Tag Archives: investing

lighting a financial candle rather than cursing the financial darkness

Now and then, I have to give credit to a complete idiot.

Dirty laundry: I sometimes have trouble coming up with good topics to maintain a twice-monthly blog posting schedule. In this case, a friend’s friend said something so blithering that I had to contradict. Not harshly, of course. You never know when it’s someone’s wonderful Aunt Edna who, while dumber than a bag of wet nickels, has devoted her whole life to helping her nephew and about two hundred other kids from broken homes. I’d rather not find out the hard way. But the facts, at least, needed a saying.

This brought me to the realization that I have a substantial financial reading list, if I would but share it, to help people self-educate. Self-education is good. Why take my word for this stuff? Better to read people who know more about it than I do. And another of my beliefs is the old saying about lighting candles and cursing darkness. If I don’t feel good, I try to make myself do things that will make me feel more positive.

Before I go into the reading list, I ought to disclose my basic investing outlook and methods. I am not a fan of corporate America. I begin with the presumption that it is impossible to find a publicly traded American company not operated by criminals, at least as I define the term. The harder a company puts on the PR to tell me how wonderful it is, the more I assume the reality is opposite.

I am more an income investor than a growth investor. I don’t like CEO promises and predictions; my basic outlook is “Fuck you; pay up.” I like income because they can’t take it back. I own very few separate issue stocks. I go mostly for index ETFs (exchange-traded funds) and closed-end bond funds (CEFs). I can wring 2-5% payouts from the bond index ETFs, 12-15% from the CEFs (with capital loss potential), and results from the stock ETFs vary but are more volatile than most of the market (this works to my advantage). My primary objective, naturally, is to make money. The secondary objective, which leads to the primary but has to come first, is to keep emotion out of my investing.

It follows, therefore, that I don’t much believe in ethical investing. If you want to get all ethical, buy Satan Inc.’s stock (DEVL), donate the dividends to their enemies, and vote against all management’s recommendations. That is the action on your part that they fear most–but don’t confuse it with investing for gain.

I do believe that financial innumeracy is one of the leading causes of youth poverty in this country. The schools and parents didn’t teach them. The young made the naive assumption that opportunities would be the same for them as they were for their parents, a myth their parents knew was bullshit, but did not puncture. The parents should have.

With that, I offer you a list of excellent reads about money management, investing behaviors, strategies, and suchlike. I hope it will help you beat the rigged game that is our market, even if your method doesn’t even involve buying any stocks.

  • Financially Stupid People Are Everywhere; Don’t Be One of Them, by Jason Kelly. You’ll be seeing his name a couple more times, for good reason: Jason combines a very readable style with an iconoclastic, no-bullshit approach. We’re friends, but I was a fan of his writing years before we became personally acquainted. If adulting classes existed, this could be the textbook. If you’re in your twenties and you have debt and/or no savings, start here. It’s the icewater bath you need.
  • Warren Buffett Invests Like a Girl, and Why You Should, Too, by Louann Lofton. It turns out that women have investing tendencies that work to their advantage, and Lofton has taken time to observe and quantify these. It’s an excellent read, and likely to promote confidence on the part of women navigating what has historically been a male-dominated industry. Bottom line: if you’re beating their numbers, it doesn’t matter whether you do it through newsletter picks, tarot, Sacred Vagina Meditations, research, or free association. It means you’re better.
  • The Motley Fool Investment Guide, by David & Tom Gardner. While I’m out of the business of researching and picking separate issue securities (that would include common stocks), others might not be. Either way, this is a fun read full of helpful education.
  • Priceless: The Myth of Fair Value (and How to Take Advantage of It), by William Poundstone. Poundstone is the guy you have never read that you should be reading: author of the Secrets books, who then turned to studies of human psychology. Distilled essence: marketers use our instincts to lead us to decisions that work to their advantage and against ours. Understanding this is worth your while.
  • The 3% Signal: The Investing Technique that will Change Your Life, by Jason Kelly. Jason publishes The Kelly Letter, an outstanding investment newsletter. He used to pick stocks. He stopped, and his life got better. This book tells what he does now, and how anyone with an investment account can do the same. Five stars without a moment’s hesitation.
  • Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, by Jason Zweig. Another good entry in the field of investing and money psychology. I don’t believe you can go too far wrong applying critical thinking to an understanding of how our minds work.
  • The Neatest Little Guide to Stock Market Investing, by Jason Kelly. There is some overlap here between more recent versions of this book and The 3% Signal. That said, if you want to go stock hunting, I’d take this book in addition to the Gardners’ treatise.

