Wednesday, June 17, 2009
A Little History
In 1940, executives (the three highest-paid officers in the 50 largest US companies) earned 56 times their average worker’s pay. In 1950, that ratio slipped to 34 times, and fell further in 1960 and 1970 to 27 and 25 times, respectively.
Then, in 1980, executive pay grew to 33 times their average worker, and in 1990, to 55 times, approximately equal to that of 1940. In the year 2000, executives were paid nearly 120 times that of their average worker.
So, what was the economic situation in 1940, how was it similar to 1990, and what happened between 1990 and 2000 that caused the average worker to lose so much ground?
The Great Depression may have improved to a recessionary status from 1938 to early 1940, but no economic recovery of significance could take place without government fiscal intervention. The recovery would have likely taken much longer if left to the private sector.
The US Gross National Product had passed the $100 billion mark in 1940, but was just 9 percent above the GNP level of 1929. It was the federal purchases of goods and services for national defense in the pre-war period - a rise from $1.2 billion in 1939 to $2.2 billion in 1940 - when the economy felt the rise in government spending that marked the end of an economically depressed era through the injection of government funds directly into the economy. While many credit the “New Deal,” evidence points more heavily toward defense spending.
After a protracted period of 14%+ unemployment, a combination of a “take any job” mentality, and a new, somewhat underpaid female workforce during the war exacerbated the CEO vs. average worker chasm during this decade, which was not again achieved until fifty years later in 1990.
After a protracted recession in the 1970’s, the 1980’s was a decade during which economic growth depended on a steady rise in consumer spending supported by both increasing debt and prices of stocks and homes. The present U.S. slump signals the end of that consumption-led growth, with an overbuilt housing market and an over employed consumption sector, from car dealers to malls. The question is whether our system can adapt to create new growth to fill the void left by embattled consumers.
The 1940s was a “boom” cycle due to government defense spending, and the 1990s, a “boom” cycle due to consumer spending. Neither was sustainable.
However, in the 1990s, a fundamental economic change took place – a “monetizing” of the financial asset growth – that largely rewarded the financing side of cash flow more than the operating side. Basically, there are three components of Cash Flow:
· Operating Activities, or producing revenue by operating the business at a profit
· Investing Activities, or buying and selling investments like property and equipment
· Financing Activities, or issuing/repaying long term debt (bonds) and issuing/buying back company stock.
As seen in both the Internet bubble in the 1990s and housing bubble in the 2000s, investors often were more highly rewarded for “flipping” their investments (or selling after owning them for a very short period) than for investing for the long-term. Both capital (stock and bond) and real estate investors saw a dramatic increase over the historic long term returns during these periods, and accepted and expected a continuation of those unsustainable returns.
Further, with the focus upon “short term” returns, management compensation became rooted in their ability to produce and sustain those returns by lessening their percentage of “salary” and increasing their percentage of “stock options” and the like, justified by their having the same stake in achieving profitability as their stock holders. Unfortunately, as seen by the collapse of the financial system, incenting management to achieve short-term profits over long-term viability can have disastrous consequences.
It’s back to basics, now, for the capital and real estate markets. Real estate loans are again being made as they were for decades – 20% down, 30 year terms, with housing costs no more than 30% of gross income to borrowers with good credit. Stock prices are again reflecting management’s ability to turn a long term profit on the business more than their ability to buy back their own stock at a high return on investment. And executive pay is again reflected primarily in salary rather than stock options.
Are salary caps now appropriate? In my opinion, no. Any attempt to artificially cap prices, as was attempted in the 1970s, has ended in disaster. But, it has also not worked well to “let the market dictate,” as we are well aware now.
Companies must find a way to have the freedom to “bid” for talented people to run their businesses without undue interference, while recognizing that paying those talented people 120 times the salary of their average worker is a poor investment. It’s a complex problem that is fraught with both the tendency to over regulate and do nothing, both of which would be a terrible mistake.
And, while consumer consumption is severely mitigated by unemployment rates not seen since the 1980s, a return to conspicuous consumption seems, at least for the foreseeable future, passé. It is incumbent upon the US to convert the financial to the operating side of its future cash flow by innovating, i.e., producing new goods and services that address the needs of a global population in need of sustainable sources of food, housing and energy. As those businesses form, those who provide capital for their formation must demand a more horizontal business model that compensates innovators more closely to the level of their managers.
It’s a big job.
