Investment Fees

January 22, 2010Leave a comment

Let’s put aside our rosy glasses, put on our fine print glasses and look at some percentages regarding investment fees.

I will compare two bond funds holding the same type of bonds. Fund A, an index fund, charges .5% while Fund B, an actively managed fund, charges 1.5% in management and other expenses. The manager or salesperson for Fund B may tell a prospective client that the returns for their fund are superior and will make up for the 1% difference in fees. Many brokers are of the Lake Wobegon mentality, believing that the products they sell are above average.

1% sounds like a small amount so this might seem reasonable to you if you are wearing your rosy glasses. But let’s look at some hard data. Let’s say that the index Fund A averages a 5% return before expenses. The more actively managed fund B would have to earn 6% before fees just to break even with the return on Fund A. Again, that 1% sounds small but what it means is that Fund B has to make a return that is 20% greater than the index. Very few funds are able to do that.

Let’s look at those fees again as a percentage of the return, not the total dollars invested. On a 5% return, index Fund A’s fee of .5% is 10% of the return. Even if Fund B can generate a 6% return, it’s 1.5% fee is a fat 25% of the return, more than what many hedge funds charge.

Let’s say that Fund B has generated these higher returns in the past. How does it do that? Often, by taking more risk than the index fund A. You can check an assessment of a fund’s return vs. risk at any number of stock research sites. Yahoo’s finance site has some good assessment tools. Enter the fund’s symbol and in the resulting summary page, click on “Risk” in the left column. You will be taken to a page which shows 3 year, 5 year and 10 year risk and return ratios.

Alpha measures the amount of return for the degree of risk involved. The average is 0. Less than 0 means that the fund does not get a return commensurate with the risks it takes. More than 0 means that the fund gets a better than average return for the risks it takes. You will be able to compare the fund with other funds in its category.

There are so many index funds and low cost index ETFs in the market for an investor to choose from. If you are willing to take more risk in bonds, for example, you can probably find an index product that invests in a riskier class of bonds. Over the long run, expense fees do matter. The lower the return, the more they matter. Over 10 years, that additional 1% in fees will cost you $1400 on a $10,000 investment in a fund averaging a 5% return.

In short, play the percentages.

Tidbits

January 21, 2010Leave a comment

A few tidbits of info sitting around on my desk:

WSJ tidbit 12/31/09 – Families USA reports that Cobra family coverage averages 83% of the average unemployment insurance check, up from 61% in 2001. The stimulus bill provides a subsidy to unemployed individuals averaging $325 a month, $715 for families.

According to a Congressional Research report – after dropping dramatically from 1950 to 1980, death from diabetes has increased to above the levels of 1950, a 33% increase from mortality rates in 1980. Unintentional injuries, including automobile accidents, has dropped by half from 1950. Cancer rates are about the same as 1950. Death from heart disease are at 40% of 1950 levels. (pg 4)

Many of us do not like government interference and mandates, yet we see the results of several decades of seat belt and product safety laws.
Despite all the money invested in cancer research over the past fifty years, the rates have not improved. Of course, more people are living longer, naturally driving up the cancer incidence rate, which disproportionately afflicts older people.
Despite the dislike that some people have for “Big Pharma”, it is thanks to the pharmaceutical industry that heart disease has become a manageable problem for many older Americans.
While many like to blame the soft drink and fast food industry for the increase in diabetes, no one is forcing anyone to drink and eat sugar laden foods. Of course, it is easier to blame the big food companies than take personal responsibility for one’s food choices.

On Oct. 16, 2009, the Bureau of Labor Statistics reported that the median (not average) weekly earnings of the nation’s 100.1 million full-time wage and salary workers was $738 in the third quarter of 2009. This was 2.5 percent higher than a year earlier. The Consumer Price Index for All Urban Consumers (CPI-U) fell by 1.6 percent over the same period.

Social Security income accounts for about 40% of retirement income.

A retired person spends, on average, about 80% of what they spent before retirement.

WSJ tidbit 12/28/09 – The Institute for Justice cites that 50 years ago, 3% of American workers were regulated or licensed by government agencies. It is 35% today.

Food, energy, housing and health care consume the same share of American spending today (55%) that they did in 1960 (53%).