Because I feel in a sharing mode, I’m going to make a number of statements that I wish more people could absorb:

  • Any stock index report that goes by points rather than percentage change just makes you dumber.
  • Any person reporting a stock index result that reports points rather than percentage is either too uneducated to know how dumb this is, or is deliberately using the big number to draw attention.
  • Conventional open-end mutual funds are usually a bad deal. They’re great investments for 1975, if you’re currently living then.
  • About 90-95% of investors should just buy and accumulate index ETFs (exchange-traded funds).
  • Financial media suck. You get stupider every time you watch or read them.
  • Bonds don’t automatically mean you get your money back. Bond funds especially don’t mean this.
  • If investing a very small amount, you can afford to shoot high. Only when you pile up a big heap o’ money do you have to think about holding onto it.
  • Emotion is your investing enemy.
  • You don’t know who you are as an investor until you see a crash. Who you are is what you do during and after that crash. A fern could make money in a bull market.
  • The Dow is worse than useless; it is distortive. Any time someone cites it as meaningful, my opinion of that person’s investing savvy drops.
  • It follows, from the above and previous commentary, that any time anyone says “Dow drops 300 [or whatever number],” without including the percentage change, I conclude that the individual doesn’t understand the markets at all. I may heart them big time, but they said a dumb thing.
  • Most people throw away about half their lifetime returns just by playing with themselves all through their twenties, only getting serious come their thirties.
  • If you buy an investment you don’t understand, you do a stupid thing.
  • Any time someone starts by saying “If you had bought XX back in X month, year Y,” this person is sharing irrelevancy. Why? Because you didn’t. You wouldn’t. Next time, you won’t either. If only that defensive end had gotten to the passer on that third down play in the first quarter, the whole game would have been different–but he did not.
  • Always buy the stocks my wife says to buy. Unless, of course, I helped pick them, in which case they’ll tank.
  • The choice of a traditional vs. Roth IRA comes down to the tax benefit. If you don’t make enough money to need the writeoff, the Roth is probably more advantageous. However, the Roth means trusting the government to honor a promise years in the future. I never have. Your call.
  • Rich traders get to cheat in ways you and I do not.
  • For IPOs, if they’re worth getting into, you probably aren’t getting in unless you’re with a big full-commission brokerage. That’s one advantage for full-commission brokers, set against an ocean of disadvantages.

Simple true statements about investing to cut through the mountain of baloney

When I talk to people about investing, I see how easily they get overwhelmed. Can’t blame ’em. So let’s reduce it to a series of statements that are simple and true (in my opinion and experience), independent of one another, and see if that helps.

My suggestion is to read and absorb just one a day. That ought to last a while.