Friday, June 12, 2009
As we said before, the first consideration regarding research is independence. Why? Let's think for a moment about the way investment banks (now chartered as commerical banks, by enlarge, but still fulfilling the primary roll of raising capital for publicly owned businesses) are structured.
The part of brokerage firms with which women are most familiar is that of the investment advisers. This consists of brokers who invest money on behalf of clients, and either:
- Earn commissions for buying and selling securities; or
- Earn a commission based on a percentage of assets under management.
In a related part of the firm, the brokerage earns fees from companies for raising money for them by
- Selling ownership in the company (stock) to their brokers' clients
- Borrowing money for the company (bonds) from their brokers' clients
- Providing strategic management advice to the company about their capitalization (stock and bonds outstanding)
In a separate part of the firm, the brokerage owns stocks and bonds in its own account, and buys and sells those securities to make a profit.
In an additionally separate part of the firm, the brokerage provides investment advice (buy and sell recommendations) to its brokers and to the general public.
While legally, there is a "Chinese wall" separating these various functions in a brokerage firm, it is apparent that there exists the possibility that, if a brokerage wanted to sell a stock from its own account, its analysts could be encouraged to provide a "buy" recommendation on that stock in order to provide both a market and favorable price to sell that stock to its brokers' clients and the general public who follows its research. I am not saying that this does happen; rather, I am saying that it could happen, and therefore there is the a possibilty of impropriety.
Remember, too, that Standard & Poor's and Moodys both provided their highest ratings to so-called Auction Rate Securities, securities that were backed by mortgages, some of which were sub-prime. When reviewing the procedures used to qualify for that rating, it became clear that the fact the issuers of those securities were paying fees to these rating agencies for the rating, resulted at least in part to receiving that highest available rating- the same as is provided to US Treasury debt. Here, the conflict of interest was obvious.
So, researcher independence is critical. Who, then, independent?
Some companies are paid for their research by their clients who are subscibers - not by the companies they analyze. The largest, and most experienced of these companies are
- Value Line (specializing in stock research)
- Morningstar (specializing in mutual fund research)
MORAL: Your research is best when in comes from a company that does not benefit from your decision of whether to buy or sell a security, and has a lengthy track record.
MORAL: Even if you use a full service broker, ask what research she uses. If it's not independent, neither is your broker.
Broadly, there are three types of investing: growth, value and passive.
- Growth investors choose securities that are growing faster than the stock market as a whole, and try to take profits before any negative news causes the stock to drop
- Value investors buy high quality but out-of-favor companies that are inexpensive because of a negative short-term situation
- Passive investors buy an "index" that replicates the market averages, thinking that no one, after trading costs and taxes on sales, beats long term market performance
Growth investors will find Value Line stocks rated as 1 for timeliness as meeting their general criteria. It is noteworthy that, over the last 25 years, a portfolio of such stocks beat the S&P 500 average significantly.
Perhaps the most famous value investor in our time is Warren Buffett. Those securities in his Berkshire Hathaway portfolio are examples of long term value investing. For individual stock research, Mary Buffett's "Buffettology" series is a good way to learn to select and evaluate such stocks. I have worked and taught with Mary, and find her books the most accurate and easy to understand approach to learning value investing research and principles.
Passive investors, and those who prefer to buy mutual funds can use Morningstar reports to find funds that meet their investment goals.
Value Line, Morningstar and the Buffettology series should all be available to you through your public libraries.
There are many other sources of independent research. If you choose to use one, check the author's experience and portfolio performance carefully, and ensure that both have been evaluated independently over at least ten years.
MORAL: Pick an investment strategy and stick to it. Moving back and forth (e.g., growth and value) does not work. Once you know your preferred strategy, use the best source of information available for that method of investing.
Thursday, June 11, 2009
This is for those of you who take more of a "hands on" approach, and are likely to do your business through a discount, or deep discount broker.
By far the most important aspect of your investing issues is where you get your information. Any company which benefits from you taking their advice is, in my opinion, automatically suspect. You may recall the recent stories about Standard & Poor's providing the highest available safety rating for so-called "Auction Rate Securities" consisting of mortgage securities, which became unsaleable soon after the mortgage crisis. The issuers of the mortgage securities were paying S&P for the rating. Whether there was actually a conflict of interest or not, there was certainly the appearance of potential impropriety.
Moral? The more independent the research, the more reliable it is.
