From the July 2009 Scientific American Magazine 41 comments
The Science of Economic Bubbles and Busts
The worst economic crisis since the Great Depression has prompted a reassessment of how financial markets work and how people make decisions about money
By Gary Stix
The worldwide financial meltdown has caused a new examination of why markets sometimes become overheated and then come crashing down.
The dot-com blowup and the subsequent housing and credit crises highlight how psychological quirks sometimes trump rationality in investment decision making. Understanding these behaviors elucidates the genesis of booms and busts.
New models of market dynamics try to protect against financial blowups by mirroring more accurately how markets work. Meanwhile more intelligent regulation may gently steer the home buyer or the retirement saver away from bad decisions.
It has all the makings of a classic B movie scene. A gunman puts a pistol to the victim’s forehead, and the screen fades to black before a loud bang is heard. A forensic specialist who traces the bullet’s trajectory would see it traversing the brain’s prefrontal cortex—a central site for processing decisions. The few survivors of usually fatal injuries to this brain region should not be surprised to find their personalities dramatically altered. In one of the most cited case histories in all of neurology, Phineas Gage, a 19th-century railroad worker, had his prefrontal cortex penetrated by an iron rod; he lived to tell the tale but could no longer make sensible decisions. Cocaine addicts may actually self-inflict similar damage. The resulting dysfunction may cause even abstaining addicts to crave the drug any time, say, the thudding bass of a techno tune reminds them of when they were stoned.
Even people who do not use illicit drugs or get shot in the head have to contend with the
reality that some of the decisions cooked up by the brain’s frontal lobes may lead them astray. A specific site within the prefrontal cortex, the ventromedial prefrontal cortex (VMPFC) is, in fact, among the suspects in the colossal global economic implosion that has recently rocked the globe.
The VMPFC turns out to be a central location for what economists call “money illusion.” The illusion occurs when people ignore obvious information about the distorting effects of inflation on a purchase and, in an irrational leap, decide that the thing is worth much more than it really is. Money illusion may convince prospective buyers that a house is always a great investment because of the misbegotten perception that prices inexorably rise. Robert J. Shiller, a professor of economics at Yale University, contends that the faulty logic of money illusion contributed to the housing bubble: “Since people are likely to remember the price they paid for their house from many years ago but remember few other prices from then, they have the mistaken impression that home prices have gone up more than other prices, giving a mistakenly exaggerated impression of the investment potential of houses.”
Economists have fought for decades about whether money illusion and, more generally, the influence of irrationality on economic transactions are themselves illusory. Milton Friedman, the renowned monetary theorist, postulated that consumers and employers remain undeluded and, as rational beings, take inflation into account when making purchases or paying wages. In other words, they are good judges of the real value of a good.
But the ideas of behavioral economists, who study the role of psychology in making economic decisions, are gaining increasing attention today, as scientists of many stripes struggle to understand why the world economy fell so hard and fast. And their ideas are bolstered by the brain scientists who make inside-the-skull snapshots of the VMPFC and other brain areas. Notably, an experiment reported in March in the Proceedings of the National Academy of Sciences USA by researchers at the University of Bonn in Germany and the California Institute of Technology demonstrated that some of the brain’s decision-making circuitry showed signs of money illusion on images from a brain scanner. A part of the VMPFC lit up in subjects who encountered a larger amount of money, even if the relative buying power of that sum had not changed, because prices had increased as well.
The illumination of a spot behind the forehead responsible for a misconception about money marks just one example of the increasing sophistication of a line of research that has already revealed brain centers involved with the more primal investor motivations of fear (the amygdala) and greed (the nucleus accumbens, perhaps, not surprisingly, a locus of sexual desire as well). A high-tech fusing of neuroimaging with behavioral psychology and economics has begun to provide clues to how individuals, and, aggregated on a larger scale, whole economies may run off track. Together these disciplines attempt to discover why an economic system, built with nominal safeguards against collapse, can experience near-catastrophic breakdowns. Some of this research is already being adopted as a guide to action by the Obama administration as it tries to stabilize banks and the housing sector.
The Rationality Illusion
The behavioral ideas now garnering increased attention take exception to some central ideas of modern economic theory, including the view that each buyer and seller constitute an exemplar of Homo economicus, a purely rational being motivated by self-interest. “Under all conditions, man in classical economics is an automaton capable of objective reasoning,” writes financial historian Peter Bernstein.
Another central tenet of the rationalist credo is the efficient-market hypothesis, which holds that all past and current information about a good is reflected in its price—the market reaches an equilibrium point between buyers and sellers at just the “right” price. The only thing that can upset this balance between supply and demand is an outside shock, such as unanticipated price setting by an oil cartel. In this way, the dynamics of the financial system remain in balance. Classical theory dictates that the internal dynamics of the market cannot lead to a feedback cycle in which one price increase begets another, creating a bubble and a later reversal of the cycle that fosters a crippling destabilization of the economy.
A strict interpretation of the efficient-market hypothesis would imply that the risks of a bubble bursting would be reflected in existing market prices—the price of homes and of the risky (subprime) mortgages that were packaged into what are now dubbed “toxic securities.” But if that were so and markets were so efficient, how could prices fall so precipitously? Astonishment about the failure of conventional theory was even expressed by former chair of the Federal Reserve Board Alan Greenspan. A persistent cheerleader for the notion of efficient markets, he told a congressional committee in October 2008: “Those of us who looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shocked disbelief.”
Animal Spirits
The behavioral economists who are trying to pinpoint the psychological factors that lead to bubbles and severe market disequilibrium are the intellectual heirs of psychologists Amos Tversky and Daniel Kahneman, who began studies in the 1970s that challenged the notion of financial actors as rational robots. Kahneman won the Nobel Prize in Economics in 2002 for this work; Tversky would have assuredly won as well if he were still alive. Their pioneering work addressed money illusion and other psychological foibles, such as our tendency to feel sadder about losing, say, $1,000 than feeling happy about gaining that same amount.
A unifying theme of behavioral economics is the often irrational psychological impulses that underlie financial bubbles and the severe downturns that follow. Shiller, a leader in the field, cites “animal spirits”—a phrase originally used by economist John Maynard Keynes—as an explanation. The business cycle, the normal ebbs and peaks of economic activity, depends on a basic sense of trust for both business and consumers to engage one another every day in routine economic dealings. The basis for trust, however, is not always built on rational assessments. Animal spirits—the gut feeling that, yes, this is the time to buy a house or that sleeper stock—drive people to overconfidence and rash decision making during a boom. These feelings can quickly transmute into panic as anxiety rises and the market heads in the other direction. Emotion-driven decision making complements cognitive biases—money illusion’s failure to account for inflation, for instance—that lead to poor investment logic.
The importance of both emotion and cognitive biases in explaining the global crisis can be witnessed throughout the concatenation of events that, over the past 10 years, left the financial system teetering. Animal spirits propelled Internet stocks to indefensible heights during the dot-com boom and drove their values earthward just a few years later. They were present again when reckless lenders took advantage of low-interest rates to proffer adjustable-rate mortgages on risky, subprime borrowers. A phenomenon like money illusion prevailed: the borrowers of these mortgages failed to calculate what would happen if interest rates rose, which is exactly what happened during the middle of the decade, causing massive numbers of foreclosures and defaults. Securitized mortgages, debt from hundreds to thousands of homeowners packaged by banks into securities and then sold to others, lost most of their value. Banks witnessed their lending capital decline. Credit, the lifeblood of capitalism, vanished, bringing on a global crisis.
Rules of Thumb
Behavioral economics and the related subdiscipline of behavioral finance, which pertains more directly to investment, have also begun to illuminate in more detail how psychological quirks about money can help explain the recent crisis. Money illusion is only one example of irrational thought processes examined by economists. Heuristics, or rules of thumb that we need to react quickly in a crisis, are perhaps a legacy that lingers from our Paleolithic ancestors. Measured reasoning was not an option when facing down a wooly mammoth. When we are not staring down a wild animal, heuristics can sometimes result in cognitive biases.
Behavioral economists have identified a number of biases, some with direct relevance to bubble economics. In confirmation bias, people overweight information that confirms their viewpoint. Witness the massive run-up in housing prices as people assumed that rising home prices would be a sure bet. The herding behavior that resulted caused massive numbers of people to share this belief. Availability bias, which can prompt decisions based on the most recent information, is one reason that some newspaper editors shunned using the word “crash” in the fall of 2008 in an unsuccessful attempt to avoid a flat panic. Hindsight bias, the feeling that something was known all along, can be witnessed postcrash: investors, homeowners and economists acknowledged that the signs of a bubble were obvious, despite having actively contributed to the rise in home prices.
Neuroeconomics, a close relation of behavioral economics, trains a functional magnetic resonance imaging device or another form of brain imaging on the question of whether these idiosyncratic biases are figments of an academician’s imagination or actually operate in the human mind. Imaging has already confirmed money illusion. But investigators are exploring other questions as well; for instance, does talking about money or looking at it or merely thinking about it activate reward and regret centers inside the skull?
In March at the annual meeting of the Cognitive Neuroscience Society in San Francisco, Julie L. Hall, a graduate student of Richard Gonzalez at the University of Michigan at Ann Arbor, presented research showing that our willingness to take risks with money changes in response to even subtle emotional cues, again undercutting the myth of the steely, cold investor. In the experiment, 24 participants—12 men and 12 women—viewed photographs of happy, angry and neutral faces. After exposure to happy faces, the study’s “investors” had more activation in the nucleus accumbens, a reward center, and consistently invested in more risky stocks rather than embracing the relative safety of bonds.
“Happy faces” were a constant presence during the real estate boom earlier in this decade. The smiling visage and happy talk of Carleton H. Sheets, the late-night real estate infomercial pitchman, promised fortunes to those who lacked cash, credit or previous experience in owning or selling real estate. Lately, Sheets’s pitch now highlights “Real Profit$ in Foreclosures.”
Behavioral economics has gone beyond just trying to provide explanations for why investors behave as they do. It actually supplies a framework for investing and policy making to help people avoid succumbing to emotion-based or ill-conceived investments.
The arrival of the Obama administration marks a growing acceptance of the discipline. A group of leading behavioral scientists provided guidance on ways to motivate voters and campaign contributors during the presidential campaign. Cass Sunstein, a constitutional scholar who wrote the well-regarded book Nudge, which President Barack Obama has reportedly read, was appointed head of the Office of Information and Regulatory Affairs, which reviews federal regulations. Other officials who are either behavioral economists or aficionados of the discipline are now populating the White House.
Sunstein and his Nudge co-author Richard Thaler, the latter one of the founders of behavioral economics, came up with the term “libertarian paternalism” to describe how a government regulation can nudge people away from an inclination toward poor decision making. It relies on a heuristic called anchoring—a suggestion of how to begin thinking about something in the hope that thought carries over into behavior. People, for example, might be prodded into saving more for retirement if they were enrolled automatically in a pension plan from the outset, rather than merely being given an option to sign up. “Employees are enrolled if they do nothing, but they can opt out,” Thaler remarks. “This assures that absentmindedness does not produce poverty when old.” This idea was reflected in the Obama administration’s plans to automatically enroll people in a retirement plan in their workplace.
Decision making can be more complex than simply responding to a gentle push down a given path. In those circumstances, a “choice architecture” is needed to help someone decide among various options. In buying a house, for instance, purchasers need clearer information about money illusion and the like. “When all mortgages were of the 30-year, fixed-rate variety, choosing the best one was simple—just pick the lowest interest rate,” Thaler says. “Now with variable rates, teaser rates, balloon payments, prepayment penalties, and so forth, choosing the best mortgages requires a Ph.D. in finance.” A choice architecture would require that lenders “map” options clearly for borrowers, reducing an imposing stack of paperwork when buying a house into two neat columns, one that lists the various fees, the other that notes interest payments. Captured in a digital format, for instance, these two spreadsheet columns could be uploaded and compared with offerings from other lenders.
Along similar lines, Yale’s Shiller outlines an intricate strategy designed to avoid the excesses of bubble economics by educating against errors in “economic thinking.” Shiller suggests adopting new units of measurement akin to the unidad de fomento (UF) put in place by the Chilean government in 1967 and also embraced by other Latin American governments. The UF is a safeguard against money illusion, allowing a buyer or seller to know whether a price has increased in real terms or is just an inflationary mirage. It represents the price of a market basket of goods and is so commonly used that Chileans often quote prices in these units. “Chile has been the most effectively inflation-indexed country in the world,” Shiller says. “House prices, mortgages, some rentals, alimony payments, and executive incentive options are often expressed in these inflation units.”
Shiller also remains an ardent advocate of new financial technology that could serve as
antibubble weapons. Regulators are now scrutinizing the sophisticated financial instruments that were supposed to protect against default on the mortgage-backed securities that fueled the housing boom. Shiller, however, argues that derivatives (a class of financial instruments that is meant to shield against risk but whose misuse for speculation contributed to the credit crisis) can help guarantee that there are enough buyers and sellers in housing markets. Derivatives are financial contracts “derived” from an underlying asset, such as a stock, a financial index or even a mortgage.
Despite the potential for abuse, Shiller perceives derivatives as prudent “hedges” against dire economic scenarios. In the housing market, homeowners and lenders might use these financial instruments to insure against falling prices, thereby providing sufficient liquidity to keep sales moving.
Can Biology Save Us?
Ultimately, a solution to the current crisis will have to be informed by new ways of thinking about how investors act. One particularly creative approach would correct deficiencies in existing economic theory by melding the old with the new. Andrew Lo, a professor of finance at the Massachusetts Institute of Technology and an official at a hedge fund, has devised a theory that gives equilibrium economics and the efficient-market hypothesis their due while also acknowledging that classic theory does not reflect the way markets work in all circumstances. It attempts a grand synthesis that combines evoutionary theory with both classical and behavioral economics. Lo’s approach, in other words, builds on the idea that incorporating Darwinian natural selection into simulations of economic behavior can help yield useful insights into how markets operate and provide more accurate predictions than usual of how financial actors—both individuals and institutions—will behave.
Similar ideas have occurred to economists before. Economist Thorstein Veblen proposed that economics should be an evolutionary science as early as 1898; even earlier Thomas Robert Malthus had a profound influence on Darwin himself with his musings on a “struggle for existence.”
