A Rose by Any Other Name

As our nation grinds to a halt under the failure of statesmanship, I refuse to take a side.  You may not characterize me with a word, when doing so will only give me the opportunity to give countless examples of when that word does not accurately describe my position. 
Democrat, Republican, Independent, Libertarian - or Capitalist
In my study of political structures, and which function best, I've concluded that capitalism is my preference.  I prefer that to Democrat, Republican, Independent, or Libertarian.  In societies where capitalism flourishes, there is likely

• Greater opportunity
• Tolerance of diversity
• Social mobility
• Commitment to fairness
• Dedication to democracy.

But, we must take care in how we define capitalism.  Unbridled free markets recently rocked global finance to its core, and financial reform is stalled in a gridlocked Congress over a year from barely skirting a depression.  Without requiring that capitalism be characterized as pursuit of a rising standard of living for the clear majority of citizens, it is reduced to a system that benefits the few.
Pursuit of a Rising Standard for All
With that definition in mind, it is interesting that the ratio of compensation of CEOs to workers was 30:1 in 1970 and 120:1 in 2000.  These data were provided by the Economic Policy Institute, a think tank dedicated to including the interests of low to middle income workers in economic policy.
The growth in CEO earnings virtually mirrors in the growth in the S and P 500 Index over that same period.  While workers are generally paid in the form of cash compensation, CEOs in non-financial firms earn over 70% of their compensation in the form of equity pay.  Therefore, the inequity appears to be based more in the performance of the price of their company stock options than any other factor.  If the CEO is ultimately responsible to her stockholders for the performance of the company, then this inequity is readily explained.
Further, during this period retirement savings changed from company-provided defined benefit pensions to  retirement programs where employees make contributions that are deducted from their income.  For example, a worker who contributes 15% of her $50,000 salary to a 401 (k) plan will show a taxable income of $42,500 after deducting the contribution.  Because the IRS limits the dollar amount of contributions, a $250,000 executive at that same firm would be limited to a $16,500 contribution.
The worker's salary in this example would be decreased by 15%, and the executive's by less than half that (6.6%), even though the executive contributed $9,000 more.  As you can see, workers contributing to these plans make their income appear proportionately less than CEOs.
Finally, because transfer (unemployment, welfare, disability and social security) payments are taxed, if at all, at a lesser percentage for lower income taxpayers, those amounts are not fully represented as income, based on tax return data.
A 2007 article by the Cato Institute demonstrates that many studies, including recent work from Paul Krugman, grossly overstate the disparity between CEO and worker income, and estimate, based on Congressional Budget Office figures, that the top 1% of earners in 2003 earn between 14:1 to 15:1 more than workers, up from about 9:1 in 1981.  
So, while the current climate is not one that shows capitalism in its finest light, we do appear to be in a rising tide that lifts most boats.  And, with that, I will add a codicil to my "Capitalist" title.
Barron's Byline Admission
One of my favorite economists is Gene Epstein, who is the Economics Editor of Barron's magazine.  I have often referenced his work when teaching Security Analysis at UCLA because of its data-orientation and lack of agenda.
Mr. Epstein recently gave a speech to young people that he was kind enough to share with me, wherein he described himself as a "bleeding heart capitalist."  It was at that moment that I adopted a party affiliation.
I am in favor of a system that is most likely to result in greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.  I am, indeed, a capitalist.
But, I also demand that that system results in a rising standard of living for the clear majority of their citizens.  Rather than a "laissez faire" approach to free markets, I favor a properly regulated financial system that compels those who take extraordinary risk be subject to extraordinary loss - and be outside the realm of Federal insurance, either by mandate or by being "too big to fail."
I favor protection of the finest educational system in the world by protecting the free exchange of ideas in a meritocracy, encouraging participation with the world's greatest minds regardless of their country of birth, and funding their priceless contributions to our competitiveness in the global economy.
I, too, am a bleeding heart capitalist, and will support whichever political party that furthers these ideals.

Greed and Fear

I was just looking over a list of the cities where the highest percentage of homes was "under water," i.e., the mortgage is higher than the house is worth. 
And a light went on in my head.
I used to manage money.  I heard people throw around the words "greed and fear" almost every day.  When markets were expensive, EVERYBODY wanted to buy.  When they crashed, you couldn't give stock away.
So, back to mortgages, more than half of the people in these cities owe more on their houses than they can get from a buyer.

• Bakersfield, CA
• Riverside, CA
• Fort Meyers, FL
• Fairfield, CA
• Orlando, FL
• Reno, NV
• Port St. Lucie, FL
• Phoenix, AZ
• Stockton, CA
• Modesto, CA
• Merced, CA
• Las Vegas, NV

