Mutual Funds by Management or by Indexes

Experience and research show that the so-called “best” managed mutual funds in any year are achieved mostly by chance.

In any category of mutual funds, only a small percentage of active managers beat the performance of indexes or un-managed funds. Furthermore, those who have distinguished performance in any one year, generally cannot repeat their performance the next, or on any consistent basis.

Few managers can outperform indexes over a few years time, and if they do, it is pure luck, not ability.

Financial Stimulus Success?.

Interest rates normally adjust to supply and demand forces and thereby adjust economic events. However, whenever the government imposes stimulus proposals to raise credit and lift the economy, the system is disturbed and thus distorted.

This unbalances the economy and does the exact opposite of what has been intended. It’s a lesson politicians wantonly overlook to suit their election goals.

Ludwig von Mises wrote fully about the phenomenon in the 1920s but the economist in fashion during the 1930s recession was, unfortunately, John Maynard Keynes. He became the political icon of that recovery movement.

The Keynes government pump-priming thesis used prolonged stimuli that actually deepened and helped induce the Great Depression. Nevertheless, it is the premise of failed current policy.

Getting a Grasp on our Deficit

The U.S. debt is over $14 trillion, with the federal budget deficit at $1.4 trillion. Add to that the liability the federal government has for Social Security, Medicare, Medicaid and prescription drugs) and you have an estimated deficit ranging between 60 and 100 trillion dollars.

Entitlements now account for almost 60 percent of federal outlays.

Every year, non-discretionary spending eats up more of the federal budget.

But for the past 30 years, U.S. tax revenues have averaged 18 percent of the GDP with spending, about 30 percent of the GDP.

Defense spending, which is called discretionary, totals $685 billion. Our deficit is $1.4 trillion. So, essential defense spending, even if eliminated, would not solve the huge deficit problem.

And despite what the left loves to say about the uselessness and waste of U.S. defense expenditures, it returns immeasurable benefits in the form of global economic prosperity, freedom and security.

Bank Credit Under Pressure

Banks are not making sufficient loans to small business, even when they have the ability to do so. The fact is, they make more money these days, with far less risk, by borrowing cheaply from the Federal Reserve and investing in government bonds.

Also, that there is political meddling and strict bank supervision adding to the bank-lending picture.

Some banking groups are now complaining that they have the money to lend, but with less takers because of the recession.

Many thriving businesses, especially commercial real estate operations, are genuinely seeking loans from banks with funds. But, too many lenders are hesitant about extending loans they once more readily made.

The Federal Reserve’s Poor Job

We unfortunately use Federal Reserve edicts as gospel, even though they often are proven wrong. This has been the case in almost half the decisions we have gotten under the auspices of the governorships of Alan Greenspan and Ben Bernanke.

We have to remember that economists are fallible, even when they direct the Federal Reserve.

In the past, those in the Fed worried we may have deflation; they therefore inflated the economy, and added too much currency. In fact the Fed, almost automatically, has been on the side of targeting some inflation, in an attempt to prevent deflation.

Thus, the Fed has been the chief culprit, causing bubbles which invariably lead to busts and eventual depressions.

And today is aiding and abetting inflation with the buying of Treasury bonds.

Back-Testing of Investment Strategies

Professional investors use back data to sell strategy based on future events. Wall Street financial models often resort to what is known as data mining. Information on various investing strategies of the past. They are collected and tested on a “what if’ basis for the future. This is also called back-testing; the strategies of the past are used to see what would happen, hypothetically, when projected into the future.

All this is based on many assumptions that the mathematical models are supposed to predict.

After my decades-long investigations of investment strategies over the years I can tell you this: There are some worthwhile concepts as well as gibberish in all. But no panacea exists. I would say that most of the data mining is therefore useless, except for their marketing of investment management services. ( See the Earl J. Weinreb NewsHole® comments.

The Annuities Sales Pitch

Annuity salesmen often compare benefits with the investing risks that attend stocks and bonds. They mention all the hazards of securities markets and the possibilities of market loss. But annuity salesmen often overlook downsides of their offering.