Just as natural selection postulates that certain organisms are best able to survive in a particular ecological niche, the adaptive-market hypothesis considers different market players from banks to mutual funds as “species” that are competing for financial success. And it assumes that these players at times use the seat-of-the-pants heuristics described by behavioral economics when investing (“competing”) and that they sometimes adopt irrational strategies, such as taking bigger risks during a losing streak.
“Economists suffer from a deep psychological disorder that I call ‘physics envy,’ ” Lo says. “We wish that 99 percent of economic behavior could be captured by three simple laws of nature. In fact, economists have 99 laws that capture 3 percent of behavior. Economics is a uniquely human endeavor and, as such, should be understood in the broader context of competition, mutation and natural selection—in other words, evolution.”
Having an evolutionary model to consult may let investors adapt as the risk profiles of different investment strategies shift. But the most important benefit of Lo’s simulations may be an ability to detect when the economy is not in a stable equilibrium, a finding that would warn regulators and investors that a bubble is inflating or else about to explode.
An adaptive-market model can incorporate information about how prices in the market are changing—analogous to how people are adapting to a particular ecological niche. It can go on to deduce whether prices on one day are influencing prices on the next, an indication that investors are engaged in “herding,” as described by behavioral economists, a sign that a bubble may be imminent. As a result of this type of modeling, regulations could also “adapt” as markets shift and thus counter the type of “systemic” risks for which conventional risk models leave the markets unprotected. Lo has advocated the establishment of a Capital Markets Safety Board, similar to the institution that investigates airline accidents, to collect data about past and future risks that could threaten the larger financial system, which could serve as a critical foundation for adaptive-market modeling.
As brain science unravels the roots of investors’ underlying behaviors, it may well find new evidence that the conception of Homo economicus is fundamentally flawed. The rational investor should not care whether she has $10 million and then loses $8 million or, alternatively, whether she has nothing and ends up with $2 million. In either case, the end result is the same.
But behavioral economics experiments routinely show that despite similar outcomes, people (and other primates) hate a loss more than they desire a gain, an evolutionary hand-me-down that encourages organisms to preserve food supplies or to weigh a situation carefully before risking encounters with predators.
One group that does not value perceived losses differently than gains are individuals with autism, a disorder characterized by problems with social interaction. When tested, autistics often demonstrate strict logic when balancing gains and losses, but this seeming rationality may itself denote abnormal behavior. “Adhering to logical, rational principles of ideal economic choice may be biologically unnatural,” says Colin F. Camerer, a professor of behavioral economics at Caltech. Better insight into human psychology gleaned by neuroscientists holds the promise of changing forever our fundamental assumptions about the way entire economies function—and our understanding of the motivations of the individual participants therein, who buy homes or stocks and who have trouble judging whether a dollar is worth as much today as it was yesterday.
Note: This article was originally printed with the title, "Bubbles and Busts."
http://www.scientificamerican.com/article.cfm?id=the-science-of-economic-bubbles
Friday 3 July 2009
Look at the long term and be aware of stocks that dip as the business cycle dips.
Always be wary of cyclical stocks.
Also read:
True, companies may look irresistable with low PE and high short-term sales and earnings growth rates.
But a closer look at the long term reveals a PE in the teens and years of marginal earnings or even losses mixed in.
Look at the long term and be aware of stocks that dip as the business cycle dips.
Basic industries, such as capital equipment, natural resources, paper, farm mchinery, automobiles, and auto suppliers, are notorious for sending signals of intermittent strength while showing little in the way of sustained growth.
The recent tanking of homebuilding stocks is an extreme case in point. It is amazing how many short-term-oriented investors bit on the apparent "value" in this sector.
Also read:
Is the Firm Cyclical?
For cyclical stocks, your best bet is to look at the most recent cyclical peak, make a judgment whether the next peak is likely to be lower or higher than the last one, and calculate a P/E based on the current price relative to what you think earnings per share will be at the next peak.
For cyclical stocks, your best bet is to look at the most recent cyclical peak, make a judgment whether the next peak is likely to be lower or higher than the last one, and calculate a P/E based on the current price relative to what you think earnings per share will be at the next peak.
The expanding P/E in cyclical stocks
Here’s the rub about cyclical stocks: Their valuations are counterintuitive. In other words, you should be looking at cyclical stocks as their P/Es expand, not shrink.
Here’s the rub about cyclical stocks: Their valuations are counterintuitive. In other words, you should be looking at cyclical stocks as their P/Es expand, not shrink.
Recognizing Value Situations - Cyclical Plays
Generally, cyclical companies shouldn't be confused with value investments. Growth, although apparent in the short term, usually isn't sustainable. If a company seems cheap and has something new in its portfolio to avoid cyclical price and earnings behaviour, it may be worth a look.
Generally, cyclical companies shouldn't be confused with value investments. Growth, although apparent in the short term, usually isn't sustainable. If a company seems cheap and has something new in its portfolio to avoid cyclical price and earnings behaviour, it may be worth a look.
Parents Can Help Ease the Burden
By Mara Lee
Special to The Washington Post
Saturday, July 19, 2008; Page F02
There are things parents can do to make it easier for their children to handle their affairs after they die or if they should become unable to manage them.
Most important:
Tell them where everything is.
http://www.washingtonpost.com/wp-dyn/content/article/2008/07/18/AR2008071801433.html
Special to The Washington Post
Saturday, July 19, 2008; Page F02
There are things parents can do to make it easier for their children to handle their affairs after they die or if they should become unable to manage them.
Most important:
Tell them where everything is.
- Where's your will?
- Where do you have bank accounts, stock holdings or safety deposit boxes?
- Where are those statements?
- Where are your tax records?
- Your utility bills?
Elinor Ginzler, a co-author of "Caring for Your Parents: The Complete Family Guide," said children should bring these things up, as uncomfortable as it is.
"Don't wait until bitter crisis," she said. She recommends that children broach the subject by saying, "I want you always to be in control."
It's not comfortable to talk about funerals and burials, she acknowledged, but if parents tell their children how they want them to handle things, they can be assured that they'll do what they want.
Ginzler said parents should give a child power of attorney in case they have medical problems that prevent them from making their own decisions.
Carylin Waterval, whose mother died rather suddenly in September, established power of attorney while her mother was in the hospital. It was helpful, she said.
Ginzler said that if a parent has become incapacitated before getting this set up, it's arduous to get it done. "Just being her daughter doesn't give you that authority," she said.
Mary Ann Brewer is co-owner of Busy Buddies, a company in Northern Virginia that helps elderly people with downsizing moves, as well as helping people whose parent has died.
She said parents want to treat all their children equally and so sometimes they'll make them all executors of their will.
"At some point in time, all those children may not be getting along," Brewer said. "Pick one executor."
Cyndy Esty, one of six children, traveled from her home in Chevy Chase to Boston to take care of her father's estate after he died of cancer nine years ago at age 79. She and one sister were co-executors. "It's amazing how much bickering can come up over the littlest thing," she remembered, even a candy jar.
After 14 years in the business, Brewer and her partner, Nancy Loyd, have seen a lot of parents seek to minimize conflict over their things, either for a downsizing or planning for after they die.
Some are simple, such as putting the name of the intended recipient on the back of a piece of furniture or the bottom of an heirloom. Or letting the children draw straws about asking for certain pieces.
Others are more involved. In one case, parents gave each child a chance to pick something they wanted, starting from youngest to oldest, then changing the order in each successive round.
Another couple gave each child $500 in play money and set starting bids for belongings. The children had to outbid each other if more than one wanted the same thing.
http://www.washingtonpost.com/wp-dyn/content/article/2008/07/18/AR2008071801433.html
Financial Lessons From Michael Jackson
Michelle Singletary
Thursday, July 2, 2009; 9:58 AM
Financial Legacy
There's much talk about the musical genius of the late Michael Jackson. But in my column today I wanted to discuss the lesson we can learn from how Jackson handled his money.
At one point the pop icon was spending about $20 to $30 million above his earnings each year, according to one expert. And he came very close to losing his Neverland ranch to foreclosure. Read about how a sense of entitlement can cost a fortune in Jackson's Money Woes Can Teach Us About the Dangers of Entitlement.
Jackson's financial downfall is surprising considering his assets, which include the partial rights to many of the greatest hits by The Beatles and other great artists. But Jackson apparently borrowed heavily against his catalog of songs. He also had some hefty legal bills.
Read Legally, Jacksons Face Long & Winding Road (June 30) by Paul Fahri.
The Associated Press reported Jackson's net worth at $236.6 million. But according to the news service, "Documents do not show how much money he had coming in that year or how much he was spending, which makes it hard to estimate just how cash-poor he was."
Here are some of the latest reports about Jackson's finances:
* Battle to control Jackson's fortune begins (June 30)
* AP Exclusive: Jackson said net worth $236M in 2007 (June 30)
* Jackson's will cuts out ex-wife Debbie Rowe (July 1)
What's In the Will?
For a time it was unclear whether or not Jackson had left a will. However a will has surfaced.
Jackson's mother, Katherine, was named guardian of his children and the will puts his assets in a trust.
Here are a few articles that emphasize the necessity of a will:
* Property Rights and Responsibilities After a Loved One Dies (May 30) by Benny L. Kass
" Parents Can Help Ease the Burden (July 19, 2008) by Mara Lee
" A Worthy Read to Get Serious About Estate Planning (Aug. 28, 2008)
By Ilyce R. Glink with Samuel J. Tamkin
http://www.washingtonpost.com/wp-dyn/content/article/2009/07/02/AR2009070201452.html
Thursday, July 2, 2009; 9:58 AM
Financial Legacy
There's much talk about the musical genius of the late Michael Jackson. But in my column today I wanted to discuss the lesson we can learn from how Jackson handled his money.
At one point the pop icon was spending about $20 to $30 million above his earnings each year, according to one expert. And he came very close to losing his Neverland ranch to foreclosure. Read about how a sense of entitlement can cost a fortune in Jackson's Money Woes Can Teach Us About the Dangers of Entitlement.
Jackson's financial downfall is surprising considering his assets, which include the partial rights to many of the greatest hits by The Beatles and other great artists. But Jackson apparently borrowed heavily against his catalog of songs. He also had some hefty legal bills.
Read Legally, Jacksons Face Long & Winding Road (June 30) by Paul Fahri.
The Associated Press reported Jackson's net worth at $236.6 million. But according to the news service, "Documents do not show how much money he had coming in that year or how much he was spending, which makes it hard to estimate just how cash-poor he was."
Here are some of the latest reports about Jackson's finances:
* Battle to control Jackson's fortune begins (June 30)
* AP Exclusive: Jackson said net worth $236M in 2007 (June 30)
* Jackson's will cuts out ex-wife Debbie Rowe (July 1)
What's In the Will?
For a time it was unclear whether or not Jackson had left a will. However a will has surfaced.
Jackson's mother, Katherine, was named guardian of his children and the will puts his assets in a trust.
Here are a few articles that emphasize the necessity of a will:
* Property Rights and Responsibilities After a Loved One Dies (May 30) by Benny L. Kass
" Parents Can Help Ease the Burden (July 19, 2008) by Mara Lee
" A Worthy Read to Get Serious About Estate Planning (Aug. 28, 2008)
By Ilyce R. Glink with Samuel J. Tamkin
http://www.washingtonpost.com/wp-dyn/content/article/2009/07/02/AR2009070201452.html
The Right Direction Starts With the Right Decisions
The Right Direction Starts With the Right Decisions
By Michelle Singletary
Sunday, June 28, 2009
Over the years, I've found that people end up in financial trouble not only because they don't have enough money. It's also because of poor decision-making.
The following is an edited transcript of an online chat with people who needed to be pointed in the right financial direction.
QI am separated, with two young sons, and my husband lost his job about five months ago. I am solely supporting myself and my children and am finding it difficult to cover all of our expenses. I have stopped dining out, I bring my lunch, don't have cable, etc., but my income just doesn't cover the monthly bills. I think I have to cut back my Thrift Savings Plan contribution to 5 percent or possibly less. I currently contribute 10 percent. There really isn't anything more I can do to cut expenses. Do you agree about reducing my retirement contribution?
AI do agree. I would cut out your contributions completely for now.
Although I'm a huge advocate for saving for retirement, you need the money right now so you don't go down financially. Even when there is an employer match, I would urge you to cut back on investing for retirement until you can figure out how to make your income match your expenses. For example, can you move to cut housing costs? Can you get a roommate? I know people don't like to do that with kids, but at least explore the option, perhaps with a close friend or relative.
Also, have you explored everything to keep your marriage together? Even without a job, having your husband help at this point could allow one or both of you to get a part-time job. And he wouldn't be paying for the cost of his separate living expenses. Just asking.
We're in a position to refinance our home at a lower interest rate, and we need a new roof. You usually advise against treating your equity like an ATM, but what about needed repairs? It's very unlikely we can set aside $7,000 to $10,000 in cash without wiping out our emergency funds. My husband and I are journalists, so our jobs are on the line these days with the awful economy. Any suggestions?
Here's how I would approach this decision. Find out how much it costs to fix the roof and whether not fixing it would create major damage to your home. In other words, is this something that can wait or be fixed more cheaply for now? If you are unsure about your job situation, I wouldn't deplete your savings. So in this case, if you absolutely need the roof done, pulling that money -- and that money alone -- out of the house equity during the refinance is acceptable. Try your best, though, to find another way to pay cash to fix the roof.
I have a friend who lives in the District who really wants to buy a house in Maryland to move her children to a better school district. She has a good job making decent money, at least $45,000 to $50,000 a year. She has credit scores between 500 and 700. She does not have money for a down payment. She has some credit card and student loan debt. I have suggested that my friend rent in Maryland until she is ready to buy. What advice would you give her?
You are a good, good friend giving great advice. Your friend is not ready to buy a home and would probably have trouble doing so anyway with the tougher lending standards. At any rate, let's look at her financial profile:
-- She has credit scores in the 500 to 700 range. That's a huge range. In the case of a mortgage, the lender will take your middle credit score. Still, having a score in the 500 range is not good.
-- She has credit card debt. Not good.
-- She has student loan debt. Not good.
-- Her income is decent, but it will be hard finding a home in Maryland in a decent neighborhood with that income.
So you are right. She should rent and build up her emergency savings, pay off the credit card and student loan debt and get her low credit scores up.
Why did you say student loans are not good? As long as you're paying them back, what's the deal?
The deal is, it's debt.