  • All stocks, bonds, and mutual funds are securities. When one says ‘securities,’ one means all those, but excludes raw precious metals, commodities, real estate, Cabbage Patch Dolls, and stuff like that.
  • An index, like the Dow or S&P 500 or NASDAQ, just watches a pool of securities and reduces it to a total number. It’s only as indicative as the chosen securities and the weight each receives.
  • In all investing, percentage is key. Don’t look at the raw number change of the index, or the security. Look at percentage change. If you can’t divide using Windows Calculator, you can’t understand investing. Of course, if you can divide using Windows Calculator, you can understand investing.
  • Stock splits mainly change looks and convenience. If a $500 stock splits ten for one, the fundamental valuation didn’t change. Everyone just got ten shares of $50 stock in return for one share of $500 stock. It’s about as significant as breaking a $20 bill into tens, fives, ones, whatever.
  • A common stock represents a share of ownership of a company. On the fundamental level, it is buying a piece of a business.
  • A bond represents borrowed money, with bondholders as debtholders. Your car loan or mortgage would be in effect a bond issued by you to your bank, if you only had to pay the monthly interest as you went and then had to fork over the principal at the end of the term. Since you have to cough up principal as you go, it’s not quite the same.
  • A preferred stock is a hybrid of bond and stock (oversimplification for ease of understanding), but in my opinion is more like the bond part than the stock part.
  • When we say ‘fixed income,’ we generally mean bonds, but preferred stocks fit the category as well.
  • There are two main ways to make money: growth and income.
  • In growth, you want to sell it later for more than you paid for it. In income, you want to get paid as you go along. Some go for one, some the other, some for a combination. I like getting paid as I go along, myself. Then it’s too late for them to back out on paying me.
  • Conventional open-end mutual funds (most of the ones you hear about) apply 1975 logic and constraints to 2015 investing. Which was fine in 1975, less so today.
  • Roth vs. traditional IRA: you are deciding whether you want to get the tax benefit now (traditional) or trust the government to give it to you later (Roth). Your call, and there are good arguments for both sides.
  • Your employer’s 401k often limits your choices to crappy open-end conventional mutual funds. Not much you can do about it. It’s a great racket for fund administrators and fund companies, which is not to say it’s all bad for you. Rather, it’s not as good as if you were free to invest it as you chose.
  • Most conventional open-end mutual funds don’t beat their target market indices, so it raises the question of why keep paying them 1-2% per year when you can, in effect and with ease, buy the performance of the index and pay the index fund manager about 0.2%.
  • Buying a precious metal fund or mining company stock is not the same as buying the metal, and the two shouldn’t be confused.
  • Looking at interest/dividend yields, here’s the simple math: divide the total annual money they pay you per share by the price you paid for the share. Payout$ / price$ = yield%. If they pay you $5 per year for a share that cost you $100, you are getting 5%. If the share went up to $150, you are still getting 5%, provided the dollars paid you per year do not change.
  • A full-commission broker is only as good as his or her thinking, and has to outperform by the commission amount just to break even for you. Worse: the broker generally has a vested interest in trading. Buy-and-hold makes him/her no money, unless it’s an unlimited free trades setup, in which case you’ll pay about what you’d pay a conventional mutual fund manager.
  • The Dow Jones Industrial Average is worse than worthless. Why? Because if you take two stocks of companies of the same overall value, one priced at $10 and one priced at $100, and each change by $1 in a given day, for the first it’s 10% (a huge day) and for the second it’s 1% (a typical day). Yet both have equal impact on the Dow. You would be better off if you strove never to even learn what the Dow does.
  • You don’t know how good your investing nerves are until you watch the whole market go to hell one day. What you do, or do not, when that happens for weeks, is your answer.
  • Bond funds are not the same as bonds, any more than gold stocks are the same as gold.
  • Bonds don’t have a market like the NYSE or NASDAQ. They’re bought and sold from inventories. As such, bond indexes can’t perfectly imitate their markets; they can only try very hard for representative samples.
  • Bonds die. Stocks don’t. In ten years, a ten-year bond goes away, with its principal paid out in redemption, and it no longer exists to buy or sell. IBM stock, in some form, has existed for nearly a century.
  • The bond your school wants you to approve involves them getting a loan from investors, with you agreeing to pay the investors the interest, and in time, reimburse the investors for the principal. So investing is part of your world if you pay rent, because your rent covers the property taxes, and that’s where school bond taxes are paid.
  • It’s unrealistic to expect gains every year. The realistic comparison is to the relevant indices: did your total return % (growth plus income) exceed them? Match them? Underperform them? If the indices took a 20% dump, and you only took 15%, good job, well done. If the indices climbed 30%, and you only got 20%, you took a bath. Terrible year.
  • The market is full of euphemisms. One is ‘correction.’ A correction means that the market took a big dump. It sounds so much better in print than ‘big dump,’ more dignified, but money is money.
  • Feel free to engage in ethical investing, long as you accept that you have reduced the focus on making money. And remember this: the total amount of stock doesn’t change because you refuse to own Monsatan (poisons), Wal-Mart (first world exploitation), Nike (third world exploitation), Reynolds (tobacco), or Exxon (fossil fuels), or Diageo (alcohol). To sell it, someone has to buy it. If you really want to annoy the company, buy their stock, donate the dividends to causes that hassle the company, and vote against management’s recommendations in shareholder elections.
  • Read too much investment media, and it’s like politics or football: you can find articles to confirm any perception. Want to believe next year is crash year? There’s a guy at Marketwatch who predicts crashes every year. About once a decade, he’s right. No one calls him out on the other nine years.
  • If you get your market information from Jim Cramer, that’s like getting your history information from the History Channel, or your understanding of basketball from the Globetrotters, or your science information from a religious scripture. As in all media, do not confuse financial news with financial news entertainment.
  • If you hand your money to a financial planner, find out how s/he gets paid. With every investment: find out who gets paid, and what. No one’s doing any of this free. Two things are true: 1) everyone is getting paid, and 2) you are paying them, somehow, somewhere. It’s okay to pay, but stupid not to know what/who/when you pay.
  • I keep using the long phrase ‘conventional open-end mutual funds’ not to be cumbersome, but because there are a number of mutual funds that are neither conventional nor open-ended, which I want to exclude from the statement.
  • For equities (securities representing ownership rather than debt), we identify them by a ‘ticker’ of one to five letters (AT&T is T, Microsoft is MSFT, Fidelity Magellan Fund is FMAGX). Five letters ending in X is a conventional open-end mutual fund. Five ending in Q is usually a company in bankruptcy, delisted from the major exchanges. Five ending in Y is a foreign stock’s American shares, without getting too complicated. Five ending in F is a foreign stock.
  • Note that there is no way to tell exchange-traded mutual funds, real estate investment trusts, closed-end mutual funds, and many other pooled investment shares from common stocks by looking at the ticker symbol. Note also that not all foreign stocks have an F or Y at the end, or five letters. Toyota is TM.
  • Any dividend that looks too enormous is soon to be cut or eliminated. Simple.
  • When you see lots of people around you doing a stupid thing financially, brace for impact. Security guards bragging in the elevator of your skyscraper about big returns? Venture capitalists throwing money at anyone with a domain name and a tattoo? Banks lending money to people who can’t pay it? Brace for impact.
  • 95% of Americans should just buy index ETFs and sit on them, rebalancing every year or two. That works unless you forecast an apocalypse that destroys the value of the US dollar and economy.
  • If you forecast an apocalypse, not even your mattress is safe. If you really believe it, you should emigrate to someplace you do not forecast will face an apocalypse, because even if your doomsday doesn’t kill you, it will make your life suck.
  • Investing is a great way to find out what people really believe, as distinguished from what they like to say and think they believe. Show me someone who thinks it’s all going to hell, and who’s putting money in a 401k, and I’ll show you someone who doesn’t believe his or her own words.
  • Rebalancing is good. It means when you divide your investments among several things, and adhere to a percentage allocation by selling what you now have an excess of, and using it to buy what you have a shortage of.
  • Yes, Wall Street is ripping us all off. Imagine if you were allowed to go to Vegas (or the local Native American casino), but if you lost big, got bailed out. You will not get to play by Wall Street rules, which are for very rich people. That, however, doesn’t mean you can’t make gains; they just will never match the gains guaranteed to those who own the system and operate it mostly for their own profit. That’s no reason not to get some gains of your own.
  • If you think the investing public is smarter than you are, think on this. Money market mutual funds are basically savings accounts in most people’s eyes, but in reality they aren’t guaranteed. They maintain a share value of $1 a share, and that’s what you actually own in them: shares. In 2008 or so, a few MMFs ‘broke the buck’–had their share value slip below the $1 which everyone takes for gospel. It was cause for panic, and in panic times, people run for safe havens. Where did they rush to? The safe haven of…money market mutual funds! To get out of the burning building, they ran outside, then back into the building. That’s your competition. Still think they’re smarter?