Annuities do have negatives; they are not for everyone. They have an insurance factor which may not be needed. And if not required, why pay for it?

There are annuity management fees, contrary to some sales pitches and also early termination charges.

Then there are fixed or variable annuities to select, that further complicate the picture. Fixed annuities have set returns which means the buyer has no protection from any future inflation. Variable annuities tie in securities markets but not as much as you may desire.

So always be alert to the annuity sales pitch; ( See the Earl J. Weinreb NewsHole® comments.

Undisciplined Investors

I have documented over 1600 investment strategies used by professionals, and have looked at their pros and cons.

While there is no perfect strategy, the chief pitfall in their usage is usually the lack of discipline employed to follow through, not the strategy itself.

Additionally: I discovered why markets can be so rash and erratic. When institutional investors account for 80% and more of trades, why should the markets behave so erratically? Wall Street "wizards" invariably act in an undisciplined, mob-like manner; not as true experts.

Their investment results speak accordingly. ( See the Earl J. Weinreb NewsHole® comments.

As Good as Gold?

The answer to buying gold? The correct answer is not what you probably expect.

What type of investment are you seeking? You can trade gold as a commodity, as many do. At times, even government trades impact short-term supply/demand and thus prices..

Want an inflation hedge? Sorry. For 25 years, from 1985 to 2010, consumer prices went up a bit more than 200%. Yet, during this time, gold prices were off by about 20%,

Want to head for the hills in an emergency? Gold bars are too heavy; rare gold coins would do it. But try this only in an dire emergency.

Need a weakened dollar hedge? Gold is still not a panacea. It offers no earnings. And has storage and insurance costs if bought outright. This isn’t too bad when interest rates are low, but proves costly when interest rates rise. And you can be sure interest rates will go far higher as inflation becomes more of an economic factor for the Federal Reserve’s attention.

Moreover, higher interest rates generally spell a stronger dollar, and more pressure on gold. (See my Earl J.Weinreb comments.)

The Volcker Rule “I Told You So”

A headline reporting that Volcker Rule regulators cannot measure the risk being taken by bankers is an oft-repeated lesson we never learn.

Regulators in Washington have little idea of what they are doing. They are often wrong. And they are not penalized for their errors.

Under the so-called Volcker Rule, banks are not supposed to trade with their own money. That sounds good to politicians because it appears simplistic enough to sell to voters who haven’t a clue about banking. But funds are intermingled and the extent of supervision depends on size and there are simply too many “ifs” in the picture.

Political influence also rears its ugly head. Need I say more?

The Options Market?

Options offer an investor the right but not the obligation to buy or sell a security at a set price.

Options also, protect shares from under-performing. And to make money when market conditions are extreme.

To invest in options, you must take time to learn about them. Know the difference between a call and a put, strike price and all the rest of arcane terms.

There is no quick options course, Take your time because of the complex nature of this aspect of the securities business.

Do not attempt to get involved unless you learn about options both academically and in practice. Therefore, run through fantasy dry-runs with no real funds, just to see how you would have done with real money.

Then use your own real capital.

Financial Mathematical Models

I would like to review again why vaunted mathematical models have done so poorly in preventing financial meltdowns.

I refer to just two examples, the LTCM (1998) and the subprime mortgage (2008) disasters.

Why did the math models behind them fail?

These math models were made up by top researchers, mathematicians, and celebrated “quants,” who figured they had anticipated all cyclic contingencies.

Yet, bond markets eventually fell apart despite their calculations. Afterward, the ones responsible found they should have looked at contingencies even further back than they had.

But I see a bottom line weakness in math models, no matter how much research is done. It happened with the LTCM breakdown. It very definitely is what I feel was a factor in the subprime crisis, which haunts America and the world to this day.

There is a common thread between the two breakdowns which has to do with the fact that we react to problems with panic. That is because our “experts” who come to the rescue are unfortunately from the financial community, attuned only to the short term. They cannot see how caution and avoiding over-zealous, impulsive action can overcome the danger. So they act in haste.

There was a human error in these instances, other than in mathematical calculations. Often that error is enforced by government in the form of strict regulation that is actually a reaction with the very panic that such regulation supposedly has been developed to suppress.

