones were tools, not toys. People who used their phones for work used a Blackberry, a phone with a keyboard that kicked butt over the iPhone and had a great email interface to boot. The low cost workhorse phones were Nokia models. They stood up to daily wear and tear and the little screen was adequate for reading text messages.

The previous year, a relatively new company called Facebook notched 12 million monthly users (Guardian) and their user count was growing fast. Facebook was a social networking site for people who had time on their hands and the desire to connect with their friends. A passing fancy for the kids, no doubt, just like rock and roll was to an earlier generation of parents.  Or so it seemed.

That same year, the internet search company Google developed a beta version of a phone operating system (OS) that could compete with Apple’s iOS.  In the fall of 2008, a year later, Google released version 1 of the OS.  It was built with an open source code that Google called Android. That same month, the wheels came off the global economy. As millions of people lost their jobs, they worried more about paying their bills than a phone operating system.  By November 2008, both Google and Apple had lost half of the value they had in the summer.  Blackberry lost 2/3rds of its value.

In June 2009, two years after the launch of the iPhone, the electronics division of the conglomerate Samsung introduced the Galaxy smartphone.  The phone used the new Android OS and, to compete with Apple’s App Store, hundreds of apps were available for the phone.

Clickety-click as we turn the time dial to the present.  At $10, Blackberry’s stock sells for 7% of its price in June 2008.  Hillary Clinton likes her Blackberry but too many people switched. Until the fourth quarter of 2016, Samsung sold more phones than Apple, but Apple makes more profit on their phones and is the largest company by market capitalization.   Since the iPhone launch Apple’s stock price has soared 900%. Together the two companies account for almost half of all smartphones. They have become wearable computers and cameras and music players and podcast devices.

The iPod was the marriage of a CD player and a portable radio – a consolidation of two functions. Following its introduction in 2001, the iPod became the dominant music player.  Umpteen million songs were available on the device through the iTunes store.  In April 2007, Apple announced that they had sold 100 million iPods in 5-1/2 years, and by the end of 2014, that figure stood at 390 million.  But smartphone users were now using their phones to play music.  In 2014, sales of the iPod fell by half to 15 million. In 2015, Apple stopped reporting the number of iPods sold.  Consolidation had been the key to the iPods success and its demise.

The iPhone and the various Android models of smartphones have depended on increasing network availability and quality – “can you hear me now?” – and the thousands, or millions, of apps available for the phones. I can read email on my phone as well as my newspaper, a book or magazine. Students can read their textbooks on their phones. In addition to music, I can listen to podcasts or radio stations from far away.

The sophistication and accuracy of Google maps is science fiction made fact. I was recently in the middle of beautiful Idaho. The topographic map published a few years ago indicated that a particular county road was improved but unpaved. Google maps marked the road as paved for about ten miles. Google was right. Portions of Nevada that were blurred a few years ago on Google maps now show roads that lead to where? Maybe some alien city in the middle of the desert.

As I mentioned last week, the top 5 companies in the SP500 are tech companies. Ten years ago, the top 5 were Wal-Mart, Exxon, GM, Chevron and ConocoPhillips (Fortune), a mix of retail, automotive and oil sectors. Now there is only one sector at the top: technology. As a rule, concentration is not a good thing.

Let’s turn from tech to banks.  Since 2007, America has lost a third of its banks, a continuation of a trend that began after the Savings and Loan crisis in the late 1980s. The number of commercial banks in the U.S. is about a third of what it was in 1990. New York has lost half of its banks in that time. California has lost about 60% of its banks. You can check your state at the Federal Reserve Database  and search for [postal abbreviation for state]NUM. As an example, Colorado is CONUM. New York is NYNUM. California is CANUM. The U.S. figures I mentioned earlier come from the series USNUM.

Consolidation is spreading throughout the economy. In the last 12 months, more retail stores closed than during 2008, the year of the financial crisis. The stocks of the retail sector (XRT) have fallen 20% from their highs.

Adding to the pressure on brick and mortar retail stores, Amazon recently announced that they were buying Whole Foods. Amazon’s sales have grown by more than 1000% since 2007, and America’s stores have felt the pain.

The consolidation in the retail space has been going on since the 2001 recession and the demise of the dot-com boom. The population has grown 14% since then but the number of employees in retail has grown less than 3%. Inflation adjusted sales per employee have grown by 61% in the past 16 years but the inflation adjusted wages of retail workers have declined 1%.

We ourselves are concentrating. For the first time in the nation’s history, more people live in urban areas than rural areas. That concentration has pushed home prices up in the larger metropolitan areas. The S&P/Case-Shiller 20 city home price index has doubled since 2000, easily outpacing the 45% gain in prices, averaging 2% better than inflation.
Smaller cities and rural areas have not done as well. Below is a 40 year chart of inflation adjusted residential prices for all of the U.S. The average yearly gain is 1.7% above the inflation rate, slightly below the 20 city gains of the past 16 years. But the ten year average tells a story of crisis, erratic recovery and migration. The 20 city price index has lost only 1/4% per year since the highs of 2007. The country as a whole has lost 2% per year.

ResPricePctGain

(Sources: National sources, BIS Residential Property Price database)

Where will this consolidation lead?
Less competition
Less responsiveness to customer needs
More political power to create a regulatory environment which guards against competition.

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Performance

Mutual funds and ETFs usually specify their historical performance for several time frames, i.e. 1 year, 3 year, 5 year, 10 year, Lifetime. Four years ago, I noted the diffiiculties of getting a reasonable appraisal of performance if the comparison period begins with a trough in price and ends near a peak.

It is best to disregard the five year performance of many large cap stock funds this year because they include the 13% gain of 2012 and the 33% gain of 2013. A more honest appraisal is the ten year performance. Comparisons start in 2007, near the highs of the market before the start of the 2007-2009 recession and the financial crisis.

Vanguard’s SP500 index fund VFINX reports a ten year average annual return of 7.39%.  Their blended corporate bond fund VBMFX has an annual return of 4.12% over the past ten years.  If I had nothing but these two funds in my portfolio since 2007, my portfolio of 60% stocks, 40% bonds would have gained about 6.1%.  With a conservative allocation of 40% stocks, 60% bonds the annual return was about 5.5%.  The .6% percent difference in returns is slight but it adds up over ten years.  In the first case, a $100,000 portfolio would have grown to $181,000.  In the second case, about $171,000.

Let’s compare those returns to two actively managed blended funds that Vanguard offers.  VWINX is a balanced fund oriented toward income.  The mix is about 40% stocks, 60% bonds and it has earned 6.7% per year over the past ten years.  The Wellington fund VWELX has a mix of 65% stocks, 35% bonds and cash and earned 7.13% each year since 2007.  Both funds have fees that are slightly higher than Vanguard’s index funds but are relatively low at .22% and .25%.  Depending on allocation preference, either fund could serve as a core “gone fishing” fund.  You can use these as a basis for comparison with products that your fund company offers.

Next week I’ll put my ear to the ground and listen for….