Our system is greed-based, and the extent and style of your participation in it is a personal decision.

Ebowling for dividends and growth

I take a weekly investing e-letter authored by Jason Kelly, a Coloradoan* who lives in Japan. Jason is an interesting guy, a rare combination: an experienced financial advisor with a fine track record and a degree in English. He is author of The Neatest Little Guide to Stock Market Investing, which remains the clearest introductory book I have seen on the topic. Jason has writing game. Jim Cramer is not fit to do Jason’s laundry, either as writer or financial advisor.

In addition to insightful, readable commentary on the financial markets, the typical Kelly Letter incorporates some social comment at the end. Like me, Jason does not consider himself obligated to join in media-purveyed panic. Also like me, Jason doesn’t mind making fun of the inherently ridiculous. This week’s edition ended with Jason’s commentary on the Ebola situation. I laughed so hard that I requested and received gracious permission to share its full text with my small but smart audience. Thanks, Jason.

===

That’ll do it for this week.

With America’s nationwide Ebola death toll up to one and possibly rising, public health officials warn it’s not too early to take personal precaution. A recent survey by Boston-based Hitseeker Group found that six of nine people who’ve heard Ebola mentioned at least three times since Oct 6 believe they know somebody who comes into frequent physical contact with Ebola-infected blood, urine, saliva, stool, and/or vomit, and are therefore at risk of contracting the deadly virus themselves by handling said fluids among their friends.

Worse, this is under current circumstances. Should the American hot zone spread, the incidence of thinking one knows a person at risk of contracting Ebola is likely to spread, too. Officials point out that should authorities in Dallas fail to contain the disease, it could get as far as Plano and Fort Worth. Pressed for details, they project the maximum possible death toll in the United States to lie between 316.1 and 317.9 million people accounting for those who die prior to contracting Ebola due to heart disease, cancer, or stroke.

A spokesperson for the new Homeland Quarantine Coordination Agency cautioned against distraction from the Ebola threat by reports that, every day, an average of 1,973 Americans suffer a heart attack. “This is old news,” he said. “We must face the new threat head-on while there’s time.” Citing a statistics book, he illustrated how easily the Ebola death toll could double. “With one more death,” he said, holding up a finger and pausing, “just one, we would double the number of people who have died from this terrible disease. Think of what two more would do to the growth rate. Then … three. We could see the number of deaths rise tenfold in no time if we don’t nip this in the bud.”

The agency has devised a color-coded Ebola alert system to help guide behavior. It’s currently flashing bright red, leading some to wonder what color will be used should the rate of expansion increase, but the issue has been tabled for a less pressing moment. The simplest cautionary procedure during a bright-red alert such as the current one is to limit blood, urine, stool, and vomit play to people one knows well and trusts, an admittedly daunting task in a society as friendly as America’s, but well worth it in the short term.

Be careful out there.

Yours very truly,
Jason Kelly

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*Some say ‘Coloradan,’ others ‘Coloradoan.’ My own Colorado cred comes from Fort Collins, where the city newspaper is called The Coloradoan. My parents were/are CSU Ram alumni, and we lived up on the Poudre. Jason’s a CU Buff, but I also like to see them win, so no divide there. But I will always maintain that the term for a Coloradoan is, well, a Coloradoan, because when I was a Coloradoan, that’s how I learned it was put.

Stopping out

When I talk about investing with people, it’s natural that most of them don’t understand there are a lot of different types of orders. Most people know that you can place an order to buy or sell when a stock hits a certain price, but it gets more sophisticated than that. One form of sophistication is the trailing stop-loss order, which is available from any fully equipped discount brokerage.