Debt = bondage.
* * *
I added that last question from the chat to illustrate one of the reasons people make bad decisions. Too many people blindly follow conventional wisdom -- that a student loan is good debt -- when that wisdom is and has always been wrong.
As I pointed out in the chat, lose a job, get sick, etc., and no loan looks good at that point.
-- By mail: Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.
By Michelle Singletary
Sunday, June 28, 2009
Over the years, I've found that people end up in financial trouble not only because they don't have enough money. It's also because of poor decision-making.
The following is an edited transcript of an online chat with people who needed to be pointed in the right financial direction.
QI am separated, with two young sons, and my husband lost his job about five months ago. I am solely supporting myself and my children and am finding it difficult to cover all of our expenses. I have stopped dining out, I bring my lunch, don't have cable, etc., but my income just doesn't cover the monthly bills. I think I have to cut back my Thrift Savings Plan contribution to 5 percent or possibly less. I currently contribute 10 percent. There really isn't anything more I can do to cut expenses. Do you agree about reducing my retirement contribution?
AI do agree. I would cut out your contributions completely for now.
Although I'm a huge advocate for saving for retirement, you need the money right now so you don't go down financially. Even when there is an employer match, I would urge you to cut back on investing for retirement until you can figure out how to make your income match your expenses. For example, can you move to cut housing costs? Can you get a roommate? I know people don't like to do that with kids, but at least explore the option, perhaps with a close friend or relative.
Also, have you explored everything to keep your marriage together? Even without a job, having your husband help at this point could allow one or both of you to get a part-time job. And he wouldn't be paying for the cost of his separate living expenses. Just asking.
We're in a position to refinance our home at a lower interest rate, and we need a new roof. You usually advise against treating your equity like an ATM, but what about needed repairs? It's very unlikely we can set aside $7,000 to $10,000 in cash without wiping out our emergency funds. My husband and I are journalists, so our jobs are on the line these days with the awful economy. Any suggestions?
Here's how I would approach this decision. Find out how much it costs to fix the roof and whether not fixing it would create major damage to your home. In other words, is this something that can wait or be fixed more cheaply for now? If you are unsure about your job situation, I wouldn't deplete your savings. So in this case, if you absolutely need the roof done, pulling that money -- and that money alone -- out of the house equity during the refinance is acceptable. Try your best, though, to find another way to pay cash to fix the roof.
I have a friend who lives in the District who really wants to buy a house in Maryland to move her children to a better school district. She has a good job making decent money, at least $45,000 to $50,000 a year. She has credit scores between 500 and 700. She does not have money for a down payment. She has some credit card and student loan debt. I have suggested that my friend rent in Maryland until she is ready to buy. What advice would you give her?
You are a good, good friend giving great advice. Your friend is not ready to buy a home and would probably have trouble doing so anyway with the tougher lending standards. At any rate, let's look at her financial profile:
-- She has credit scores in the 500 to 700 range. That's a huge range. In the case of a mortgage, the lender will take your middle credit score. Still, having a score in the 500 range is not good.
-- She has credit card debt. Not good.
-- She has student loan debt. Not good.
-- Her income is decent, but it will be hard finding a home in Maryland in a decent neighborhood with that income.
So you are right. She should rent and build up her emergency savings, pay off the credit card and student loan debt and get her low credit scores up.
Why did you say student loans are not good? As long as you're paying them back, what's the deal?
The deal is, it's debt.
Debt = bondage.
* * *
I added that last question from the chat to illustrate one of the reasons people make bad decisions. Too many people blindly follow conventional wisdom -- that a student loan is good debt -- when that wisdom is and has always been wrong.
As I pointed out in the chat, lose a job, get sick, etc., and no loan looks good at that point.
-- By mail: Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.
Where Kids Learn All About The Bulls and the Bears
Where Kids Learn All About The Bulls and the Bears
(By Tim Grajek For The Washington Post)
(By Tim Grajek For The Washington Post)
By Candice Lee Jones
Kiplinger's Personal Finance
Sunday, June 21, 2009
Long division or long stock position? Both are part of the curriculum at Chicago's Ariel Community Academy, a public school sponsored by Ariel Investments, where the kids are managing real-life portfolios.
Each first-grade class is given $20,000 to seed a portfolio. At first, the money is invested on their behalf as they study the savings-and-investment curriculum, a joint project of Ariel Investments and Nuveen Investments.
Finance classes start with counting coins. By sixth grade, students take more control of their portfolio.
Teacher Connie Moran says students usually choose to invest in names they recognize -- Nike, Target, McDonald's. And yes, their investments are down just like yours. Between March 31, 2008, and March 31, 2009, class portfolios fell an average of about 40 percent.
"They're no different than other investors; they're not happy with the loss," Moran said. Academy instructors are turning those losses into lessons learned.
When each eighth-grade class graduates, the original grant is donated to the incoming first-grade class. Half of any profits go toward a gift that the class gives the school -- hence, students also learn about philanthropy -- and the other half is divided among the students. (The school is hoping that this year will not be the first without profits.)
When the proceeds are divvied up in August, each student can either keep the cash or invest it for college. Lessons must be sinking in -- 95 percent of the students choose to invest.
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/19/AR2009061903908.html
Kiplinger's Personal Finance
Sunday, June 21, 2009
Long division or long stock position? Both are part of the curriculum at Chicago's Ariel Community Academy, a public school sponsored by Ariel Investments, where the kids are managing real-life portfolios.
Each first-grade class is given $20,000 to seed a portfolio. At first, the money is invested on their behalf as they study the savings-and-investment curriculum, a joint project of Ariel Investments and Nuveen Investments.
Finance classes start with counting coins. By sixth grade, students take more control of their portfolio.
Teacher Connie Moran says students usually choose to invest in names they recognize -- Nike, Target, McDonald's. And yes, their investments are down just like yours. Between March 31, 2008, and March 31, 2009, class portfolios fell an average of about 40 percent.
"They're no different than other investors; they're not happy with the loss," Moran said. Academy instructors are turning those losses into lessons learned.
When each eighth-grade class graduates, the original grant is donated to the incoming first-grade class. Half of any profits go toward a gift that the class gives the school -- hence, students also learn about philanthropy -- and the other half is divided among the students. (The school is hoping that this year will not be the first without profits.)
When the proceeds are divvied up in August, each student can either keep the cash or invest it for college. Lessons must be sinking in -- 95 percent of the students choose to invest.
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/19/AR2009061903908.html
US Stocks Fall Sharply as Jobless Claims Hit 26-Year High
Stocks Fall Sharply as Jobless Claims Hit 26-Year High
By Renae Merle
Washington Post Staff Writer
Thursday, July 2, 2009; 4:58 PM
Stocks tumbled today after a government report showed the country's unemployment rate reached 9.5 percent last month as employers cut more jobs than expected, stoking investor concerns of a prolonged recession.
This Story
467K Jobs Cut in June; Jobless Rate at 26-Year High
Stocks Fall Sharply as Jobless Claims Hit 26-Year High
The losses were broad based with all 30 blue chip stocks on the Dow Jones industrial average losing ground. All of the major indexes, including the Dow, fell at least 2.5 percent and posted another weekly loss. Meanwhile, nervous investors moved into government bonds, a traditional safe haven during market turbulence, raising prices on some long-term notes.
After Wall Street closed the second quarter with its first quarterly gain in more than a year and a half, "many investors were feeling that the worse was behind us," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel, an investment management firm. "This is a reminder that, no, it's not."
The Dow fell 2.63 percent, or 223.32 points, to close at 8280.74, while the broader Standard & Poor's 50-stock index was down 2.91 percent, or 26.91 points, to close at 896.42. The tech-heavy Nasdaq Composite index tumbled 2.67 percent, or 49.20 points, to close at 1796.52. After a short trading week, the Dow and S&P were down 2.8 percent and 3.2 percent respectively. The Nasdaq lost 2.58 percent for the week.
Financial stocks helped lead the declines today. Bank of America and Morgan Stanley fell 3 percent and 4.8 percent respectively. And energy stocks also took major losses after crude oil prices fell nearly 4 percent to $66.73 a barrel on the New York Mercantile Exchange. Exxon Mobil and Chevron each fell about 3 percent, while ConocoPhillips was down 2.6 percent.
Investors have been caught between optimism about early signs the recession is easing and pessimism about the pace of economic recovery. The labor report out this morning exacerbated concerns that the nation's workforce remains under assault and is unlikely to recover soon.
The number of jobs on employers' payrolls fell by 467,000 in June, according to a Labor Department report. That was significantly worse than analysts had expected. The unemployment rate rose to 9.5 percent, from 9.4 percent. Many economists expect that the rate will surpass 10 percent by fall.
The report suggests that hopes for an economic recovery during the second half of the year are "overly optimistic," Steven Ricchiuto, chief economist for Mizuho Securities, wrote in a research note. "Instead, the data is fully consistent with our forecast for a slower rate of decay in the economy. The worst of the contraction may be behind us but the economy is still in consolidation and will be through year end."
In one piece of upbeat labor news, the numbers of workers filing new claims for jobless benefits last week fell by 16,000 to 614,000, according to a Labor Department report out today. But the rate remains historically high and economists have said the number of workers needing unemployment insurance for an extended period is troubling.
Overseas stocks were also down. The FTSE 100 in London fell 2.6 percent and the Dax index in Germany fell 2.5 percent. Japan's Nikkei 225 average closed down 0.6 percent in trading Thursday.
By Renae Merle
Washington Post Staff Writer
Thursday, July 2, 2009; 4:58 PM
Stocks tumbled today after a government report showed the country's unemployment rate reached 9.5 percent last month as employers cut more jobs than expected, stoking investor concerns of a prolonged recession.
This Story
467K Jobs Cut in June; Jobless Rate at 26-Year High
Stocks Fall Sharply as Jobless Claims Hit 26-Year High
The losses were broad based with all 30 blue chip stocks on the Dow Jones industrial average losing ground. All of the major indexes, including the Dow, fell at least 2.5 percent and posted another weekly loss. Meanwhile, nervous investors moved into government bonds, a traditional safe haven during market turbulence, raising prices on some long-term notes.
After Wall Street closed the second quarter with its first quarterly gain in more than a year and a half, "many investors were feeling that the worse was behind us," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel, an investment management firm. "This is a reminder that, no, it's not."
The Dow fell 2.63 percent, or 223.32 points, to close at 8280.74, while the broader Standard & Poor's 50-stock index was down 2.91 percent, or 26.91 points, to close at 896.42. The tech-heavy Nasdaq Composite index tumbled 2.67 percent, or 49.20 points, to close at 1796.52. After a short trading week, the Dow and S&P were down 2.8 percent and 3.2 percent respectively. The Nasdaq lost 2.58 percent for the week.
Financial stocks helped lead the declines today. Bank of America and Morgan Stanley fell 3 percent and 4.8 percent respectively. And energy stocks also took major losses after crude oil prices fell nearly 4 percent to $66.73 a barrel on the New York Mercantile Exchange. Exxon Mobil and Chevron each fell about 3 percent, while ConocoPhillips was down 2.6 percent.
Investors have been caught between optimism about early signs the recession is easing and pessimism about the pace of economic recovery. The labor report out this morning exacerbated concerns that the nation's workforce remains under assault and is unlikely to recover soon.
The number of jobs on employers' payrolls fell by 467,000 in June, according to a Labor Department report. That was significantly worse than analysts had expected. The unemployment rate rose to 9.5 percent, from 9.4 percent. Many economists expect that the rate will surpass 10 percent by fall.
The report suggests that hopes for an economic recovery during the second half of the year are "overly optimistic," Steven Ricchiuto, chief economist for Mizuho Securities, wrote in a research note. "Instead, the data is fully consistent with our forecast for a slower rate of decay in the economy. The worst of the contraction may be behind us but the economy is still in consolidation and will be through year end."
In one piece of upbeat labor news, the numbers of workers filing new claims for jobless benefits last week fell by 16,000 to 614,000, according to a Labor Department report out today. But the rate remains historically high and economists have said the number of workers needing unemployment insurance for an extended period is troubling.
Overseas stocks were also down. The FTSE 100 in London fell 2.6 percent and the Dax index in Germany fell 2.5 percent. Japan's Nikkei 225 average closed down 0.6 percent in trading Thursday.
Thursday 2 July 2009
Ben Graham has a lot of ideas about what you should avoid
You’ve probably observed that Ben Graham has a lot of ideas about what you should avoid.
Defensive investors should avoid everything but large, prominent companies with a long history of paying dividends.
Even enterprising investors should avoid junk bonds, foreign bonds, preferred stocks, and IPOs.
To put it simply, Graham doesn’t like risk. It comes through time and time again in every chapter of the book - do the footwork, minimize risk, and don’t swing for the fences.
http://www.thesimpledollar.com/2008/11/28/the-intelligent-investor-the-positive-side-to-portfolio-policy-for-the-enterprising-investor/
Defensive investors should avoid everything but large, prominent companies with a long history of paying dividends.
Even enterprising investors should avoid junk bonds, foreign bonds, preferred stocks, and IPOs.
To put it simply, Graham doesn’t like risk. It comes through time and time again in every chapter of the book - do the footwork, minimize risk, and don’t swing for the fences.
http://www.thesimpledollar.com/2008/11/28/the-intelligent-investor-the-positive-side-to-portfolio-policy-for-the-enterprising-investor/
The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor
Chapter 7 - Portfolio Policy for the Enterprising Investor: The Positive Side
Graham says that there are four clear areas of activity that an enterprising investor (read: not an ultra-conservative investor) should focus on:
1. Buying in low markets and selling in high markets.
Graham says, in essence, that this is a good strategy in theory, but that it’s essentially impossible to accurately predict (on a mathematical basis) when the market is truly “low” and when it’s truly “high.” Why? Graham says that there’s inadequate data available to be able to accurately predict such situations - he basically believes fifty years of data is needed to make such claims, and as of the book’s writing, he did not believe adequate data was available in the post-1949 modern era. Note, though, that Graham returns to the notion of high and low markets in the next chapter.
2. Buying carefully chosen “growth stocks.”
What about growth stocks - ones that are clearly showing rampant growth? Graham isn’t opposed to buying these, but says that one should look for growth stocks that have a reasonable P/E ratio. He wouldn’t buy a “growth stock” if it had a price-to-earnings ratio higher than 20 over the last year and would avoid stocks that have a price-to-earnings ratio over 25 on average over the last several years. In short, this is a way to filter out “bubble” stocks (one where irrational exuberance is going on) when looking at growth stocks.