So, who is the author of the "research reports" provided by your broker? The best sources would be those who earn their revenue from their subscribers, like Value Line and Morningstar.
a. Mutual Funds
If you are a mutual fund investor, keep an eye on your fees. No-load does NOT mean no fees.
Mutual funds that do not pay a "load," or commission to a broker or planner to sell the fund, instead pay advertising and marketing fees to sell the fund directly to you. These are called 12(b)1 fees, and vary widely from company to company. Your fund will also charge you "management fees" to compensate the person(s) who manage the fund.
You will pay these fees every year, and these fees will be deducted from the return on your investment.
If you are a mutual fund investor, know your fees.
Before opening your account, get a complete fee schedule. Will there be a charge:
- To close your account?
- If you fail to keep a minimum amount?
- Annually to maintain your retirement plan?
- To talk to a representative?
- If you don't make a minimum number of trades per year?
3. A Second Pair of Eyes
In previous discussions, we talked about financial planners. They may practice similarly to a broker, i.e., charging commissions only when selling a product or "fee only," which is similar to the way an attorney or accountant charges.
Periodically, even if you are a very experienced investor, it is a good idea to have a review of your portfolio. This can be accomplished very cost-effectively by finding a financial planner who specializes in investments review and comment on your portfolio. Generally, unless you have an extraordinarily complex situation, this should be about a two hour project, and will be well worth the time and expense if you have overlooked anything critical in your portfolio.
Wednesday, June 10, 2009
If you are a woman who is best suited with an adviser who will walk you through the entire investing process, this discussion is for you.
Broadly, there are two type of advisers who fit your needs:
- Full service brokers (like those employed by Goldman Sachs, JP Morgan, etc.)
- Fee-only financial planners
Full Service Brokers
Education and Experience
Series 7 License
A full service broker will have a Series 7 (General Securities Registered Representative)licence, that shows at least 70% accuracy in answering 250 questions about
- Mutual Funds
- Options (derivative instruments)
as well as a Series 63 (State specific) license.
This individual will have passed a background check by the employing firm and be fingerprinted.
Most investment bankers (Goldman Sachs, JP Morgan, Morgan Stanley, etc.) have changed their charter to commercial bankers because it allows them to raise money more cost effectively. If, for example, you bank at Chase, you will find that it is owned by JP Morgan, formerly an investment bank. In your bank branch, you may find a person who sells securities. This person is not a bank employee, but works under a separate "umbrella" company - which is different and separate from JP Morgan brokerage.
Series 6 License
These advisers may have only a Series 6 (mutual fund representative) license, and are not authorized to sell individual stocks and bonds.
These advisers will be familiar with general guidelines as to whether a particular fund or group of funds is appropriate for your level of risk.
CFP - Certified Financial Planner
This is a national designation that the adviser has passed a rigorous course of study that includes budgeting and cash flow, investments, taxation, risk management, education financing and estate planning. There are additional requirements for continued education.
CFA - Chartered Financial Analyst
This person will be skilled in analyzing both portfolios and individual securities.
Other Professional Designations
Advisers may also have licenses to sell insurance products (such as annuities), regional professional designations issued by the American Banker's Association, various universities and other financial education providers. Contacting the issuer will give you the scope of training represented by the license or designation.
ASK THE ADVISER
- What licences she has
- What professional designations she has
- The length of experience she has
and verify that information through:
or http://www.cfp.net/search/ for a fee only planner.
You want a person that has significant experience and training.
2. Type of Client
The type of adviser that will likely serve you best is one who serves people like you. If your adviser's clients are primarily 70 year old retired executives from Boeing and you are a 30 year old middle management woman, your adviser may not have the background to best address your particular financial needs.
ASK THE ADVISER TO DESCRIBE HER TYPICAL CLIENT.
- Average account size
- Risk tolerance
If the description is significantly different from your situation, you may be best advised to keep looking.
3. Historic performance
Over very long periods of time
- The stock market yields about 8 - 10% per year
- The bond market yields about 4.5% - 6.5% per year
- A portfolio of 60% stock and 40% bonds yields about 6.6% to 8.6% per year
- With significant differences from year to year.
One of the red flags that should have been seen by Madoff and Standford's clients was consistently beating market averages year after year after year, with no apparent increase in risk. Not Peter Lynch, not Warren Buffett, not ANYONE has achieved this performance, and no credible investment managers would intimate that such returns are either probably or possible.