It works like this. Suppose your shares of Baloney, Inc. (BLNY) are way up. You’re not eager to sell, but you think the markets are high, and you really don’t want to ride BLNY down the chute of a big selloff. Okay. You place a trailing stop-loss order to sell all shares, good till canceled (at Fidelity they expire after a max of six months). The trigger condition is a percentage that you choose. If you pick 1%, you must really want out, because a 1% drop in value is typical on a down market day–and isn’t even remarkable over two days or more.  If you pick 5%, it would take a very big single day of loss to trigger that, or a loss of that size spread over multiple days.

The mechanics of this are a headache for the brokerage, but that’s why they get paid. Suppose BLNY is at 100 when you place a trailing stop-loss order to sell it, trigger 5%. As of right then, the trigger price is 95. However, if BLNY goes over 100, the trigger point is recalculated (each time it gets above the high) based upon a 5% drop from the new price. So if BLNY climbs to 120, without ever declining 5% from its highest price since the order, its trigger point will be 114. That is 5% less than 120. The brokerage keeps this stuff in a separate file so it can keep updating your trigger point. When it sells, we say that it ‘stopped out.’

Seems like cheating, doesn’t it? That’s what seasoned investors do any way they can legally or practically do: cheat. Of course, you have to realize what exactly occurs with this type of order. When your shares drop to the trigger point, your order converts to a market order (and it is not going back; the die is cast). You may not get your trigger price, though it should be close. There has to be someone wanting to buy the shares for that market price. A market order, the simplest form of order, simply says ‘sell this now at what the market will pay.’ No type of order can create liquidity (investor-speak for ‘someone wants this, so I can sell it’) if liquidity doesn’t exist.

Can this hurt you? Well, there is no crying in investing. Big kid tools are for big kid investors. Most people are thinking of crash protection, but remember that once a trigger point is established for the order, it will never go down. If you aren’t serious about protecting some form of profit (or avoiding further faceplant), better not place one of these, because the smaller your % loss specified in the order, the more likely it is that a moderate market shift could trigger your sale.

My own belief on stop-loss orders is that they are for times when you think the market is stupidly high, you’ve profited handsomely from it, and you’re ready to protect the profits. I’m at that point right now. There isn’t really a good reason for the markets to be as high as they are, at least not as far as I can see; banks still aren’t lending much, interest rates on savings are an insult, there’s no big job boom, and the economy is still fought over by the macaques, gibbons, chimpanzees and ourangoutangs in Congress, who are doing nothing to help it, being too distracted by ideological feces-flinging competitions. If there’s a big long market slide, I expect to buy these stocks back at discount prices. It’s not that I don’t like the companies’ prospects; it’s just that in investing, I don’t give a damn about anything but money. I gain no emotional satisfaction from holding Berkshire Hathaway (BRK.B) shares; I just think they are a good investment. However, I’m not stopping out of those, because I think they are such a good investment they will weather a market decline very well. I’m not stopping out of my dividend farms (closed-end bond funds), because I didn’t buy them for capital appreciation. I bought them so they’d pay me money every month. They will still do that, by and large, regardless of what their prices do.

We–you and I–didn’t invent this game. We have the right to play it for keeps, for our own reasons, using whatever tools are available to us. For me, one of those is the stop-loss order.

Destroying the Dow

The Dow is ‘struggling toward 15,000.’ I don’t care, for many reasons, and you also should not care. You will be a smarter investor if you banish all knowledge of the Dow from your mind. Every time you see it, you get dumber.

Here’s a radical stance: the Dow could be construed as a form of ongoing terrorism, since (much like a bomb threat) it causes panic that need never be, and works to destabilize the economic underpinnings of society. It presents a widely accepted, grossly distorted picture of the market, and unfortunately, most of us are unwise enough to validate it.

I believe that the Dow Jones Industrial Average, commonly called the DJIA or just ‘the Dow,’ needs to be suppressed on the principle that free speech does not include the right to yell “fire!” in a crowded theater, nor make obscene phone calls, nor publicly advocate terrorist acts–if your free speech would cause unnecessary harm or panic, it can be prohibited. (It should also be suppressed because it’s stupid, even though policing the propagation of damaging stupidity has never worked. It would be a blow struck for brains.)

Two objections to this come readily to mind:

  1. “But it’s useful in some ways.”
  2. “You just can’t suppress free speech like that.”

1. No, in fact, it’s worse than useless, for it is misleading. It is based purely on share price (adjusted for splits since entry into the index), which is always an arbitrary number. Don’t believe me? Suppose a company goes public with $45 billion in market cap: $45/share for 1 billion shares. The company could just as easily have gone public at $90/share, issuing only 500 million shares.  Same market capitalization, double the Dow impact. That’s just ridiculous.

In terms of day-to-day movement, imagine that Dow component BS rises from $100 to $101, a very minor 1% change. Another Dow component, FY, rises from $10 to $11–an enormous 10% gain. Dow doesn’t care about how much market value was created or lost. Dow considers both movements to have the same impact.