3. Buying bargain issues of various types.
Here, Graham finally gets around to the idea of buying so-called “value stocks.” For the most part, Graham focuses on market conditions as they existed in 1959, pointing towards what would constitute value stocks then. What I found most profound, though, is a brief bit on page 169. Here, Graham discusses “filtering” the stocks listed by Standard and Poor’s (essentially a 1950s precursor to the S&P 500) and identifying 85 stocks that meet basic value criteria, then buying them and finding that, over the next two years, most of them beat the overall market.
That’s an index fund, my friends. Graham had basically conceived of the idea in the 1950s - it worked then, and it works now.
4. Buying into “special situations.”
Graham largely suggests avoiding “topical” news as a reason to buy or sell, mostly because it’s hard for investors to gauge how exactly such news will truly affect the stock’s price. Instead, one should simply file away interesting long-term news for later use if you’re going to evaluate the stock. For example, recalling that a company is still paying off an incurred debt from ten years ago and that debt is about to be paid off might be an indication of an upcoming jump in profit for the company - and a possible sign of a good value.
Commentary on Chapter 7
Zweig provides a ton of supporting evidence that market timing doesn’t really work, and that “examples” of market timing that are often used to show how good it can be are cherry picked using the amazing power of hindsight.
He makes a similar argument about growth stocks, saying that there are often periods where growth stocks appear to be taking off like a rocket, but that it’s impossible to know where the top of that rocket ride is. He provides several examples of this and largely seems to agree with Graham that the only growth stocks a person should invest in are ones that are truly sound as a business and not merely the beneficiaries of a lot of hype. How can you do this? Keep a very close eye on the real business numbers of any growth stock you own.
In the end, Zweig argues that the best solution for most investors is pretty simple: diversify, diversify, diversify. Don’t put all your eggs in one basket, ever. Instead, buy lots of different stocks from lots of different industries and from lots of different markets (foreign and domestic).
Ref: The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor
Graham says that there are four clear areas of activity that an enterprising investor (read: not an ultra-conservative investor) should focus on:
1. Buying in low markets and selling in high markets.
Graham says, in essence, that this is a good strategy in theory, but that it’s essentially impossible to accurately predict (on a mathematical basis) when the market is truly “low” and when it’s truly “high.” Why? Graham says that there’s inadequate data available to be able to accurately predict such situations - he basically believes fifty years of data is needed to make such claims, and as of the book’s writing, he did not believe adequate data was available in the post-1949 modern era. Note, though, that Graham returns to the notion of high and low markets in the next chapter.
2. Buying carefully chosen “growth stocks.”
What about growth stocks - ones that are clearly showing rampant growth? Graham isn’t opposed to buying these, but says that one should look for growth stocks that have a reasonable P/E ratio. He wouldn’t buy a “growth stock” if it had a price-to-earnings ratio higher than 20 over the last year and would avoid stocks that have a price-to-earnings ratio over 25 on average over the last several years. In short, this is a way to filter out “bubble” stocks (one where irrational exuberance is going on) when looking at growth stocks.
3. Buying bargain issues of various types.
Here, Graham finally gets around to the idea of buying so-called “value stocks.” For the most part, Graham focuses on market conditions as they existed in 1959, pointing towards what would constitute value stocks then. What I found most profound, though, is a brief bit on page 169. Here, Graham discusses “filtering” the stocks listed by Standard and Poor’s (essentially a 1950s precursor to the S&P 500) and identifying 85 stocks that meet basic value criteria, then buying them and finding that, over the next two years, most of them beat the overall market.
That’s an index fund, my friends. Graham had basically conceived of the idea in the 1950s - it worked then, and it works now.
4. Buying into “special situations.”
Graham largely suggests avoiding “topical” news as a reason to buy or sell, mostly because it’s hard for investors to gauge how exactly such news will truly affect the stock’s price. Instead, one should simply file away interesting long-term news for later use if you’re going to evaluate the stock. For example, recalling that a company is still paying off an incurred debt from ten years ago and that debt is about to be paid off might be an indication of an upcoming jump in profit for the company - and a possible sign of a good value.
Commentary on Chapter 7
Zweig provides a ton of supporting evidence that market timing doesn’t really work, and that “examples” of market timing that are often used to show how good it can be are cherry picked using the amazing power of hindsight.
He makes a similar argument about growth stocks, saying that there are often periods where growth stocks appear to be taking off like a rocket, but that it’s impossible to know where the top of that rocket ride is. He provides several examples of this and largely seems to agree with Graham that the only growth stocks a person should invest in are ones that are truly sound as a business and not merely the beneficiaries of a lot of hype. How can you do this? Keep a very close eye on the real business numbers of any growth stock you own.
In the end, Zweig argues that the best solution for most investors is pretty simple: diversify, diversify, diversify. Don’t put all your eggs in one basket, ever. Instead, buy lots of different stocks from lots of different industries and from lots of different markets (foreign and domestic).
Ref: The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor
But first, a chapter of cautionary advice. Graham is nothing if not cautious, after all. The focus here is on things that even enterprising investors should avoid.
Chapter 6 - Portfolio Policy for the Enterprising Investor: Negative Approach
So, what should you avoid?
First, avoid junk bonds. If they have anything less than a stellar bond rating, don’t bother, even if they appear to return very well. Junk bonds put your principal at risk, and the point of buying bonds is to have a safe portion of your portfolio.
Second, avoid foreign bonds. Here, there are stability issues, and it’s often hard to adequately judge the risk of buying bonds from government and private entities operating under rules unfamiliar to you. Today, arguably, Graham would be okay with buying bonds within the European Union, but I would guess Graham would avoid anything outside of that.
Third, avoid preferred stocks. Preferred stocks are ones that have a higher priority in the event of a liquidation of the business, but often come at a premium price. Almost always, Graham doesn’t feel these are worth any sort of premium. Of course, in the United States, preferred stock is generally not sold directly to individual investors, only to large institutions, so it’s largely a moot point.
Finally, avoid IPOs. To put it simply, new issues do not have any track record upon which to adequately judge the company. The “hype” of an IPO is all you really have to judge the issue on. Instead, let others jump into that feeding frenzy and wait until time has shown which companies swim and which ones sink.
Those are some good rules for anyone to follow, particularly if you’re concerned about not losing the money you invest. Most of these investments have a pretty significant amount of risk and in Graham’s world, one shouldn’t put the principal at undue risk.
Commentary on Chapter 6
Zweig looks at modern examples of all four of these cases and largely comes to the same conclusions as Graham: they’re quite risky and probably not worth it for the average investor. The only caveat that Zweig makes is that there could be room for a mutual fund of junk bonds in a large and diverse portfolio, but it should be considered risky and not be considered anywhere close to a “safe” portion of the portfolio.
Zweig also covers day trading here, describing it as something for most people to avoid. Why? In a world where trading is completely free and trades could be always executed without delay, many people could make a solid income from day trading.
But that’s not the real world. Brokerage fees can eat up a lot of one’s gains, as can trading delays. This forces day traders to walk a tightrope - it becomes a high risk game, and that’s not a game for an investor with any conservative streak. Zweig almost writes it off as gambling, in fact.
So, in short, avoid junk bonds, foreign bonds, IPOs, and day trading and you’re off to a good start in Graham’s world.
Ref: The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor
Chapter 6 - Portfolio Policy for the Enterprising Investor: Negative Approach
So, what should you avoid?
First, avoid junk bonds. If they have anything less than a stellar bond rating, don’t bother, even if they appear to return very well. Junk bonds put your principal at risk, and the point of buying bonds is to have a safe portion of your portfolio.
Second, avoid foreign bonds. Here, there are stability issues, and it’s often hard to adequately judge the risk of buying bonds from government and private entities operating under rules unfamiliar to you. Today, arguably, Graham would be okay with buying bonds within the European Union, but I would guess Graham would avoid anything outside of that.
Third, avoid preferred stocks. Preferred stocks are ones that have a higher priority in the event of a liquidation of the business, but often come at a premium price. Almost always, Graham doesn’t feel these are worth any sort of premium. Of course, in the United States, preferred stock is generally not sold directly to individual investors, only to large institutions, so it’s largely a moot point.
Finally, avoid IPOs. To put it simply, new issues do not have any track record upon which to adequately judge the company. The “hype” of an IPO is all you really have to judge the issue on. Instead, let others jump into that feeding frenzy and wait until time has shown which companies swim and which ones sink.
Those are some good rules for anyone to follow, particularly if you’re concerned about not losing the money you invest. Most of these investments have a pretty significant amount of risk and in Graham’s world, one shouldn’t put the principal at undue risk.
Commentary on Chapter 6
Zweig looks at modern examples of all four of these cases and largely comes to the same conclusions as Graham: they’re quite risky and probably not worth it for the average investor. The only caveat that Zweig makes is that there could be room for a mutual fund of junk bonds in a large and diverse portfolio, but it should be considered risky and not be considered anywhere close to a “safe” portion of the portfolio.
Zweig also covers day trading here, describing it as something for most people to avoid. Why? In a world where trading is completely free and trades could be always executed without delay, many people could make a solid income from day trading.
But that’s not the real world. Brokerage fees can eat up a lot of one’s gains, as can trading delays. This forces day traders to walk a tightrope - it becomes a high risk game, and that’s not a game for an investor with any conservative streak. Zweig almost writes it off as gambling, in fact.
So, in short, avoid junk bonds, foreign bonds, IPOs, and day trading and you’re off to a good start in Graham’s world.
Ref: The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: The Defensive Investor and Common Stocks
Chapter 5 - The Defensive Investor and Common Stocks
Graham’s advice, then, tends to focus on people who are willing to put in that extra time - and if you’re willing to do that, he has a lot of wisdom to share.
First of all, diversify. You should own at least ten different stocks, but more than thirty might be a mistake, as it becomes difficult to follow all of them carefully and also seek out new potential stock investments.
Second, invest in only large, prominent, and conservatively financed companies. Look for ones with little debt on the books and ones with a large market capitalization.
Third, invest only in companies with a long history of paying dividends. If a company rarely pays dividends, your only way to earn money from that company is if the market deems the stock to be valuable, and you shouldn’t trust that the market will do so.
Graham seems to point strongly towards the thirty stocks that make up the Dow Jones Industrial Average as a good place to start looking, as they usually match all of these criteria. I’d personally stretch that to include stocks that make up the S&P 500, but the Dow is a great place to find very large blue chip companies that are very stable and have paid dividends for a long time.
Other than that, Graham pooh-poohs many other common strategies.
Buying growth stocks? Nope.
Dollar-cost averaging? Good in theory, not great in practice.
Portfolio adjustments? Be very, very careful - and only do annual evaluations.
In short, be very, very wary and play it very, very cool.
Remember, this is Graham’s advice for the defensive, very conservative investor.
Commentary on Chapter 5
So, what does Jason Zweig have to say about all of this?
His big point is that simply “buying what you know” isn’t enough. You shouldn’t buy Starbucks’ stock simply because you drink their coffee. You need to spend the time to analyze the company’s situation, both internally and in the marketplace, and determine whether or not it’s a reasonable value. You can’t get there just by knowing the products they produce.
Zweig seems to generally feel that most people on the ground that are defensive investors are better off just buying mutual funds (preferably index funds) or seeking help from investment advisors, because the work needed to adequately study enough companies to build a good defensive portfolio is beyond what’s available to most people in their busy lives.
For me? I might tinker with individual stock buying, but I think I’d prefer to keep most of my money in index funds, simply because I, too, don’t feel like I have adequate time to really study enough stocks to build a good defensive stock portfolio.
Ref: The Intelligent Investor: The Defensive Investor and Common Stocks
Graham’s advice, then, tends to focus on people who are willing to put in that extra time - and if you’re willing to do that, he has a lot of wisdom to share.
First of all, diversify. You should own at least ten different stocks, but more than thirty might be a mistake, as it becomes difficult to follow all of them carefully and also seek out new potential stock investments.
Second, invest in only large, prominent, and conservatively financed companies. Look for ones with little debt on the books and ones with a large market capitalization.
Third, invest only in companies with a long history of paying dividends. If a company rarely pays dividends, your only way to earn money from that company is if the market deems the stock to be valuable, and you shouldn’t trust that the market will do so.
Graham seems to point strongly towards the thirty stocks that make up the Dow Jones Industrial Average as a good place to start looking, as they usually match all of these criteria. I’d personally stretch that to include stocks that make up the S&P 500, but the Dow is a great place to find very large blue chip companies that are very stable and have paid dividends for a long time.
Other than that, Graham pooh-poohs many other common strategies.
Buying growth stocks? Nope.
Dollar-cost averaging? Good in theory, not great in practice.
Portfolio adjustments? Be very, very careful - and only do annual evaluations.
In short, be very, very wary and play it very, very cool.
Remember, this is Graham’s advice for the defensive, very conservative investor.
Commentary on Chapter 5
So, what does Jason Zweig have to say about all of this?
His big point is that simply “buying what you know” isn’t enough. You shouldn’t buy Starbucks’ stock simply because you drink their coffee. You need to spend the time to analyze the company’s situation, both internally and in the marketplace, and determine whether or not it’s a reasonable value. You can’t get there just by knowing the products they produce.
Zweig seems to generally feel that most people on the ground that are defensive investors are better off just buying mutual funds (preferably index funds) or seeking help from investment advisors, because the work needed to adequately study enough companies to build a good defensive portfolio is beyond what’s available to most people in their busy lives.
For me? I might tinker with individual stock buying, but I think I’d prefer to keep most of my money in index funds, simply because I, too, don’t feel like I have adequate time to really study enough stocks to build a good defensive stock portfolio.
Ref: The Intelligent Investor: The Defensive Investor and Common Stocks
Strong, thorough research is the most important part about owning stocks.
There’s one big underlying theme to this book, Intelligent Investor. It’s the one point that I believe Graham wants people to take home from this book.
Strong, thorough research is the most important part about owning stocks.
If you can’t - or aren’t willing to - put in a lot of time studying individual stocks, identifying ones that genuinely have potential to return good value to you over time, and keep careful tabs on those individual stocks, then you shouldn’t be investing in stocks.