Revolving credit, primarily credit cards, declined at a steep 18.5% annual rate last year.

Smaller businesses are a dying breed in the U.S. Companies with less than 250 workers comprise 70% of the private-sector work force in the European Union, compared with 49% in the U.S., according to EU figures.

In 2009, 804 companies cut dividends, up sharply from 110 two years earlier and the highest level since S&P started to collect such data in 1955. Conversely, the number of dividend increases dropped 36.4% to a record low.

More than 6% of commercial-mortgage borrowers in the U.S. have fallen behind in their payments, a sign of potential troubles ahead as nearly $40 billion of commercial-mortgage-backed bonds come due this year. Moody’s reported a 4.9% actual delinquency rate. It is projected to go above 8% by the end of 2010.

The Mortgage Bankers Association reported that almost 6.2% of mortgages in Arizona and 9.4% of mortgages in Nevada were in foreclosure by the end of the third quarter of 2009. In California, 5.8% of mortgages are in foreclosure and personal bankruptcy filings rose almost 60% last year.

Forecast: Clearing

January 13, 2010Leave a comment

In forecasting future company profits, there are two Ouija boards and each board comes up with different results.

On the first Ouija board, equity analysts put their hands on the triangular platen and divine the future profits of each company they cover. All the results are then added up for a total “bottom up” forecast for earnings of the S&P 500. For 2010, the analyst Ouija board spelled out $77.54 in profits, a 30% increase over 2009.

On the other Ouija board, a bunch of economists put their fingers on the platen and foretell future profits. This is termed a “top-down” forecast. The economist board says $72.52. This small $5 difference in the two forecasts – a year ago the difference was $40 – is a good indicator of greater clarity looking forward, and a more stable market.

The Dump

January 13, 2010Leave a comment

Recycling has become popular in China.

In 1999, Chinese state owned banks dumped $200B (U.S.) of bad loans made during the 1990s into Asset Mgmt Companies (AMC) or “bad banks”, banks set up to hold “toxic assets” and non-performing loans. Six years later, they dumped another $170B into these AMCs. Many of these loans are carried on the books at face value, far above their true market value. When the loans came due this year, most were rolled over for another ten years. Here is a brief summary from the Gerson Lehman Group.

Large private companies have been accused of managing, or massaging, earnings in order to sustain a higher stock price for the company’s stock. Tempting as this practice is for private executives, public officials are under even greater pressure to put their best foot forward by manipulating asset values. China’s strong, rapid move to urbanize is bound to incur casualties along the way. The commercial real estate market is beset with vacancies, while newly constructed factories stand ready to supply a world whose demands have slowed. When state owned banks defer the recognition of bad real estate loans, it becomes difficult to honestly evaluate their financial status.

FXI is an ETF that tracks China’s top banks. A word of caution.

Housing Boom

January 12, 2010Leave a comment

An August 2005 NY Times article reported Robert Shiller’s – the Shiller in the Case-Shiller housing index – clarion call that the housing boom would soon bust. Since we are now in the future, we know how that prediction turned out. What interested me was Shiller’s brief 400 year history of housing prices.

The Commons

January 11, 2010Leave a comment

Several hundreds of years before Adam Smith wrote his seminal work “The Wealth of Nations” (full text ), England wrestled with the Problem of the Commons, which is the title of a book by Gordon Marshall.

“The use of commons (publicly available land on which farmers graze their cattle) becomes a problem when one such farmer reasons that he or she can expand his or her herd since this small addition to the total stock will contribute little harm to the available pasture. However, if other farmers reason likewise, these incremental additions to the stock using the land lead to overgrazing and thus the destruction of the resource itself. In other words, if each individual in this situation rationally pursues his or her own short-term interest while disregarding others similarly pursuing theirs, then the long-run consequence is that everyone loses their share in the collective resource.” (GORDON MARSHALL. “Problem of the Commons.” A Dictionary of Sociology. 1998. Encyclopedia.com. 23 Sep. 2009)

Communism and other forms of collectivism try to solve this thorny problem by eliminating one of the sources of the conflict, private property. In an ideal form, free market capitalism denies the existence of the commons, thereby eliminating the other source of the problem.