The formulae probably would have worked over the longer term. These are never successful for short-term markets that regulation certainly overlooks.

Politics and Bank Credit

Many smaller banks don’t have sound loans on their books. They are, therefore, under constant pressure to clean up their financials and/or add to basic capital.

Unfortunately, politicians in their area are putting pressure on the bank examiners to allow these banks with questionable standing to make loans which ordinarily should not be made.

Unfortunately, banks are not making sufficient loans to small business even if they have the ability to do so, The truth is, they make more money these days by borrowing cheaply from the Federal Reserve and investing in government bonds.

This unhealthy environment is perfect for the likes of meddling politicians in Washington whose influence is being made in the wrong place, in the wrong manner.

Supervise banks gingerly but independently of politics. Secondly, permit banks to make riskier small business loans and restrict their tendency to borrow cheaply and invest in government bonds.

It is also time to raise the cost of Fed money to banks, so the latter do what they are in business to do.

Wall Street Analyst Advice

Little independent thought comes from the analytical ranks. What goes for research on Wall Street is primarily corporate reports. Little is done on all-important strategy. Most analysts have no time for careful, insightful thought. Moreover, the investment community is incestuous, feeding on itself in a way which foments herd-like and impulsive instincts.

Yet, we constantly hear about expert securities-pickers and newly-found, can’t-miss strategies. Your may hear or read of it as if they have just found gold. I have heard of comparable new-strategies for decades and I have investigated them. There are no panaceas. ( See the Earl J. Weinreb NewsHole® comments.

Avoid Investing Style Changes

Some advisers tell a mutual fund investor not to buy a fund that clings to a particular “style” of investment, such as small cap or large cap. But to pick and choose what is just right for the times.

That advice will tip you off that the adviser has no specific strategy because he or she is willing to change strategy to suit whatever style may be popular at the time. That’s a form of market timing that doesn’t work and besides, it indicates a lack of required discipline.

My experience has shown that such undisciplined investments with no set strategy tend to not do well. ( See the Earl J. Weinreb NewsHole® comments.

Are TIPS Needed?

Financial community gurus recommend TIPS with the first vestige of increasing interest rates. They’re bonds issued by the federal government through a bank, broker, or the Treasury, for five, ten and twenty year maturities. They also can be bought in the form of mutual funds and Exchange Traded Funds (ETFs).

TIPS’ values grow to the extent of inflation. They are not actually part of the investment essential tools I recommend; for several reasons I have repeatedly explained in the past.

Their function can be accomplished better with the use of proper duration principles and their implementation. Furthermore, they sell at a premium to value and their inflation advantages are taxable. ( See the Earl J. Weinreb NewsHole® comments.

Banks Too Big to Fail

The Dodd-Frank legislation of 2010 supposedly was enacted, among its hodge-podge of intentions, to prevent big banks from failing. To do so, it helped impose rules on banks, against trading for their own accounts; so-called Volcker Rules, after Paul Volcker, a former Chairman of the Federal Reserve.

The Glass-Steagall Act, preventing commercial banks from being in the investment banking business, had been around under the Banking Act of 1934 until it was terminated during the Clinton administration.

A similar law could probably have been passed, without all the talk that casts gloom over industry and finance and sees to it that we remain in a deep recession. Right now, commercial banks are spinning off trading activities for their own accounts but it’s difficult to distinguish activities done on behalf of clients.

The upshot? Confusion and bigger banks than ever because Dodd-Frank is murder on smaller banks. The bigger than ever banks will continue to be too big to fail.

Gibberish In Lieu of Financial Facts

The reading public has had its financial basics poorly taught by the vast majority of book experts, in addition to Wall Street insiders and often inept financial media.

Everyone’s always looking for confirmation of investment facts they can use to advantage. But unfortunately with what I find has become dubious input.

And so the public continues to buy into pap. Garbage often sells like proverbial hot cakes. Gobbled up by the same unwary and gullible folks who believe gibberish and fantasy thrown at them every day. ( See the Earl J. Weinreb NewsHole® comments.