Over and over again, Graham makes this point, in both obvious and subtle ways. He’s a strong, strong believer in knowing the company. If you don’t have clear, concrete reasons for buying a stock, then you shouldn’t be buying that stock, period.
What if you don’t have that time? This book was written before the advent of index funds, but I tend to think that broad-based index funds can be a reasonable replacement for the stock portion of your portfolio.
Strong, thorough research is the most important part about owning stocks.
If you can’t - or aren’t willing to - put in a lot of time studying individual stocks, identifying ones that genuinely have potential to return good value to you over time, and keep careful tabs on those individual stocks, then you shouldn’t be investing in stocks.
Over and over again, Graham makes this point, in both obvious and subtle ways. He’s a strong, strong believer in knowing the company. If you don’t have clear, concrete reasons for buying a stock, then you shouldn’t be buying that stock, period.
What if you don’t have that time? This book was written before the advent of index funds, but I tend to think that broad-based index funds can be a reasonable replacement for the stock portion of your portfolio.
The Intelligent Investor: General Portfolio Policy for the Defensive Investor
Chapter 4 - General Portfolio Policy: The Defensive Investor
Graham opens the chapter defining two different kinds of investors: the “active” investor, which is the kind of investor that actively seeks new investments and invests serious time into studying investments, and the “passive” or “defensive” investor, the kind of investor that wants to invest once (or on a highly regular basis) and just let his or her portfolio run on autopilot.
Regardless of the activity that you apply to your investments, Graham sticks hard with his recommendation from the earlier chapter: 50% stocks, 50% bonds (or a close approximation thereof, with an absolute maximum of 75% in either side). It’s important to remember with a recommendation like that that Graham is very conservative in his investing, dreading the idea of an actual loss in capital. Only in the most dire of down markets (like 2008, for example) would such a portfolio actually deliver a loss to the investor.
Much of this chapter is spent talking about the various types of bonds that a person can buy:
Zweig also covers several additional options for the bond portion that didn’t exist in Graham’s day, such as bond funds, mortgage securities (no, no, no, no, NO!), and annuities. More importantly, Zweig actually looked at holding cash as an investment option in such things as high-interest online savings accounts and CDs. All of these can be a big part of the conservative half of one’s portfolio, sharing space with (or replacing) bonds.
Most interestingly, though, Zweig suggested that buying stocks solely for the dividends might be considered something that could be a part of the conservative side of a portfolio. Zweig points out that many common stocks pay out 3% or more of their value in dividends each year, so if you select a high-dividend stock from a very stable company, it could potentially serve as part of the conservative side of a defensive investor’s portfolio. I don’t know if I agree with this, given the inherent riskiness of owning individual stocks, that companies reset their dividends annually, and that even the most stable of companies can fall apart quicker than you might expect.
(Comment: In the absence of easy access to bonds for individual investors in Malaysia, the FDs and selected high-dividend stock from a very stable company are the 'equivalent' alternatives to the bond portion of the portfolio.)
Ref: The Intelligent Investor: General Portfolio Policy for the Defensive Investor
Graham opens the chapter defining two different kinds of investors: the “active” investor, which is the kind of investor that actively seeks new investments and invests serious time into studying investments, and the “passive” or “defensive” investor, the kind of investor that wants to invest once (or on a highly regular basis) and just let his or her portfolio run on autopilot.
Regardless of the activity that you apply to your investments, Graham sticks hard with his recommendation from the earlier chapter: 50% stocks, 50% bonds (or a close approximation thereof, with an absolute maximum of 75% in either side). It’s important to remember with a recommendation like that that Graham is very conservative in his investing, dreading the idea of an actual loss in capital. Only in the most dire of down markets (like 2008, for example) would such a portfolio actually deliver a loss to the investor.
Much of this chapter is spent talking about the various types of bonds that a person can buy:
- savings bonds,
- treasury notes/bills,
- municipal bonds, and
- corporate bonds
- some short term,
- some long term,
- some free from taxes,
- some not.
Commentary on Chapter 4
So, how can you tell whether you should be 75% stock and 25% bonds or 50/50 or 25/75? Or somewhere in between? Zweig argues that it mostly comes down to
- your goals,
- the stability in your life,
- your other savings, and
- your tolerance for risk.
Zweig also covers several additional options for the bond portion that didn’t exist in Graham’s day, such as bond funds, mortgage securities (no, no, no, no, NO!), and annuities. More importantly, Zweig actually looked at holding cash as an investment option in such things as high-interest online savings accounts and CDs. All of these can be a big part of the conservative half of one’s portfolio, sharing space with (or replacing) bonds.
Most interestingly, though, Zweig suggested that buying stocks solely for the dividends might be considered something that could be a part of the conservative side of a portfolio. Zweig points out that many common stocks pay out 3% or more of their value in dividends each year, so if you select a high-dividend stock from a very stable company, it could potentially serve as part of the conservative side of a defensive investor’s portfolio. I don’t know if I agree with this, given the inherent riskiness of owning individual stocks, that companies reset their dividends annually, and that even the most stable of companies can fall apart quicker than you might expect.
(Comment: In the absence of easy access to bonds for individual investors in Malaysia, the FDs and selected high-dividend stock from a very stable company are the 'equivalent' alternatives to the bond portion of the portfolio.)
Ref: The Intelligent Investor: General Portfolio Policy for the Defensive Investor
An intelligent and patient investor has a big advantage over the “gambler”-investor.
A lot of people like to argue that the rate of return you can expect from an investment is directly related to the amount of risk you take on. The more risk you have, the greater the potential return - but also the greater risk if you suddenly need to pull out your money.
I’ve always felt that this is a very limited view of things and that it ignores the effort and intelligence of the investor. An investor who can invest a lot of time studying the market and specific investments and can apply cool reasoning and behavior to his or her investments can get a better return than an investor who just wants to stick his or her money somewhere.
Take index funds, for example. Stock index funds are made up of all of the stocks that meet a certain criteria. If you buy into an index fund, it’ll essentially do as well as the average of all of those stocks. That actually also lowers your risk a fair amount because you’re not tied to the ups and downs of a specific company.
For an investor with limited time to research and understand specific investments - such as me - that’s a great way to invest. However, I know that if I had adequate time to actually study the market and played it cool, I could often (not always, but often) pick specific stocks that would beat this return.
Why don’t I do that? With the amount of money I have to invest (relatively small) and the time it would take to actually do the research and pick the investments (relatively large), it’s not a cost-effective use of my time. Give me index funds or give me death!
This is much the same logic that this chapter provides. Graham also buys into the idea that an intelligent and patient investor has a big advantage over the “gambler”-investor.
http://www.thesimpledollar.com/2008/11/07/the-intelligent-investor-general-portfolio-policy-for-the-defensive-investor/
I’ve always felt that this is a very limited view of things and that it ignores the effort and intelligence of the investor. An investor who can invest a lot of time studying the market and specific investments and can apply cool reasoning and behavior to his or her investments can get a better return than an investor who just wants to stick his or her money somewhere.
Take index funds, for example. Stock index funds are made up of all of the stocks that meet a certain criteria. If you buy into an index fund, it’ll essentially do as well as the average of all of those stocks. That actually also lowers your risk a fair amount because you’re not tied to the ups and downs of a specific company.
For an investor with limited time to research and understand specific investments - such as me - that’s a great way to invest. However, I know that if I had adequate time to actually study the market and played it cool, I could often (not always, but often) pick specific stocks that would beat this return.
Why don’t I do that? With the amount of money I have to invest (relatively small) and the time it would take to actually do the research and pick the investments (relatively large), it’s not a cost-effective use of my time. Give me index funds or give me death!
This is much the same logic that this chapter provides. Graham also buys into the idea that an intelligent and patient investor has a big advantage over the “gambler”-investor.
http://www.thesimpledollar.com/2008/11/07/the-intelligent-investor-general-portfolio-policy-for-the-defensive-investor/
The Intelligent Investor: Shareholders and Managements: Dividend Policy
Chapter 19 - Shareholders and Managements: Dividend Policy
Here, Graham seems to indicate that if a stock that otherwise appears to be a value stock isn’t paying out dividends, something is afoot. If there’s not a very clear and concrete reason for no dividends (and the overly simplistic “we’re investing in the company” isn’t satisfactory), then there’s something afoot.
This is not true for companies that would be considered “growth” investments. Quite often, the absence of a dividend (or the presence of only a small dividend) in a growth company is a sign that the company is actually doing what they claim - investing in the company with the intent of maintaining the impressive rate of growth.
The big difference is in why you invest in these different types of stocks. You invest in growth stocks to enjoy the increase in stock price - dividends aren’t really a part of the equation. You intend to ride that wave of growth until it runs out, then sell the stock somewhere near the peak (when the stock is still selling at a premium because of its “growth” status, but the growth is slowing).
However, the typical reason for owning a value stock is income. You don’t expect that the price of a value stock will jump greatly over time. Instead, you own it for that dividend - it’ll keep putting money in your pocket over the long haul. This isn’t a good enough reason for speculators to own the stock - dividend earnings are a long term thing - so good value stocks tend to be forgotten in the mad rush.
If you see a stock that’s undervalued, it should either
Here, Graham seems to indicate that if a stock that otherwise appears to be a value stock isn’t paying out dividends, something is afoot. If there’s not a very clear and concrete reason for no dividends (and the overly simplistic “we’re investing in the company” isn’t satisfactory), then there’s something afoot.
This is not true for companies that would be considered “growth” investments. Quite often, the absence of a dividend (or the presence of only a small dividend) in a growth company is a sign that the company is actually doing what they claim - investing in the company with the intent of maintaining the impressive rate of growth.
The big difference is in why you invest in these different types of stocks. You invest in growth stocks to enjoy the increase in stock price - dividends aren’t really a part of the equation. You intend to ride that wave of growth until it runs out, then sell the stock somewhere near the peak (when the stock is still selling at a premium because of its “growth” status, but the growth is slowing).
However, the typical reason for owning a value stock is income. You don’t expect that the price of a value stock will jump greatly over time. Instead, you own it for that dividend - it’ll keep putting money in your pocket over the long haul. This isn’t a good enough reason for speculators to own the stock - dividend earnings are a long term thing - so good value stocks tend to be forgotten in the mad rush.
If you see a stock that’s undervalued, it should either
- be paying out a good dividend,
- have a stellar reason for not doing so, or
- it should be avoided.
Commentary on Chapter 19
Zweig offers up one nugget that really caught my attention. From page 506:
Research by money managers Robert Arnott and Clifford Asness found that when current dividends are low, future corporate earnings also turn out to be low. And when current dividends are high, so are future earnings. Over 10-year periods, the average rate of earnings growth was 3.9 points greater when dividends were high than when they were low.
What does that mean? Good, strong companies can afford to pay out dividends. Thus, to an extent, a company paying solid dividends - particularly over a lot of years - is likely a company that’s on very solid footing and sure of their future.
Companies that pay good dividends don’t need to hoard money. They don’t need to invest in themselves. Instead, they’re able to provide direct value to their stockholders.
It’s a pretty good argument for value stocks, I must say.
To make money in the stock market, you must have discipline
When it pays to follow rules
Hemananthani Sivanandam
T3B (Track the Trend Breakthrough) system founder Keane Lee believes it pays to follow the rules — literally. This belief, held steadfastly for many years, has made him who he is today — a financially free man.
“If you want to make money in the stock market, you must have discipline. The trading plan is something you must abide by. It is your compass in the forest.”
T3B is a web-based trading system which identifies stocks and derivatives that are about to rise significantly or plunge drastically.
“As we all know, the most vital elements in trading stocks are to pick the right stocks and the right price to enter and exit the market.
“T3B is a charting system that allows people to pinpoint the exact buying and selling price of stocks in markets such as Malaysia, Hongkong, Singapore and Indonesia,” said Lee, who also conducts courses on the T3B system.
With more than 5,000 people in Singapore, Indonesia and Malaysia following the system, Lee said the system allows one to be emotionally detached, which he said is crucial in order to trade.
He said the most important factor when buying shares is the price and knowing when to sell without being influenced by emotions.
“Many people make the mistake of listening to rumours or people when it comes to buying shares. Some buy in a frenzy and some sell (shares) in a panic.
“If you know how to get into the share market but not out, then you’ll be stuck and suffer losses. The system helps you to get in but most importantly, get out and cut your losses.”
Is the system foolproof? Lee said the system is not a miraculous or magical formula as it is merely a guide to help people make the right decision.
“I can tell you that not all 5,000 of my students are completely financially free because to me, there are three types of people when it comes to trading.”
He said there are some people who embrace the system but at the same time they go back to their old habit of listening to rumours and tips about the market.
“Then there are also those who are not disciplined and focused to follow the system and give up.
“Lastly, there are people who procrastinate. The procrastinators are the ones who believe in the system but somehow find it hard to make the first move of trading and postpone it,” said Lee, who has 20 years’ experience in trading and broking.
He likened the system to someone in a forest but is equipped with infra-red goggles.
“I can give you the goggles to guide you but I cannot change what is on your path. We cannot change what will happen in the stock market but the system allows you clarity to see the movements in the market and tells you which to follow,” said Lee.
Lee said the system was initially created for his personal use but through word of mouth, it became popular.
“I taught it to some of my clients but soon others were willing to pay me to teach them about the system, so I thought, why not?”
He said apart from attaining financial freedom, it gives him satisfaction when he sees people who use the system becoming successful.
“I believe if you give the world the best, the best comes back to you.”
Lee’s investment tips
» Be financially educated.
Ignorance is expensive
» Find a trading niche which
is suitable for you
» Focus and follow through your
investment plan
» Set realistic goals
» Make money but also save to re-invest
Hemananthani Sivanandam
T3B (Track the Trend Breakthrough) system founder Keane Lee believes it pays to follow the rules — literally. This belief, held steadfastly for many years, has made him who he is today — a financially free man.
“If you want to make money in the stock market, you must have discipline. The trading plan is something you must abide by. It is your compass in the forest.”
T3B is a web-based trading system which identifies stocks and derivatives that are about to rise significantly or plunge drastically.
“As we all know, the most vital elements in trading stocks are to pick the right stocks and the right price to enter and exit the market.
“T3B is a charting system that allows people to pinpoint the exact buying and selling price of stocks in markets such as Malaysia, Hongkong, Singapore and Indonesia,” said Lee, who also conducts courses on the T3B system.