Between those two extremes lie various attempts to form societies to manage, not solve, this enduring struggle, allowing the two competing interests of private and public to wrestle.

The Labor Force

January 10, 2010January 27, 2017Leave a comment

Here’s a time series graph of the Colorado civilian labor force, which includes everyone over 16 not institutionalized or in the service and who is either working at least a few hours or looking for work. If a person is retired, they are not in labor force. Nor is a person who has given up looking for work and no longer bothers to register with the state unemployment office after running out of benefits.

I have added some approximate numbers in the graph to highlight the employment – or rather lack of it – problem. The difference between the upper green line and lower green line is about 100,000 decrease in the number of people counted in the labor force in the last 15 months or so. Despite that decrease, the graph shows an increase of 300,000 in the labor force over the past decade. Until the latter part of 2008, Colorado enjoyed a low unemployment rate, meaning that most of that net 300,000 growth was new jobs being created. So, what’s the problem? New jobs are good, right?

This past week came the announcement that Colorado’s estimated population had crossed the 5 million mark, meaning that, in the past decade, the population has grown by approximately 700,000. Colorado has a relatively younger population. In a healthy economy, the ratio of those in its workforce to those not in the workforce is about 55 to 45, higher than the national average of 51 to 49. As a comparison, Florida has an older population and its ratio has averaged 49 to 51 over the decade.

With the population increase scaled to this ratio and overlayed on the graph (blue line), we can see that the growth in the labor force matched the growth in the population until the past year or so. With an total estimated population of 5 million, a healthier labor force would total about 2.75 million. We are about 80,000 short.

Future Fun Facts

January 9, 2010Leave a comment

In 1950, life expectancy at birth was about 67 years. In 2003, it was 80 years. That dramatic increase in life expectancy over a span of 50 years is less dramatic when we look at a comparison of life expectancy for a 65 year old. During that same 50 years, it had gone up only 3 years, from almost 78 years of age to 81 years of age.

Although less impressive in years, those three extra years of life equals 36 additional months of collecting Social Security and that’s one problem: old people getting older and continuing to collect Social Security.

The way to fix that problem is to have more workers contributing to Social Security. That’s the second problem. Not enough young people and we can blame parents for that. People are just having fewer kids, leaving fewer workers to pay for the old people continuing to collect Social Security.

How to fix that problem? Immigration. Relaxed immigration standards will allow more workers to come into the country and contribute to Social Security. That’s the third problem. Immigrants may require more social services than what they contribute in taxes and Social Security and eventually those immigrants will get old and start collecting Social Security themselves.

A 2006 Congressional Research Service (CRS) report projected that, by 2075, an average life expectancy for a 65 year old to be about 86.5 years of age. That’s an additional 66 months of Social Security payments.

The solutions to the relentless march of these demographic numbers are politically unpalatable so we can expect that our elected representatives will do everything else before finally adopting them.

First, expect retirement ages to increase. Older workers will not like that. Second, expect the Social Security contribution rate to increase. Workers of all ages will not like that. To avoid their anger, politicians will “soak the rich” by increasing the amount of income that is subject to Social Security tax. Those in the upper income brackets get far less in return for what they contribute and they can expect to pay more and get less. Third, expect Social Security payments to decrease or to increase at a slower rate. Retired people vote and they will not like that.

These are the fun facts of the future. Maybe the “Future Fairy” will take away these problems and leave us a quarter.

Money Ratios

January 9, 2010Leave a comment

A Denver investment advisor, Charles Farrell, has just written a book titled “Your Money Ratios” that should be part of a course for high school seniors. Mr. Farrell gives clear, simple guidelines for personal savings goals and debt ratios based on your income and age. The book lays out a game plan for making the transition from laborer to capitalist, from working for money in your twenties to having your money work for you to support you in retirement.

In simple language, Mr. Farrell explains many financial products that a person will encounter during their lifetime: stocks, bonds, various forms of insurance. He gives clear guidelines for mortgage and education debt as a ratio of your income and age. He compares the long term costs or savings of buying a house vs. renting.

His ratios are age-adjusted signposts, easy to understand and easy to use as a financial fitness check.

Innocent Investor

A helpful understanding