And this gets even worse. The Dow serves mainly as a useful tool for the financial media to get us stirred up, increasing our consumption of…financial media! This is partly because it is a Big Number. Well, it was not always a big number, but we react just as we did when it was smaller. I was alive, adult (by age if not by maturity), and losing money (buying stupid investments with money I could not afford to lose) when the market wrapped around a tree in 1987. The Dow lost 508 points, a 22.6% decline for the day. That was nearly a quarter of its value. It closed at 1738.7. We’d all agree that over 20% is massive.

If you are paying attention, and picturing the headlines of the day, you can see that a 100-point shift in the 1987 Dow would still have been a large percentage change, and a loss of over 500 would be (and was) a catastrophic decline. I will now take a bullet for you: I will look at the current value of the Dow. As I compose this, it is at 14974. Suppose it had the ‘triple-digit decline’ of which the media are so eager to shriek: a drop of 100 points. That would be a decline of less than 1%; about 0.67%, a very normal daily shift, and nothing for any investor who thinks for him or herself to freak about. Okay, now suppose we had a loss of 500. It would be about 3.3%, certainly a big day, but something that happens now and then. I was reading financial media then, as I read them now. They react to ‘triple digit Dow’ nearly the same way. It is as if your doctor treated every mole on your body as melanoma until proven otherwise, even though most moles are just brown spots. You’d live in constant terror of a horrible death which most people would not actually suffer. You’d overreact. You’d probably have them all removed, traumatizing and scarring your entire body–for nothing. The only people who would benefit would be those helping to spread the panic.

Welcome to the market.

Of course, if our precious financial media focused purely on percentage change, we would be spared this problem. It will not, and why should it? Said media are in the business of getting you worked up, getting you to read and watch and not relax. Fear is their product. Why would they change their practices in the interest of market stability, to their own detriment? Care about society over self? Are you mad? This is Wall Street’s publicity arm. Don’t talk to it about anything but purest avarice that burns with a purple fire. Talking about them caring about anything above self and profit is like talking to Kim Jong Un about caring about freedom for North Koreans to criticize his regime.

2. Let’s break that down. Can you legally suppress it? You sure as hell can. We suppress or restrict free speech all the time, generally for good reasons, from the crowded-theater example to the fact that saying “Go to hell, judge, I don’t have to take your orders” will get you jailed for contempt of court. A person using free speech to disclose national security secrets will soon learn the limits of that free speech–and sensibly so.

But is it practical to suppress the Dow? On the grand scale, surely not. I mean, any fool with a spreadsheet can easily continue the Dow math, rename the index, and post it online. Prosecuting this in full would be impossible, especially since nothing is stopping some dude in Malaysia (for example) from calculating it and posting it on his blog, in defiance of US law–which is not in force in Malaysia, any more than Malaysian law could prohibit me from posting stuff that the Malaysian government might not like. Try and get the Malaysian government to get interested in investigating and extraditing him for something that isn’t even illegal in his country, and let me know how that works out for you.

Well, what could we suppress in practice? We could certainly prohibit major domestic media from publishing it, since they are the most visible. A few examples of reporters and executives thrown in jail would cause a lot of bleating, but you can bet Marketwatch (owner of the index rights) would can it, whining the whole time about the police state. This wouldn’t apply law uniformly, but we don’t do that anyway. Tons of people cheat on taxes; they don’t audit everyone, just the ones they believe cheated big time. Tons of people pirate intellectual property; the RIAA doesn’t sue everyone, just a few people to make the point. Tons of people speed on the freeway; they don’t all get a ticket, just enough to remind of consequences.

The most powerful argument against this, I believe, is the ‘you can’t legislate intelligence’ perspective. Let me make it myself: “So what you’re saying is that this should be banned because ignorant people tend to validate and react to it, thus doing dumb things, flogged onward by media who can benefit from that. Why complain? If you yourself are not ignorant, you have an advantage and should profit from it. Why should dumbness be protected from itself? Shut up and take their money, like I do!” The rejoinder is: “First of all, Dreamboat Aynnie, it’s not all about me or you. Second, the core problem is that the psychological impact of the Dow distorts reality for enough people, helped by our adored media, to create instability which in fact doesn’t exist. The overall harm to the national economy is serious, with potential for panic which need never be. The national interest is more important than yours and my ability to profit.”

I don’t much advocate attempts to nerf Darwinism in action; if you want to ride a motorcycle without a helmet, I’m okay with you risking having your brains bashed out. Here’s the problem: it is likely to leave you in Schiavo mode, slurping up enormous resources and starting a fight over whether to withdraw your feeding tube. Indirectly, I will be billed for your choice. If there were a way for me not to pay for your foolishness, I’d say go for it. In practice, there is not, and I resist paying that bill. Anti-tobacco advocates feel the same way, and one can hardly blame them. One of the most oppressive examples of this is the homeowners’ association, in which people say ‘you can’t do that because it will lower my property value.’ I hate HOAs. And yet…I do have the choice to live somewhere without an HOA. I don’t have much practical choice about not participating in the national economy. The principle may be similar, but the difference in scope matters. Some dumbnesses can be addressed with law, to some degree, and others can’t.