With more than 5,000 people in Singapore, Indonesia and Malaysia following the system, Lee said the system allows one to be emotionally detached, which he said is crucial in order to trade.
He said the most important factor when buying shares is the price and knowing when to sell without being influenced by emotions.
“Many people make the mistake of listening to rumours or people when it comes to buying shares. Some buy in a frenzy and some sell (shares) in a panic.
“If you know how to get into the share market but not out, then you’ll be stuck and suffer losses. The system helps you to get in but most importantly, get out and cut your losses.”
Is the system foolproof? Lee said the system is not a miraculous or magical formula as it is merely a guide to help people make the right decision.
“I can tell you that not all 5,000 of my students are completely financially free because to me, there are three types of people when it comes to trading.”
He said there are some people who embrace the system but at the same time they go back to their old habit of listening to rumours and tips about the market.
“Then there are also those who are not disciplined and focused to follow the system and give up.
“Lastly, there are people who procrastinate. The procrastinators are the ones who believe in the system but somehow find it hard to make the first move of trading and postpone it,” said Lee, who has 20 years’ experience in trading and broking.
He likened the system to someone in a forest but is equipped with infra-red goggles.
“I can give you the goggles to guide you but I cannot change what is on your path. We cannot change what will happen in the stock market but the system allows you clarity to see the movements in the market and tells you which to follow,” said Lee.
Lee said the system was initially created for his personal use but through word of mouth, it became popular.
“I taught it to some of my clients but soon others were willing to pay me to teach them about the system, so I thought, why not?”
He said apart from attaining financial freedom, it gives him satisfaction when he sees people who use the system becoming successful.
“I believe if you give the world the best, the best comes back to you.”
Lee’s investment tips
» Be financially educated.
Ignorance is expensive
» Find a trading niche which
is suitable for you
» Focus and follow through your
investment plan
» Set realistic goals
» Make money but also save to re-invest
Malaysia's Affirmative Action
JUNE 30, 2009
Malaysia Eases Race Rules
By JAMES HOOKWAY
Malaysian Prime Minister Najib Razak's move to relax race-based investment restrictions is his latest effort to roll back a decades-old affirmative action program criticized for benefiting the country's majority ethnic Malay population at the expense of the broader economy's competitiveness.
Some political analysts say the latest measures don't spell the end for Malaysia's New Economic Policy, as the affirmative action policies are known. Instead, Mr. Najib is attempting to balance the needs of Malaysia's shrinking economy with a social policy that many Malaysian politicians say they believe has helped stabilize the country's racial mix, which includes large ethnic-Chinese and Indian minorities.
"The world is changing quickly and we must be ready to change with it or risk being left behind," Mr. Najib told an investment conference Tuesday in Kuala Lumpur.
In his address, he outlined a package of measures to spur foreign investment in the Malaysian economy, which private economists say could contract as much as 5% this year amid the global downturn. Among the new policies, companies listing on the Kuala Lumpur Stock Exchange will be required to allocate just 12.5% of their equity to ethnic Malays, compared with 30% before.
Foreign investors will be able to own as much as 70% of stock-brokerage companies -- up from the current 49% cap -- while foreign fund managers will be allowed to establish 100%-foreign-owned fund-management companies in Malaysia, which has one of the largest stock markets in Southeast Asia.
Citigroup economist Kit Wei Zheng said the moves were consistent with earlier measures and would likely enhance Malaysia's competitive edge in attracting foreign investment. Earlier this year, Malaysia allowed foreign companies to enter certain service sectors without allocating 30% of their equity to ethnic Malays.
The main index at the Kuala Lumpur Stock Exchange fell 0.1% to close at 1075.24 Tuesday, but the ringgit strengthened to 3.5170 ringgit against the U.S. dollar at the close of trade compared with 3.5730 ringgit on Monday.
Mr. Najib, 55 years old, emphasized that Malaysia wasn't giving up its affirmative action policies, which were introduced in 1971 following bloody race riots, to help ethnic Malays catch up economically with ethnic Chinese Malaysians. The target of putting 30% of the economy in Malay hands, Mr. Najib said, remains intact. "But this 30% figure is now a macro target, not a micro target," he told reporters.
Significantly, the 30% Malay-ownership rules remain in force for "strategic industries" such as telecommunications, ports, energy and transport. In many cases, state investment funds have large controlling interests in these businesses.
"We will help the best and the good in business. We want to be fair to all communities," Mr. Najib said. "It is a tricky balancing act, but it is doable."
Some activists in the ethnic Malay community, which comprises 60% of Malaysia's 28 million people, have warned there could be protests if Mr. Najib moves too quickly to remove affirmative action policies. Last week, Mr. Najib took other steps to placate the country's ethnic Chinese and Indian minorities by announcing plans for merit-based university scholarships for which Malay, Chinese and Indian students can compete on an equal basis.
Some economists were surprised at the number of policy changes that Mr. Najib announced. "I didn't expect that," said Tim Condon, chief Asia economist with ING Group in Singapore. "But Mr. Najib appears to be responding to what people want and as pro-market measures go, these can only be seen as positive."
—K.P. Lee contributed to this article.
Write to James Hookway at james.hookway@wsj.com
http://online.wsj.com/article/SB124633190411371761.html
Malaysia Eases Race Rules
By JAMES HOOKWAY
Malaysian Prime Minister Najib Razak's move to relax race-based investment restrictions is his latest effort to roll back a decades-old affirmative action program criticized for benefiting the country's majority ethnic Malay population at the expense of the broader economy's competitiveness.
Some political analysts say the latest measures don't spell the end for Malaysia's New Economic Policy, as the affirmative action policies are known. Instead, Mr. Najib is attempting to balance the needs of Malaysia's shrinking economy with a social policy that many Malaysian politicians say they believe has helped stabilize the country's racial mix, which includes large ethnic-Chinese and Indian minorities.
"The world is changing quickly and we must be ready to change with it or risk being left behind," Mr. Najib told an investment conference Tuesday in Kuala Lumpur.
In his address, he outlined a package of measures to spur foreign investment in the Malaysian economy, which private economists say could contract as much as 5% this year amid the global downturn. Among the new policies, companies listing on the Kuala Lumpur Stock Exchange will be required to allocate just 12.5% of their equity to ethnic Malays, compared with 30% before.
Foreign investors will be able to own as much as 70% of stock-brokerage companies -- up from the current 49% cap -- while foreign fund managers will be allowed to establish 100%-foreign-owned fund-management companies in Malaysia, which has one of the largest stock markets in Southeast Asia.
Citigroup economist Kit Wei Zheng said the moves were consistent with earlier measures and would likely enhance Malaysia's competitive edge in attracting foreign investment. Earlier this year, Malaysia allowed foreign companies to enter certain service sectors without allocating 30% of their equity to ethnic Malays.
The main index at the Kuala Lumpur Stock Exchange fell 0.1% to close at 1075.24 Tuesday, but the ringgit strengthened to 3.5170 ringgit against the U.S. dollar at the close of trade compared with 3.5730 ringgit on Monday.
Mr. Najib, 55 years old, emphasized that Malaysia wasn't giving up its affirmative action policies, which were introduced in 1971 following bloody race riots, to help ethnic Malays catch up economically with ethnic Chinese Malaysians. The target of putting 30% of the economy in Malay hands, Mr. Najib said, remains intact. "But this 30% figure is now a macro target, not a micro target," he told reporters.
Significantly, the 30% Malay-ownership rules remain in force for "strategic industries" such as telecommunications, ports, energy and transport. In many cases, state investment funds have large controlling interests in these businesses.
"We will help the best and the good in business. We want to be fair to all communities," Mr. Najib said. "It is a tricky balancing act, but it is doable."
Some activists in the ethnic Malay community, which comprises 60% of Malaysia's 28 million people, have warned there could be protests if Mr. Najib moves too quickly to remove affirmative action policies. Last week, Mr. Najib took other steps to placate the country's ethnic Chinese and Indian minorities by announcing plans for merit-based university scholarships for which Malay, Chinese and Indian students can compete on an equal basis.
Some economists were surprised at the number of policy changes that Mr. Najib announced. "I didn't expect that," said Tim Condon, chief Asia economist with ING Group in Singapore. "But Mr. Najib appears to be responding to what people want and as pro-market measures go, these can only be seen as positive."
—K.P. Lee contributed to this article.
Write to James Hookway at james.hookway@wsj.com
http://online.wsj.com/article/SB124633190411371761.html
Affirmative action, meet economic reality.
Malaysia's Affirmative Action
By MOHAMMED HADI
Affirmative action, meet economic reality.
Facing declining interest from foreign investors and finding itself in an increasingly liberalized neighborhood, Malaysia on Tuesday unveiled some big changes in stock ownership and acquisition rules.
The boldest of these chip away at the country's nearly forty-year-old affirmative action policies -- in this case, rules over corporate ownership. Specifically, the requirement that ethnic Malays own 30% of any listed company will be watered down, effectively, to 12.5%.
Hurdles to acquisitions by foreign buyers too will be lowered, as will ownership restrictions for foreigners on fund management companies and brokerages.
Aimed at improving the lot of the country's ethnic majority Malay population, the affirmative action rules -- which govern everything from university enrollment to work force quotas -- have more recently become an anchor around the economy.
The symptoms of this -- a decline in competitiveness of non-commodity exports and foreign interest in the country -- is evident, Morgan Stanley says. Net foreign direct investment, for example, has been trending lower since the early 1990's -- contrary to the flood of inflows into the much of the region.
Malaysia trails Singapore, Thailand, and Indonesia when it comes to the volume of funds raised on its domestic stock market and value of acquisitions by foreign companies in recent years, according to Dealogic.
Tuesday's changes are unarguably a step toward fostering much needed innovation and risk-taking by Malaysian business, but relaxing rules to encourage foreign investment is surely the easy part.
Malaysia's Byzantine politics may keep any further changes -- particularly to labor laws -- off the table.
Write to Mohammed Hadi at mohammed.hadi@dowjones.com
http://online.wsj.com/article/SB124635723363472461.html?mod=googlenews_wsj
By MOHAMMED HADI
Affirmative action, meet economic reality.
Facing declining interest from foreign investors and finding itself in an increasingly liberalized neighborhood, Malaysia on Tuesday unveiled some big changes in stock ownership and acquisition rules.
The boldest of these chip away at the country's nearly forty-year-old affirmative action policies -- in this case, rules over corporate ownership. Specifically, the requirement that ethnic Malays own 30% of any listed company will be watered down, effectively, to 12.5%.
Hurdles to acquisitions by foreign buyers too will be lowered, as will ownership restrictions for foreigners on fund management companies and brokerages.
Aimed at improving the lot of the country's ethnic majority Malay population, the affirmative action rules -- which govern everything from university enrollment to work force quotas -- have more recently become an anchor around the economy.
The symptoms of this -- a decline in competitiveness of non-commodity exports and foreign interest in the country -- is evident, Morgan Stanley says. Net foreign direct investment, for example, has been trending lower since the early 1990's -- contrary to the flood of inflows into the much of the region.
Malaysia trails Singapore, Thailand, and Indonesia when it comes to the volume of funds raised on its domestic stock market and value of acquisitions by foreign companies in recent years, according to Dealogic.
Tuesday's changes are unarguably a step toward fostering much needed innovation and risk-taking by Malaysian business, but relaxing rules to encourage foreign investment is surely the easy part.
Malaysia's Byzantine politics may keep any further changes -- particularly to labor laws -- off the table.
Write to Mohammed Hadi at mohammed.hadi@dowjones.com
http://online.wsj.com/article/SB124635723363472461.html?mod=googlenews_wsj
The Intelligent Investor: A Comparison of Eight Pairs of Companies
This is really a “put the principles into practice” chapter, above all else. The premise is really simple: Graham simply picks eight pairs of companies off of a list of stocks available on the stock exchange. He simply chose ones that were adjacent to each other in name on a long list of publicly traded stocks.
So what’s the value in reading these comparisons?
The value comes in seeing what things Graham looks for when comparing two companies. If you carefully read this chapter, you can tease out a lot of interesting basic concepts that Graham seems to rely on in his analysis. Let’s dig in.
Chapter 18 - A Comparison of Eight Pairs of Companies
So, what “basic concepts” am I talking about? Here are five things that stood out to me in Graham’s comparisons.
Companies that stick to their core businesses are generally better values. Companies that dive into mergers and make big splashes into other businesses get all the attention, but if you’re looking for value, look for companies that focus in one area and do it well.
Investing on what you think will happen in the future is almost always a bad idea. No one can predict the future. If you’re investing for value, don’t bet on a company because of what they’ve done very recently. Look for a long track record.
Overvalued stocks tend to stay overvalued, while undervalued stocks tend to stay undervalued. Why? Conventional wisdom tends to rule the day. If a company is seen as “hot,” it takes a lot for that facade to go away. Similarly, if a company is seen as “boring,” it’s very hard to lose that stigma. That’s why selling short really only works well in certain specific situations where a company is clearly losing something of value, not just merely the fact that it seems overvalued.
A company in a highly competitive market is almost never a value. If a company has a lot of strong competitors, you should never view that stock as a value stock. Most good values sell products in niches where there isn’t much competition - hence the perception that such stocks are boring.
Price volatility is usually a bad sign. If a company is experiencing far greater price fluctuations than the market as a whole is seeing, particularly when it alternates between going up rapidly and going down rapidly, avoid the stock. Such events happen only in companies that are either unstable or are involved in something else going on in the market, both of which are good to avoid.
Commentary on Chapter 18
Zweig attempts to do eight similar comparisons with more modern companies, looking at them as they sat in 2002 and early 2003.
Again, most of these comparisons are really products of their times - they aren’t valid looks at the companies today. However, these comparisons do reinforce most of the principles taught in this book - nice, quiet, steady, stable companies with steady dividends and earnings growth are the ones that make for a great value.
Most importantly, it establishes that Graham’s principles are all about the long term, not the short term. If you’re interested in day trading and selling short, Ben Graham’s philosophy isn’t the right one for you.
Ref: The Intelligent Investor: Four Extremely Instructive Case Histories
So what’s the value in reading these comparisons?
The value comes in seeing what things Graham looks for when comparing two companies. If you carefully read this chapter, you can tease out a lot of interesting basic concepts that Graham seems to rely on in his analysis. Let’s dig in.