Ask your adviser what her average annual performance for clients has been with similar risk tolerance as yours over the past 5 years, and verify that information with her employer.
4. A word about risk tolerance
As it applies to you as an investor, risk tolerance is the answer to "How far can your portfolio go down before you freak out and
- Wake up in the middle of the night with cold sweats
- Call you broker and ask what the heck happened to all your money
Markets predictably and regularly correct by 20% +, and as you can see from the recent correction, sometimes 50% +. In the mid-1970's when I was but a babe in the financial industry, such a correction occurred. Another one is in process now. Answer the question about risk tolerance in terms of what percentage of your portfolio are you capable of losing before you panic.
State your risk tolerance in terms of a percentage, and obtain a commitment that your portfolio volatility will remain within an amount acceptable to you.
Keeping in mind the general market returns provided in 3 above, ask what percentage of your portfolio you will pay for management on an annual basis. Fees will vary (some mutual funds charge 5% to buy as a one-time charge), so ask for estimated fees over a 5 year term. Ask the adviser to subtract her fees from your expected portfolio annual return, provide this estimate in writing, and tell that adviser that you're comparing fees with other investment professionals.
Never ever ever ever grant discretionary trading authority to an adviser, unless you open a "wrap" account, i.e., one where your broker assigns your money to a private money manager. Under any other circumstances, this is a highly inadvisable practice.
Tuesday, June 9, 2009
Recently I asked a group of very bright women in what subjects they were most interested in their financial lives, and one question was "how to find a financial adviser."
When thinking about that subject, that simple question became a very complex answer, so we'll discuss this in the form of a series of articles.
Personal finance is generally split into categories that include:
- Budgeting and Spending
- Risk Management (Insurance)
- Investing (capital markets and real estate)
- Estate Planning (wills and trusts)
- Tax Planning
We'll start with Investing, since that's the category most women equate with having "Financial Advisers." There are many types of financial advisers available for investors, and the first way to narrow down that huge number is to ask, "How much work do YOU want to do?"
Do you want a person to manage the entire process for you? That person will be very different from (and charge much more than) a person who just buys and sells what you tell them to.
1. Full Investment Management
This person will
- Determine your financial goals
- Determine your tolerance for risk
- Suggest a portfolio that reflects both your goals and risk tolerance
- Suggest when it is appropriate to reconfigure your portfolio
- Periodically review your progress and answer any questions you may have.
Examples of this type of manager include advisers with Investment Bankers such as Goldman Sachs, JP Morgan and Raymond James.
2. Discount Broker
A person will be available for you to ask periodic questions, but research assistance is provided primarily through source material for you to use independently. Investors who are best candidates for this type of service will know
- The type of investor she is (growth, value, modern portfolio theorist)
- The level of risk she can tolerate (maximum level of price fluctuation she will accept before being tempted to sell)
- Both when to buy and when to sell an investment, and how to best replace it when selling
Examples of this type of service are Fidelity and Charles Schwab.
3. Deep Discount Broker
Assistance is provided in the form of research material, but no advice is given. Investors best suited for this type of broker are experienced investors, generally those with at least ten years' experience in investing for themselves and make all their own decisions. Some clients of deep discount brokers will employ a "Fee Only" financial planner every year of so to review her portfolio.
Examples of deep discount brokers are Scottrade and eTrade.
Now that you have made a categorical decision about the type of advisor you may wish you employ, we will discuss the level of training you can likely expect and some questions to ask that advisor before employing her in our next installment.
Please feel free to comment and share your experiences, and we do encourage you to subscribe to this blog as well.
Monday, June 8, 2009
Dr. Warshaw, Mary Buffet and I all participated in developing and presenting a UCLA seminar titled "Financial Planning for Women." Why just for women, you ask?
Having developed and taught much of the Investing portion of the Financial Planning curriculum for UCLA, I noticed that a significant number of my students were male, and those few women who did attend these classes tended to sit in the rear of the auditorium and rarely participated in discussions. Yet, these women had longer life expectencies and earned less money than men. Mastering investment skills is more critical for women.
In order to attract women attendees, we developed a seminar just for them, and found every one nearly filled to capacity.
Perhaps women prefer to discuss money with each other.
This is a forum to do that very thing in the virtual world, and you are invited to ask questions, recommend content or share your experiences that may benefit others.
I look forward to our discussions.