Here is what outlawing it would achieve: greater public awareness of how rotten the Dow is. Instead of passively acceding to the notion that the Dow is useful, the public would hear how worse it is than useless, and might at least begin caring less about it. Sure, the public should educate itself, just as motorcyclists should wear helmets. If this did not cause needless market instability, no action would be necessary–just as if all bomb threats were spurious and false, and we ignored them all, we wouldn’t need to prohibit them. Moot point. We don’t ignore them all, they are accurate just often enough to take them all seriously, and thus anyone making a bomb threat deserves all that the law can throw at him or her. In the same way, the ongoing random bomb threat that is the Dow needs suppression insofar as the law has power to do so, and to be considered as respectable and valuable to society as a bomb threat.

Screw this. The conventional mutual fund model is broken.

It pains me to say that.  I used to work for Rainier Investment Management, a good company with smart managers that ran (and still run) several relatively successful mutual funds.  They treated me well; I still have friends there, and I hope they prosper as a firm and as individuals.  I learned so much there–and ironically, learned why conventional mutual funds are a broken model.  At the time (mid-1990s), they were not.  Now they are as outdated as the idea of scanning a newspaper for stock prices, phoning a broker to get a current quote, and paying him 7% to buy a stock.

But at this point, I can’t recommend anyone invest money in conventional mutual funds unless there is no adequate alternative (as in most 401ks).  They have three big problems:  the creation/destruction of shares, the way they are transacted, and the fee locusts that eat away the money.  And that’s the no-load funds.  If there is a load (a massive commission paid to the manager for the privilege of becoming his or her customer), add a fourth big problem.  If your broker charges a transaction fee of any size, add a fifth.

Before we get into that, for benefit of anyone who’s not sure, let’s detail how a conventional mutual fund works.  I was present for the founding of four of them, so I understand how this happens.  A money management firm files all the necessary paperwork to open a mutual fund, gets assigned a 5-letter ticker ending in X, invests some seed capital, hires an agenting bank to custody the money/shares, and writes up a prospectus.  Included in this are the investment guidelines, which are what keep the manager from just buying whatever the hell s/he wants.  Typical guidelines sound like:  the Fund will invest no less than 80% of its assets in U.S. equities (that would be stocks)  with capitalization levels below $1 billion (that would be small cap stocks, i.e., little companies).  The fund may hold up to 10% of its assets in cash equivalents (that would be money market mutual funds, essentially the savings accounts of the investing world) at the manager’s discretion. Okay, fine.

All well and good…so you go to buy it.  You place an order (in dollars, not shares) during the market day.  A couple hours after market close, the fund reports its Net Asset Value (that’s the price per share) for that day, and your purchase executes, with amount of shares calculated to three decimal places.  Those shares were created on the fly, just for you.  Had you redeemed (sold), shares would have been destroyed.  Tomorrow morning at 6:30 AM PT (9:30 AM ET), your manager will start thinking about how to invest the new money you sent him (so to speak).  You’ll share in the fund’s gains, losses and fees.  What’s wrong with fees? Everyone’s got to make a little money, right?

Let us say that everyone’s got to earn a little money.  It is stupid to pay someone a fee to underperform (do worse than) the overall market, the performance of which can be purchased using an index fund.  The idea of hiring a pro, right, is that s/he knows stuff you do not, does major research, digs deep, knows the right questions to ask, has a finger on the market pulse? Then how come a majority of them do worse than the market indices they compare to, a majority of the time? With all respect to the pro’s hard work, what the hell benefit is the investor getting?

It makes sense here to explain the alternative, the index fund.  It may be conventional (which suffers from all the flaws of all conventional mutual funds, but suffers them with lower fees) or exchange-traded (hereafter called an ETF, mechanics different from conventional funds, explained later).  Its basic idea is that the manager just buys the securities in a given index.  Doesn’t take much brains, as the manager has zero discretion.  S/he must maintain the fund in as perfect a mirror of the given index as possible.  If you own the fund, your performance will be the performance of that index less relatively small, more reasonable fees than actively managed funds.

The only reason to pick conventional funds over index funds is the belief that the manager will beat the market on a consistent basis.  Most do not.  Most get beat by the market, accentuated by the fees.  This adds value…how?

In fact, it subtracts value–and you pay for that service.  Well, if I want to do worse than the market, I don’t need professional help for that.  If I want my investments screwed up, I’m capable of that all by myself.  Now that I’ve explained the model and how it functions, let’s detail why it is broken.