The AIG Bailout Disaster

I have often said that human error was instrumental in the financial meltdown of 2008/2009.

There has been finger-pointing, usually by left-leaning, anti-business politicians and by bureaucrats whose immediate impulse is to blame big business and bankers; the litany of criminalization in left-wing lexicon.

I have always blamed human error. Whether loose monetary policy of the Federal Reserve’s inflating currency, or inappropriate mark-to-market accounting rules for securities evaluation,

In the case of AIG, the value of its derivative insurance coverage was also being determined on the basis of fictitious existing market value; not on possible claims in the future, at the maturing of company obligations, but at supposed current valuations.

That produced a condition that induced panic-laden premature bankruptcy; a rush to judgment when cool heads ought to have been the hallmarks of expertise.

Another incidence of rescuers acting in the AIG panic was evidenced by the paying of debts on the basis of 100 cents on the dollar to some bankers in this country and abroad. Especially after the government unfortunately decided to take over 79.9% of the business in its panic-driven haste.

A government guarantee would have sufficed, instead of all this taxpayer outlay.

The Purchase of Individual Securities

The public will continue to buy individual stocks and bonds, though the odds of success will be shown to be better with index mutual funds and ETFs.

And many prefer to invest without wise asset allocation selection which I find is essentially a form of disciplined strategy.

And most overlook the ability to reinvest dividends or interest in such funds, particularly to take advantage of the duration principle.

Perhaps basic financial ignorance has become human nature. Despite proof that managed funds cannot consistently beat indexes; diehards will still attempt to beat indexes, and mostly fail.

While disregarding well-thought-out asset allocation and duration principles. ( See the Earl J. Weinreb NewsHole® comments.

The Wall Street Advantage

Do Wall Streeters have an advantage that smaller investors don’t?

I often discuss who I call “inside players,” those in the financial community who may have an advantage of “being there” on the inside. And how any disadvantage of being an investor “on the outside” can be avoided.

The inside players often make the bulk of their earnings from fees, plus the important fact they can arrange deals and contracts; not because they are smarter or more astute investors.

Just one example: Wall Street pros are notoriously poor market timers. ( See the Earl J. Weinreb NewsHole® comments.

Tainted Gurus

I have often mentioned how easy it is to become a financial guru. Look at the vast number of available books, by experts; questionable analysts and costly advisers. Keep this in mind whenever you get gratuitous advice, or see or hear a financial ad, giving one salesmen’s opinion for investing.

Sometimes advice may be in the form of a public relations release. Or you get a suggestion about how to find the next hot stock, or how to outwit inflation with risky alternatives.

You must also overlook the conflicts of interest if the commentators who rely on advertising face a decision about criticizing would-be or current sponsors.

Too much advice from gurus are thus tainted ( See the Earl J. Weinreb NewsHole® comments.

Market-Report Headlines

It is almost impossible to know after a trading day’s closing, the moods and sentiments that really drove that day’s market, nor the supply and demand of securities over the global markets that would have had an impact.

Short of a major calamity or an important market-impacting event, the media does not know. But it’s ready with headline answers, as if a market crystal ball has somehow telegraphed some secrets to them.

It’s a shame their crystal ball doesn’t provide accurate information in advance.

Adviser Certification

Added to all its uses of arcane terms and jargon and acronyms that confuse most of the public, Wall Street inside players, and its analysts and advisers, have to show you how truly bright they are at picking winners.

So they have come up with certification initials they post after their names, that are hard for the public to comprehend. The initials sound impressive but many are not as difficult to get as you may think. In fact, many are looked at askance by regulatory authorities.

But they help market advisory services. And they impose investor inferiority. The fear of not quite being up to the task of competing with “smarter” investors.

A test is needed to get some certifications. But who says that passing a test of routine questions makes someone a true expert at financial matte It does help someone understand the arcane terms and jargon and acronyms which mean nothing in tipping investment odds in your favor. ( See the Earl J. Weinreb NewsHole® comments.

Investment Advisers

Advisers come in different guises. They may call themselves a variety of comforting names; wealth advisers is one. They may be independent practitioners, or members of a special department set up by a conventional stock brokerage or investment banking firm or commercial bank.