That's over 1.8 million households, with houses worth about what they were sometime between 1998 and 2003.  Some of these people had to buy their homes for a new job, etc.  But most, I imagine, saw housing prices go straight up during that period and bought or refinanced, thinking they could make money when they sold.  Now, unfortunately, the majority of people in these cities are on the "fear" side of "greed and fear."
The return on investment for investors in the stock and real estate market, over the long term, is very similar.  Apparently, so is the motivation to buy.  We know, as investors, we should strive to "buy low and sell high," or as Warren Buffett says, "Be greedy when others are fearful: be fearful when others are greedy."  But that's not what we do.
Back to the stock market, you may have noticed it's going up.  A lot.  Let's take a look at that for a moment.
First of all, it's up about 50% from its low.  It came down 50% from its high.  So, does that mean we're back where we started?  Far from it.
Since we're near Thanksgiving, let's use the example of pie.  If we put a pie on the table, and the kids eat half of it, it's easy to visualize what's left: half a pie.  If we increase that half a pie by 50%, we add a quarter of a pie.  We've got 3/4 of a pie, or 25% less than the full pie that we put on the table.
So, if the market is down 25% from its high, does that mean that it's cheap?
If we look at history, the average price investors pay for every dollar the S&P 500 earns is $15.82.  Right now, you'll pay about $21 for next year's earnings.  At the market low, you'd have paid under $11.  So, it's more expensive than its average price, but that's not surprising, since it's roared back over 50% from last March.  Does that make you feel greedy (I've got to get in before I miss the boat) or fearful (I should have bought when it was down, and now it's probably due for a correction).
The best way to feel, in my opinion is emotionless.  Being rational, rather than greedy or fearful, is the best strategy.  One very good strategy is to review your spending, put some money aside every month and invest it no matter where the market is, making sure, of course that what you invest is long term money.  That means you won't be using it for ten years or so.
This constant investing strategy is called "dollar cost averaging," and will result in you buying sometimes when the market is low, and sometimes when it's high.  Overall, you'll average out the peaks and valleys and invest rationally - for the long term.
Then you can leave greed and fear for the drama queens.

The Female Retirement Dilemma

Issues involved with planning for retirement are different for women than they are for men.  And understanding them can be the difference between comfort and poverty in our old age.

I.  By Saving the Same Percentage, We Retire with Less Than Half Than Men

Let's look at the result of both men and women putting aside 10% of their earnings for retirement.

First, women current earn, on average $.80 for every dollar men earn.  So now, for every $.10 in men's retirement accounts, women have $.08 - 20% less.

Next, women spend an average of eleven years of their productive working lives as an unpaid caregiver for a family member.  Assuming a work life from college graduation at 22 to retirement at 65, that unpaid absence lessens our earning years by another 25%.  That reduction in lifetime earnings, added to the fact that we lower salaries, results in us having $.06 for every $.10 men save for retirement - or 40% less.

So, if we assume average annual earnings of $60,000 during their careers, men will save $258,000 and women, $154,800, assuming that those savings are invested in assets that keep up with inflation. 

At 65, a man will need ten years of retirement income from savings of $258,000.  Invested in assets that keep up with inflation and taxes, he will have $25,800 per year for ten years. 

A woman, because of her additional life expectancy will have a sixteen year retirement with savings of $154,800.  Invested in assets that keep up with inflation and taxes, she will have $9,675 per year.

No wonder twice as many women than men live in poverty.

II.  What To Do

First, homemakers who care for children or parents should have Spousal IRA accounts funded on their behalf every year.  Considering that replacing all the functions provided would total approximately $30 thousand per year (Source:  http://www.womenwork.org/resources/tipsheets/valuehomemaking.htm), it is only reasonable that your retirement is funded while you provide these services at no charge.

Second, women must learn to invest their retirement assets in a way that will maximize growth without taking an inordinate amount of risk.  The two long term investments that provide the highest return are stocks and real estate.

In the last few years, we have witnessed the volatility both these investments have.  But, let's put this into perspective.  The stock market high was in August, 2007.  Just over two years later, the market is down about 30% from its high.  There are two considerations we must make:

• These are long term investments, intended for use in ten years or more.  In the 30+ years since I've been in the business, I've witnessed a years-long 50%+ correction in the 70's, a heart-stopping drop in the '80's, a precipitous fall in the 90's, the dot com bubble bursting in the early part of this decade and the current correction.  These are predictable, and those who have made wise stock investments and held them have fared far better, even at this point, from those who put their money in so-called "safe" investments, like money market accounts, Treasury Bills and insured savings accounts, which fail to stay ahead of inflation and taxes.  Note that there were two times billionaire investor Warren Buffett publicly admitted to buying stock in US companies:  once, during the correction in the 1970's; and the other, from March to year end, 2008.
• Even at retirement, we have life expectancies that mandate we stay ahead of inflation and taxes, and therefore advise consideration of keeping at least a portion of our long term portfolios in capital markets.
• Conversely, our short term (five years or less) cash flow needs must be kept in safe investments, so that our expenses are met and we are not tempted to sell our long term investments during market lows. 

Third, we've seen the outcome of abdicating responsibility for our financial lives with the likes of Madoff, Stanford, Enron, WorldCom and others.  There is no one who will take more of an interest in our financial health that ourselves.

It requires only that we gain the knowledge to take action and the willingness to provide for our future.

Executive Pay

Lexington, Kentucky realtor Diana Nave suggested, “I think it is important for people to understand the spread between executives and workers and how far apart it has become.” Agreed. Let’s take a look.
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?
1940
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.
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.
Now What?
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.

Researching Investments

We briefly touched on how to research investments in our previous discussion, but will do so more thoroughly here.

Independence

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.

Methodogy

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.

Part I - How to Find an Adviser - Investing (cont'd)

In the previous discussion, we discussed the issues involved in selecting an investment adviser if you require that person to do virtually all of your work for you.

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.

1. Research

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.

2. Fees

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.

b. Brokerage

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.

Part I -How to Find a Financial Adviser - Investing

Types of Investment Advisers

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.

Welcome

Dr. Tessa Warshaw, author of "Rich is Better," titled her book after Sophie Tucker's quote, "I've been rich and I've been poor. Rich is better."
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.
Welcome.
I look forward to our discussions.