Chapter 18 - A Comparison of Eight Pairs of Companies
So, what “basic concepts” am I talking about? Here are five things that stood out to me in Graham’s comparisons.
Companies that stick to their core businesses are generally better values. Companies that dive into mergers and make big splashes into other businesses get all the attention, but if you’re looking for value, look for companies that focus in one area and do it well.
Investing on what you think will happen in the future is almost always a bad idea. No one can predict the future. If you’re investing for value, don’t bet on a company because of what they’ve done very recently. Look for a long track record.
Overvalued stocks tend to stay overvalued, while undervalued stocks tend to stay undervalued. Why? Conventional wisdom tends to rule the day. If a company is seen as “hot,” it takes a lot for that facade to go away. Similarly, if a company is seen as “boring,” it’s very hard to lose that stigma. That’s why selling short really only works well in certain specific situations where a company is clearly losing something of value, not just merely the fact that it seems overvalued.
A company in a highly competitive market is almost never a value. If a company has a lot of strong competitors, you should never view that stock as a value stock. Most good values sell products in niches where there isn’t much competition - hence the perception that such stocks are boring.
Price volatility is usually a bad sign. If a company is experiencing far greater price fluctuations than the market as a whole is seeing, particularly when it alternates between going up rapidly and going down rapidly, avoid the stock. Such events happen only in companies that are either unstable or are involved in something else going on in the market, both of which are good to avoid.
Commentary on Chapter 18
Zweig attempts to do eight similar comparisons with more modern companies, looking at them as they sat in 2002 and early 2003.
Again, most of these comparisons are really products of their times - they aren’t valid looks at the companies today. However, these comparisons do reinforce most of the principles taught in this book - nice, quiet, steady, stable companies with steady dividends and earnings growth are the ones that make for a great value.
Most importantly, it establishes that Graham’s principles are all about the long term, not the short term. If you’re interested in day trading and selling short, Ben Graham’s philosophy isn’t the right one for you.
Ref: The Intelligent Investor: Four Extremely Instructive Case Histories
The Intelligent Investor: Four Extremely Instructive Case Histories
In this chapter, Graham discusses four examples of this kind of careful study:
Penn Central (Railroad) Co., which is an example of a corporate giant that’s rotting from the inside
Ling-Temco-Vought, Inc., which is a company that builds an empire on paper, but is actually pretty fragile
NVF Corp., which is an example of corporate acquisitions gone bad
AAA Enterprises, which is an example of a “hot” stock that’s getting elevated beyond all reason
Chapter 17: Four Extremely Instructive Case Histories
Here’s how Graham sniffed out the rat in each company.
Penn Central (Railroad) Co.
A careful reading of the company’s annual reports reveals that the company had been paying virtually no income tax for a decade. That’s a huge warning sign - if they’re not paying income tax,
AAA Enterprises
If you can’t determine why exactly people are investing in a company, don’t invest. That’s basically the story here, in which a tiny company played a hype game and wound up being valued at 115 times earnings - a number that’s not realistic no matter what the company.
This was all based on potential - much like the “dot com” stocks of 1999 and 2000. Graham’s point? Avoid companies that are selling nothing more than potential. If you can’t see real assets and real business there, don’t invest.
Ref: The Intelligent Investor: Four Extremely Instructive Case Histories
Penn Central (Railroad) Co., which is an example of a corporate giant that’s rotting from the inside
Ling-Temco-Vought, Inc., which is a company that builds an empire on paper, but is actually pretty fragile
NVF Corp., which is an example of corporate acquisitions gone bad
AAA Enterprises, which is an example of a “hot” stock that’s getting elevated beyond all reason
Chapter 17: Four Extremely Instructive Case Histories
Here’s how Graham sniffed out the rat in each company.
Penn Central (Railroad) Co.
A careful reading of the company’s annual reports reveals that the company had been paying virtually no income tax for a decade. That’s a huge warning sign - if they’re not paying income tax,
- they’re either taking advantage of a ton of tax breaks (which you should be able to discover easily) or
- they’re not really earning much income at all.
How did they do it? They were reporting earnings without “charges” that were going to be taken several years down the road. These “charges,” however, were merely disguising that the company wasn’t really bringing in any income.
What can you do to avoid this? If you see a company reporting good earnings but also talking about “charges” for mysterious reasons that will be dealt with in future years, be very careful. They could be just extending the life of the company on paper when it’s actually in serious trouble.
Ling-Temco-Vought, Inc.
The warning signs? In 1966, the company stated that their assets were less than 5% of the stock value of the company. This means that if the company went bankrupt, the common stocks would pretty much be worthless - something to avoid like the plague if you’re investing for value.
Another warning sign: large investors started dumping the stock in droves. If you see big investors selling all of their stock in a company, you might want to consider doing the same. Watch out for big changes in institutional investing in the public reports on the company.
In 1969, the company reported a loss far bigger than the total profits in the history of the company. In one year, it lost more money than it ever earned - a sure sign something’s seriously wrong.
The way to avoid this is simple:
- avoid any stocks that are valued far beyond their asset value.
- Avoid any stocks that are being sold in droves by institutional investors.
- Avoid stocks that suddenly report a huge loss seemingly out of nowhere.
NVF Corp.
Here, NVF used a number of accounting gimmicks to hide the fact that they were acquiring companies with a huge amount of debt and unsteady business.
How did they do that? The most flagrant sign was that the company claimed an “asset” called “deferred debt expense” that was actually larger than the entire equity of the company. If you started digging into the annual report and figuring out what the items are, you soon realized that the company was actually claiming some debts as assets - and when you got that all straightened out, it became clear that the company was worthless.
You can avoid this by avoiding any company that has unexplainable items on their annual report. If you can’t get a rational explanation of what an element of a company’s annual report is, avoid that company.
AAA Enterprises
If you can’t determine why exactly people are investing in a company, don’t invest. That’s basically the story here, in which a tiny company played a hype game and wound up being valued at 115 times earnings - a number that’s not realistic no matter what the company.
This was all based on potential - much like the “dot com” stocks of 1999 and 2000. Graham’s point? Avoid companies that are selling nothing more than potential. If you can’t see real assets and real business there, don’t invest.
Commentary on Chapter 17
Zweig spends his commentary making modern analogies for each of these disasters.
Zweig compared Penn Central (Railroad) Co. to Lucent. Both companies were among the largest in America, but once you started digging into the books, it became clear that the large company was rotting from the inside, with apparent earnings that weren’t actually based in reality.
He compared Ling-Temco-Vought, Inc. to Tyco, both of which built a big paper empire that wasn’t really based on real-world assets, but instead based on mergers and shuffling.
He compared NVF Corp. to AOL-Time Warner, the best modern example of a merger that completely made no sense in which the minnow swallowed the whale.
Finally, the easy one: AAA Enterprises could have been compared to a lot of dot-com companies (my favorite disaster was Boo.com), but Zweig analogized it to eToys, another classic dot-com disaster.
What’s the lesson? These same tactics keep getting used and keep fooling investors. Be careful.
Ref: The Intelligent Investor: Four Extremely Instructive Case Histories
The real question in value investing
The real question in value investing is how do you identify the lemons that are mixed in with the ‘values’?
Obviously, when you’re digging into “value” companies, you’re seeking out companies that are currently undervalued by the stock market. This can happen for a lot of reasons:
http://www.thesimpledollar.com/2009/02/06/the-intelligent-investor-four-extremely-instructive-case-histories/
Obviously, when you’re digging into “value” companies, you’re seeking out companies that are currently undervalued by the stock market. This can happen for a lot of reasons:
- these companies are boring,
- these companies are not experiencing rapid growth, or,
- more ominously, something nasty is afoot with this business.
The problem with teasing out companies that are up to shenanigans is that there’s no ready made recipe for identifying them. This is where homework comes into play. You need to study the individual companies you invest in. Careful study of a company will often identify fundamental problems in their business plan - and if you see those things, you can stay away.
http://www.thesimpledollar.com/2009/02/06/the-intelligent-investor-four-extremely-instructive-case-histories/
The Intelligent Investor: The Investor and Market Fluctuations
Chapter 8 - The Investor and Market Fluctuations
Right off the bat, Graham argues that attempting to play market timing games is a fool’s game. One can never predict true market bottoms or peaks in advance - they can only be seen through hindsight. Graham also points out that some of the “markers” of a bottoming-out market won’t necessarily hold true for the next bottom, and that same effect holds true for peaks as well. In a nutshell, don’t bother trying to time things based on what you think the overall stock market is going to do.
However, for individual stocks, Graham thinks that timing can actually work well. In this case, though, Graham is referring to detailed study of a company: knowing that the company is sound, knowing how it compares to the competition, and knowing what a reasonable value of the stock should be. Once you’ve identified a good, quality company, then you should keep your eye out for the right price on that stock - when it goes below a certain number without any change in the nature of the company itself, then you buy.
This, in essence, is the key of the “buy low, sell high” idea. You don’t try to time the market at all. Instead, you merely seek out bargains in the things that you know, and you wait for them patiently.
What about selling? For the most part, Graham encourages people not to sell into fluctuations, either, and instead hold onto those steady, dividend-paying stocks. The only time Graham seems to encourage selling based on market conditions is if the prices you would get today are significantly out of whack with the long term history of the stock. For example, if the stock has pretty consistently held near a 12 P/E ratio, but is suddenly selling for 20, it’s probably a good time to sell it.
What’s the end result of all of this? A person who diligently follows Graham’s advice is going to almost always be doing the opposite of what everyone else is doing. When the bull market is roaring and everyone is buying, you’re likely to be holding or selling stocks. When the bear market is afoot and everyone is selling, you’re likely to buy up those value stocks.
What about bonds? Graham generally advocates buying bonds when there are no values to be had in the stock market. In other words, if you have money to invest and the stock market is roaring like a freight train, Graham suggests increasing the portion of bonds in your portfolio. Similarly, when the market is down, one may want to decrease the portion of their portfolio that is in bonds if there are appropriate value stocks out there for purchase. Again, it’s the opposite of what seems to be the convention on Wall Street.
Commentary on Chapter 8
Zweig spends most of the commentary ruminating on Graham’s “Mr. Market.” For those unfamiliar, Graham often liked to imagine the stock market as a person he called Mr. Market. This individual was essentially a manic depressive - when the stock market was rocketing, he’d offer to buy or sell you stocks at a price way beyond what the company was worth, but when the stock market was down, he’d only buy or sell at prices far below what the company should fetch. Graham argued that the way to deal with Mr. Market was patience - wait until he quoted you prices you liked.
Zweig uses several modern examples of irrational exuberance to show this “Mr. Market” phenomenon at work - and the dot-com boom certainly gave us a lot of examples. Zweig discusses Inktomi, which went from a peak well over $200 in 2000 to being worth a quarter a share in 2002, even though the fundamentals of the business actually improved over that time frame. In 2002, it was a bargain, and eventually Yahoo bought the company lock, stock, and barrel for roughly seven times that much.
So how can you avoid situations like Inktomi? Know what you’re buying, be patient, and only buy when the getting is good. Not only does this ensure that you get actual bargains, it also reduces the brokerage fees that a more frenetic buyer and seller would accumulate.
Zweig picks out a great quote from Graham that I think bears repeating here.
The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.
That, right there, is most of the lesson of this chapter in one sentence.
Ref: The Intelligent Investor: The Investor and Market Fluctuations
Right off the bat, Graham argues that attempting to play market timing games is a fool’s game. One can never predict true market bottoms or peaks in advance - they can only be seen through hindsight. Graham also points out that some of the “markers” of a bottoming-out market won’t necessarily hold true for the next bottom, and that same effect holds true for peaks as well. In a nutshell, don’t bother trying to time things based on what you think the overall stock market is going to do.
However, for individual stocks, Graham thinks that timing can actually work well. In this case, though, Graham is referring to detailed study of a company: knowing that the company is sound, knowing how it compares to the competition, and knowing what a reasonable value of the stock should be. Once you’ve identified a good, quality company, then you should keep your eye out for the right price on that stock - when it goes below a certain number without any change in the nature of the company itself, then you buy.
This, in essence, is the key of the “buy low, sell high” idea. You don’t try to time the market at all. Instead, you merely seek out bargains in the things that you know, and you wait for them patiently.
What about selling? For the most part, Graham encourages people not to sell into fluctuations, either, and instead hold onto those steady, dividend-paying stocks. The only time Graham seems to encourage selling based on market conditions is if the prices you would get today are significantly out of whack with the long term history of the stock. For example, if the stock has pretty consistently held near a 12 P/E ratio, but is suddenly selling for 20, it’s probably a good time to sell it.
What’s the end result of all of this? A person who diligently follows Graham’s advice is going to almost always be doing the opposite of what everyone else is doing. When the bull market is roaring and everyone is buying, you’re likely to be holding or selling stocks. When the bear market is afoot and everyone is selling, you’re likely to buy up those value stocks.
What about bonds? Graham generally advocates buying bonds when there are no values to be had in the stock market. In other words, if you have money to invest and the stock market is roaring like a freight train, Graham suggests increasing the portion of bonds in your portfolio. Similarly, when the market is down, one may want to decrease the portion of their portfolio that is in bonds if there are appropriate value stocks out there for purchase. Again, it’s the opposite of what seems to be the convention on Wall Street.
Commentary on Chapter 8
Zweig spends most of the commentary ruminating on Graham’s “Mr. Market.” For those unfamiliar, Graham often liked to imagine the stock market as a person he called Mr. Market. This individual was essentially a manic depressive - when the stock market was rocketing, he’d offer to buy or sell you stocks at a price way beyond what the company was worth, but when the stock market was down, he’d only buy or sell at prices far below what the company should fetch. Graham argued that the way to deal with Mr. Market was patience - wait until he quoted you prices you liked.
Zweig uses several modern examples of irrational exuberance to show this “Mr. Market” phenomenon at work - and the dot-com boom certainly gave us a lot of examples. Zweig discusses Inktomi, which went from a peak well over $200 in 2000 to being worth a quarter a share in 2002, even though the fundamentals of the business actually improved over that time frame. In 2002, it was a bargain, and eventually Yahoo bought the company lock, stock, and barrel for roughly seven times that much.
So how can you avoid situations like Inktomi? Know what you’re buying, be patient, and only buy when the getting is good. Not only does this ensure that you get actual bargains, it also reduces the brokerage fees that a more frenetic buyer and seller would accumulate.