They may be actually specializing in the sale of life insurance and annuity products. To round out their sales portfolio, they may even sell mutual funds on the side.

They make their earnings from sales commissions from what they sell you or from fees on your assets they manage.

But they are selling something and therefore, their advice may not be truly independent.

Aside from all that, they can be costly. ( See the Earl J. Weinreb NewsHole® comments.

Thrift Savings Plans or TSPs

The Thrift Savings Plan or TSP, administered by the Federal Retirement Thrift Investment Board, was created for U.S. civil service employees and uniformed members of armed services. Under the TSP program, individuals can make contributions to retirement savings.

The TSP is a part of the Federal Employees Retirement System, or FERS. Others include the FERS annuity and Social Security.

It’s designed to closely resemble what’s available in the private sector, with tax deferred contributions to 401ks. It is also open to employees covered under the older Civil Service Retirement System or CSRS.

There are five funds; all can be selected in varying amounts, including a diversified mix in the S&P 500; a mixture of corporate and treasury bonds.

Investing Overseas?

The financial media will often discuss investing at least some of your funds overseas. But nothing is definitive about what is global diversification of investment.

Many large American companies are doing business overseas. So investing in the S&P 500 will give you a measure of global diversification.

If you do buy overseas investments to broaden this strategic step, there are emerging or developing, as well as developed countries in which to participate. Using indexed funds or exchange traded funds (ETFs), you can invest around the globe with varying regional emphasis.

Use indexed funds which are not hedged against currency value changes. This also helps diversify against inflation in the U.S. and acts as a currency hedge.

Stock Broker Obligations

If the Securities and Exchange Commission has its way, stock and bond brokers will have to observe fiduciary rules when discussing investments with clients. In the past, all they were obligated to do was see that investments were suitable for their clients.

Under fiduciary rules, brokers could be sued by tort lawyers for any imagined infraction and/or lack of explanation. This makes the broker’s job too scary for any practitioner to contemplate keeping.

It’s a scary possibility even for efficient stock brokers, that can drive them all out of business.

Keep tuned.

Corporate Bonds, Duration and Inflation

There is a possible solution to the quandary of bond ownership and inflation. I refer you to my Earl J. Weinreb NewsHole® comments.

Most investors who look ahead many years, some as much as fifty, tend to overlook the principle of duration..

Overcoming inflation with the wise use of bonds concerns constant reinvestment in low-cost mutual funds or ETFs (Exchange Traded Funds).

The proper implementation of duration should suit the investor’s personal time horizon. That is, how long the bond fund will be held before the funds will be needed.

Corporate bonds can help overcome inflation and the dearth of income and potentially limited growth from stocks.

But be sure you invest in a low-cost bond mutual fund or ETF where interest earned is automatically reinvested in shares of the same fund each month.

Your Portfolio Earnings in The Future?

I find a major disconnect among investors on Main Street and Wall Street about what they expect to earn from their securities portfolio over the next ten, twenty, even fifty years, after tax and inflation.

Admittedly, that is a tough prediction because investors must take income taxes and inflation into account, along with projected securities’ yield and market returns. None of that is simple.

In one survey I noted net/net/net predicted return by a number of experts over the next fifty years. Interestingly, returns ranged between 2% and 3% annually.

That is unusual and shocking to many. Investors’ experience from the past would have had expectations of close to 6%.

In other words, many securities markets observers believe that potential, along with taxation and inflation bites, will reflect dismal future market returns.

I have written about alternatives and will take them up in future blogs. ( See the Earl J. Weinreb NewsHole® comments.

Why Use Financial Advisers?

Some financial and business insights that will make it easier to invest without having to hire an advisor whose fees will take 15%, 20% and more of your investment earnings every year, slice by slice. Without you feeling it until it’s too late.

Figure it out for yourself. That’s what it costs when you pay a 1 ½% management fee each year on your assets, and you’re getting earnings of 6% a year on average.

The lessons result from my observing the successes, failures and foibles on Wall Street. You probably have seen my Earl J. Weinreb comments on this subject many times in the past.