1) Creation/destruction of shares.  Sounds simple enough, right? Not so much.  Suppose the market is going great guns.  Everything the manager bought is fairly expensive right now.  Because the market is going great guns, investors’ money pours in.  The manager’s guidelines require him or her to buy–but there’s nothing out there that’s a good deal.  S/he must buy at the inflated prices.  Okay, now the market is eating flaming death, or the fund had a bad quarter.  Investors head for the exits.  They must be paid, meaning the manager must raise cash for redemptions.  But there’s nothing s/he really wants to sell right now! There is no choice.  The manager must sell a security s/he did not want to unload, probably because this is a terrible time to sell, locking in a large loss.  Both of those dynamics damage performance.  It’s bad enough with stocks; it’s worse with bonds, which is why conventional bond funds are such a dumb investment.  Bonds are mostly not traded on markets, but are sold from broker inventories.  One can’t just buy a bond index, as the bonds in it are not always available.  This is why bond funds can go up and down in price:  after their issue, bonds will trade at premiums or discounts to their original par.  So for a bond fund, you get the potential for losing money of a stock fund, but you don’t get the high upside of stocks.  Seriously? Who wants this?

2) The way they are transacted.  If you buy a stock or bond, you buy at a market price.  You can issue trading instructions.  If your trade conditions are met, bang, you bought it–same is true for selling.  If you buy a conventional mutual fund, you issue the order when the market is open, and after it closes, you find out the price you paid.  In what world is this even remotely acceptable? I have some books for sale.  If you place an order during the business day, I’ll fill it this evening, but I don’t yet know the price you’ll pay.  I’ll know that later.  Would you buy books that way? Then why will you buy thousands of dollars worth of mutual funds this way? Do you hate your money and want rid of it? If so, send it to me.  I won’t charge you any fees and I will pay your postage and/or wire fees with a friendly smile.

3) The fee locusts that eat your money.  The fees are not inconsequential.  How it works:  the fund pays out money, including (most significantly) to the manager for his or her professional expertise.  Okay, fine.  Typical management fees for actively managed stock funds amount to about 1-3% of the total money in the fund.  You pay that, though you do not see it occur.  Worse:  you pay that even when the manager underperforms the market.  Dead serious.  You often pay them to lose you money.  Is there a one of us who cannot lose his own money without help, for free? If you want a free money-losing service, the offer above stands.  I’ll take it off your hands and I swear not only never to charge you a fee, but to cover all costs.  Hang on; there are also 12b-1 fees, ranging from 0.25% to 1%, that go to pay people for marketing the fund.  I’m pretty sure, for example, that’s how Fidelity gets paid for its no-transaction-fee funds.  These, too, you pay whether the fund wins or loses.  How does it add value to you? It doesn’t.  It’s just a way to get you to pay the freight for marketing and distribution of someone else’s goods.  You are the customer, not the manufacturer.  Why are you paying your vendor to market his product to you? Isn’t that rightly his expense?

4) Sales loads.  Typically 5.75%, a one-time fee assessed when one buys (front-end load) or sells (back-end load).  Often called a ‘sales charge.’  The very term is insulting to one’s intellect and commercial sense.  You have to pay them a massive fee for the privilege of having them charge you further hefty fees to underperform the market? In order to make up for the crater this fee will put in your returns, the manager must outperform for years at a time.  Odds are heavily against that.  So, let me get this straight.  You’re willing to buy something this disadvantageous? I have a better idea.  Buy an index fund, and send me any portion of the 5.75% you feel fair and right.  I will cover all fees and expenses for this process, and I’ll never charge you any further fees for it.  Why do load funds even exist? That’s so that full-commission brokers, who sell the illusion that they are acting in their clients’ best interests and who get paid every time they trade securities, can get paid to put the client in mutual funds (which will not generate ongoing commissions for the broker, being typically buy-and-hold investments).  Full-commission brokers are as obsolete as sales loads, conventional mutual funds and learning the stock results from a newspaper.

5) Broker transaction fees.  These vary from discount brokerage to discount brokerage, so let’s talk about how Fidelity does it.  At Fidelity, I pay $7.95 to trade stocks up to some large amount of shares.  Some conventional mutual funds have no transaction fees (I assume because the fund managers agreed to slip Fidelity some 12b-1 fees).  Here is an excellent article about this.  Others have a $75 transaction fee.  If I buy $7500 worth of stock, I pay about 0.1% in commission.  If I buy $7500 worth of mutual fund shares, I pay 1% in commission (let’s call this what it is, shall we?). Every nickel of commission that you pay is a loss to you.  One always pays something, but in the gods’ names, why pay more for no benefit? Ah, but say you really want into that fund.  Do you want it badly enough to lose this much money immediately, so that a professional manager can then pay him or herself a handsome annual fee to do a worse job than an index fund? Because on balance, that is what is going to occur.

Think of your finances as a human body.  The conventional mutual fund model is a series of leeches, slowly but surely drinking the body’s nutrients.  In return for what? On balance, on average, in return for lowering the body’s health. What is the benefit? A sexy name? An illusion of security? Sorry, but to me it just looks like being covered with leeches.

If a single person asks, I will author a follow-up article about why ETFs and CEFs (closed-end funds) are so far superior.