Zweig picks out a great quote from Graham that I think bears repeating here.
The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.
That, right there, is most of the lesson of this chapter in one sentence.
Ref: The Intelligent Investor: The Investor and Market Fluctuations
Security Analysis for the Lay Investor: General Approach
Chapter 11 - Security Analysis for the Lay Investor: General Approach
How exactly can an individual estimate what a reasonable value of a given stock should be? Graham identifies five key factors that basically define the value of a stock.
The company’s “general long-term prospects”
Ignore what the talking heads are saying and look at the books. Is the company growing steadily? Is this growth actually in line with the stock price, or is the stock price jumping up and down seemingly out of touch with the actual business of the company? If the books are steady, the company is steady, and the prices jumping up and down is the result of talking heads. Be sure to look at a lot of data, though - at least five years, and ten is better.
The quality of the management
It’s hard to judge this. One way to effectively judge it is to watch the annual reports of the company over a long period and see if the management actually does what they say they’re going to do as well as frankly discuss the moves they’ve made. If the management commentary seems not well related to the business of the company, that’s a big red flag.
Its financial strength and capital structure
The less debt, the better, but a little bit of debt isn’t a big scary red flag. Again, look at the long term and see how the company has handled debt over the long term - it should always be low (or steadily going down).
Its dividend record
Graham believes that a company should be paying a pretty steady investment for at least twenty years. If the company you’re investing in doesn’t have this kind of history, that’s something of a negative.
Its current dividend rate
Since Graham wrote this book, companies have gradually shrunk their dividend payments, making the current dividend rate much less of a factor. When Graham was writing, companies typically paid around 60% of earnings out as dividends - today, 25-30% is fairly typical.
One important thing to note about Graham’s five factors is that he’s looking at these stocks as a long term investment that he hopes will return a healthy pile of dividends over that time. He’s not necessarily looking for a big ramp-up in stock price over that period - his “value” comes primarily from the dividends. That’s quite a bit different than how CNBC often talks about about stocks.
Commentary on Chapter 11
Zweig spends the commentary basically taking Graham’s five key factors and putting them in a modern context. For example, for evaluating a company’s long term prospects, Zweig encourages people to visit EDGAR (at sec.gov) and download at least five years’ worth of annual reports. That’s not exactly something that could be done in Graham’s day.
In fact, most of Zweig’s recommendations point people towards using EDGAR, which is an incredible tool for getting straightforward factual information about the status of companies you’re investing in. Zweig points out lots of things you should look for in all that data, but here’s three that stood out to me:
Form 4, which shows what a firm’s senior management has been doing in terms of buying and selling stock. If they’re buying, they believe in what they’re doing. If they’re all selling quite a bit, something’s amiss.
Statement of cash flows, which shows where the money is coming from. If you see a lot of “cash from financing activities,” that means they’re borrowing Peter to pay Paul - not a healthy long term solution.
Revenue and earnings each year for as many years as you can, which can show whether the earnings growth is smooth (good) or very bumpy (bad). No company is perfectly smooth, but if you see a 120% jump in growth followed by a 4% growth followed by a 19% growth followed by 2% shrinkage, consider that a red flag.
Ref: The Intelligent Investor: A General Approach to Security Analysis for the Lay Investor
How exactly can an individual estimate what a reasonable value of a given stock should be? Graham identifies five key factors that basically define the value of a stock.
The company’s “general long-term prospects”
Ignore what the talking heads are saying and look at the books. Is the company growing steadily? Is this growth actually in line with the stock price, or is the stock price jumping up and down seemingly out of touch with the actual business of the company? If the books are steady, the company is steady, and the prices jumping up and down is the result of talking heads. Be sure to look at a lot of data, though - at least five years, and ten is better.
The quality of the management
It’s hard to judge this. One way to effectively judge it is to watch the annual reports of the company over a long period and see if the management actually does what they say they’re going to do as well as frankly discuss the moves they’ve made. If the management commentary seems not well related to the business of the company, that’s a big red flag.
Its financial strength and capital structure
The less debt, the better, but a little bit of debt isn’t a big scary red flag. Again, look at the long term and see how the company has handled debt over the long term - it should always be low (or steadily going down).
Its dividend record
Graham believes that a company should be paying a pretty steady investment for at least twenty years. If the company you’re investing in doesn’t have this kind of history, that’s something of a negative.
Its current dividend rate
Since Graham wrote this book, companies have gradually shrunk their dividend payments, making the current dividend rate much less of a factor. When Graham was writing, companies typically paid around 60% of earnings out as dividends - today, 25-30% is fairly typical.
One important thing to note about Graham’s five factors is that he’s looking at these stocks as a long term investment that he hopes will return a healthy pile of dividends over that time. He’s not necessarily looking for a big ramp-up in stock price over that period - his “value” comes primarily from the dividends. That’s quite a bit different than how CNBC often talks about about stocks.
Commentary on Chapter 11
Zweig spends the commentary basically taking Graham’s five key factors and putting them in a modern context. For example, for evaluating a company’s long term prospects, Zweig encourages people to visit EDGAR (at sec.gov) and download at least five years’ worth of annual reports. That’s not exactly something that could be done in Graham’s day.
In fact, most of Zweig’s recommendations point people towards using EDGAR, which is an incredible tool for getting straightforward factual information about the status of companies you’re investing in. Zweig points out lots of things you should look for in all that data, but here’s three that stood out to me:
Form 4, which shows what a firm’s senior management has been doing in terms of buying and selling stock. If they’re buying, they believe in what they’re doing. If they’re all selling quite a bit, something’s amiss.
Statement of cash flows, which shows where the money is coming from. If you see a lot of “cash from financing activities,” that means they’re borrowing Peter to pay Paul - not a healthy long term solution.
Revenue and earnings each year for as many years as you can, which can show whether the earnings growth is smooth (good) or very bumpy (bad). No company is perfectly smooth, but if you see a 120% jump in growth followed by a 4% growth followed by a 19% growth followed by 2% shrinkage, consider that a red flag.
Ref: The Intelligent Investor: A General Approach to Security Analysis for the Lay Investor
The Intelligent Investor: “Margin of Safety” as the Central Concept of Investment
Chapter 20 - “Margin of Safety” as the Central Concept of Investment
A single quote by Graham on page 516 struck me:
Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.
This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?
Graham takes this point a step further, arguing that diversification is strongly correlated with margin of safety. In effect, Graham states that you introduce some additional margin of safety into your portfolio when you own a widely diverse array of value stocks that each have significant margin of safety.
Graham’s final note is pretty simple: investors get in trouble when they abandon their basic principles in the heat of the moment. One must approach investing with a set of fundamental principles and not abandon them in the heat of the moment.
Commentary on Chapter 20
Zweig closes out this final chapter by arguing that psychology is a major part of investing, one that many people overlook in the rush to find the big bargain. He goes so far as to argue that people are the primary risk in their own investing - poor decision making and abandonment of principles results in far more loss than an investment gone wrong.
Zweig actually ties this to Pascal’s wager, a famous suggestion by the French philosopher Blaise Pascal in which he argues that, since God’s existence cannot be determined through reason, one should behave as though God does exist, since living in that way (as opposed to living as though God does not exist) provides much more gain than loss. Similarly, since one cannot prove what will happen in the future with investments, we’re better off living by our investing principles than playing it by ear.
http://www.thesimpledollar.com/2009/02/27/the-intelligent-investor-margin-of-safety-as-the-central-concept-of-investment/
A single quote by Graham on page 516 struck me:
Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.
This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?
Graham takes this point a step further, arguing that diversification is strongly correlated with margin of safety. In effect, Graham states that you introduce some additional margin of safety into your portfolio when you own a widely diverse array of value stocks that each have significant margin of safety.
Graham’s final note is pretty simple: investors get in trouble when they abandon their basic principles in the heat of the moment. One must approach investing with a set of fundamental principles and not abandon them in the heat of the moment.
Commentary on Chapter 20
Zweig closes out this final chapter by arguing that psychology is a major part of investing, one that many people overlook in the rush to find the big bargain. He goes so far as to argue that people are the primary risk in their own investing - poor decision making and abandonment of principles results in far more loss than an investment gone wrong.
Zweig actually ties this to Pascal’s wager, a famous suggestion by the French philosopher Blaise Pascal in which he argues that, since God’s existence cannot be determined through reason, one should behave as though God does exist, since living in that way (as opposed to living as though God does not exist) provides much more gain than loss. Similarly, since one cannot prove what will happen in the future with investments, we’re better off living by our investing principles than playing it by ear.
http://www.thesimpledollar.com/2009/02/27/the-intelligent-investor-margin-of-safety-as-the-central-concept-of-investment/
The Intelligent Investor: Investing in Investment Funds
Chapter 9 - Investing in Investment Funds
Graham basically says that there are three questions you need to answer before investing in any fund.
1. Is there any way by which the investor can assure himself better than average results by choosing the right funds? [...]
2. If not, how can he avoid choosing funds that will give him worse than average results?
3. Can he make intelligent choices between different types of funds - e.g., balanced versus all-stock, open-end versus closed-end, load versus no-load?
Graham states that in general, individuals who invest in balanced funds tend to do better than individuals who invest in individual common stocks. The reason is simple: a person who is not an expert at picking individual stocks and balancing a portfolio is usually better off in the hands of a professional money manager even after the costs.
However (and this is big), Graham largely seems to suggest that the fees in a typical mutual fund are far too high and the time invested in finding a bargain fund (one with good results with limited costs) is well worth the time. He also believes that you should not expect to ever radically beat the market with a fund, and that funds who have astounding short term gains are usually not playing a healthy long-term gain - something that’s been shown over and over again over the history of investing.
Commentary on Chapter 9
Zweig has the advantage of knowledge of three more decades of investing history and he definitely uses it here. For the most part, Zweig applies Graham’s three big questions to modern mutual funds - and the results aren’t pretty.
Zweig seems to conclude that managed mutual funds are not a good investment for the typical investor. Over a long period, very few funds even manage to match the market, let alone beat the market. Why is this? Assuming there were no fees or costs, a truly average fund would match the market and (in theory) half of all funds would do that well or better. However, once you add in fees and costs, this sinks many of those market-beaters to a rate of return worse than the overall market.
Given that, though, Zweig is a big fan of index funds, as they overcome several of the problems with managed funds. They’re designed merely to match the market with an extremely low cost, which means that a typical index fund should beat a solid majority of mutual funds covering the same area.
Of course, Zweig advises that even if you’re using an index fund strategy, you still need to pay attention to diversification and should not have all of your eggs in one basket. Just because you’re invested with index funds doesn’t mean you shouldn’t balance your portfolio between stocks, bonds, and cash.
Ref: The Intelligent Investor: Investing in Investment Funds
Graham basically says that there are three questions you need to answer before investing in any fund.
1. Is there any way by which the investor can assure himself better than average results by choosing the right funds? [...]
2. If not, how can he avoid choosing funds that will give him worse than average results?
3. Can he make intelligent choices between different types of funds - e.g., balanced versus all-stock, open-end versus closed-end, load versus no-load?
Graham states that in general, individuals who invest in balanced funds tend to do better than individuals who invest in individual common stocks. The reason is simple: a person who is not an expert at picking individual stocks and balancing a portfolio is usually better off in the hands of a professional money manager even after the costs.
However (and this is big), Graham largely seems to suggest that the fees in a typical mutual fund are far too high and the time invested in finding a bargain fund (one with good results with limited costs) is well worth the time. He also believes that you should not expect to ever radically beat the market with a fund, and that funds who have astounding short term gains are usually not playing a healthy long-term gain - something that’s been shown over and over again over the history of investing.
Commentary on Chapter 9
Zweig has the advantage of knowledge of three more decades of investing history and he definitely uses it here. For the most part, Zweig applies Graham’s three big questions to modern mutual funds - and the results aren’t pretty.
Zweig seems to conclude that managed mutual funds are not a good investment for the typical investor. Over a long period, very few funds even manage to match the market, let alone beat the market. Why is this? Assuming there were no fees or costs, a truly average fund would match the market and (in theory) half of all funds would do that well or better. However, once you add in fees and costs, this sinks many of those market-beaters to a rate of return worse than the overall market.
Given that, though, Zweig is a big fan of index funds, as they overcome several of the problems with managed funds. They’re designed merely to match the market with an extremely low cost, which means that a typical index fund should beat a solid majority of mutual funds covering the same area.
Of course, Zweig advises that even if you’re using an index fund strategy, you still need to pay attention to diversification and should not have all of your eggs in one basket. Just because you’re invested with index funds doesn’t mean you shouldn’t balance your portfolio between stocks, bonds, and cash.
Ref: The Intelligent Investor: Investing in Investment Funds
Wednesday 1 July 2009
Intelligent Investor Notes
This book will teach you three powerful lessons:
+ how you can minimize the odds of suffering irreversible losses;
+ how you can maximize the chances of achieving sustainable games;
+ how you can control the self-defeating behavior that keeps most investors from reaching their full potential.
And Graham’s ticket to that is value investing.
The Intelligent Investor: Introduction
The Intelligent Investor: Investment Versus Speculation
The Intelligent Investor: The Investor and Inflation
The Intelligent Investor: A Century of Stock Market History
The Intelligent Investor: General Portfolio Policy for the Defensive Investor
The Intelligent Investor: The Defensive Investor and Common Stocks
The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: The Investor and Market Fluctuations
The Intelligent Investor: Investing in Investment Funds
The Intelligent Investor: The Investor and His Advisers
The Intelligent Investor: A General Approach to Security Analysis for the Lay Investor
The Intelligent Investor: Investment Versus Speculation
The Intelligent Investor: The Investor and Inflation
The Intelligent Investor: A Century of Stock Market History
The Intelligent Investor: General Portfolio Policy for the Defensive Investor
The Intelligent Investor: The Defensive Investor and Common Stocks
The Intelligent Investor: A Negative Approach to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor
The Intelligent Investor: The Investor and Market Fluctuations
The Intelligent Investor: Investing in Investment Funds
The Intelligent Investor: The Investor and His Advisers
The Intelligent Investor: A General Approach to Security Analysis for the Lay Investor
The Intelligent Investor: Things to Consider About Per-Share Earnings
The Intelligent Investor: A Comparison of Four Listed Companies
The Intelligent Investor: A Comparison of Four Listed Companies
These are notes from:
The Simple Dollar
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