“Lisa” e-mailed the radio show about a month ago, asking what she should do about a portfolio heavily weighted in financial stocks (she estimated that about 40% of her $200,000 non-retirement portfolio was concentrated in the sector). While on the air, I responded, “I would cry!” but that was obviously not the last word on the topic.
I started to e-mail with Lisa to learn more about her situation. She noted, “I must say that your response of "CRY" to my question has been my gut reaction for the past couple of months.” She had been frustrated by her advisor, who “doesn’t seem to listen to me!” Lisa’s lament was one with which I am quite familiar and I asked her to come in to the office so that I could review the portfolio and provide her with guidance.
I learned that Lisa is retired and that the money that was in this account was probably invested more aggressively than it should have been, given her overall risk tolerance and potential need for the money within the next five years. That was the first problem. Problem #2 was that the portfolio was difficult to change (she wanted her advisor to sell all of the financial stocks in the portfolio), because it was managed by a sub-advisor in a pooled account, not by her investment advisor. Finally, the last problem was the fees associated with the account were high…really high.
After identifying the three problems, it was on to the fun part: the solutions! Lisa showed me the new proposal that her advisor had presented. I pointed out that the advisor was suggesting that Lisa switch to a balanced sub-advisor to replace the more growth-oriented sub-advisor that she had. I asked her a simple question: “if that’s his answer, then why not manage the account yourself?” She looked at me as if I had suggested that she jump into the space shuttle and fly to the moon, so I elaborated on the recommendation.
If her advisor thought that Lisa should be in a balanced portfolio of stocks and bonds, she might consider purchasing a Vanguard Balanced Index Fund (VBINX) directly. Instead of paying her manager 2.25%, she would pay Vanguard .20% -- a savings of $4,100 annually! She wondered if the performance might be better over time with the sub-advisor, but it would have to be a whole heck of lot better to justify 2.05% every single year!
It seemed like a great solution to me, but Lisa said that she did not want to deal with managing her money herself and in fact, for some odd reason, despite her admission that she did not think her advisor was all that smart when it came to investments, “he does meet with me every month and help me reallocate my variable annuities.” Oi, variable annuities too? In the end, despite Lisa’s lament, I just didn’t think that she was ready to make a big change. I sent her on her way, telling her as much. She sent me an e-mail a few hours later thanking me for my time and said, “Who knows? You may not have heard the last of me yet.”
Friday, November 9, 2007
Thursday, November 8, 2007
A Chill in the Air (Don’t Worry, Chillax!)
I woke up yesterday morning and for the first time, grabbed a scarf before heading out into a crisp New England morning. There was a real chill in the air and I guessed that I would need to wrap myself in a cocoon of warmth. As the day progressed, it was clear that a cool blast was sweeping through Wall Street and by the end of the day investors would need to seek comfort in their respective scarves.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Wednesday, November 7, 2007
Two Economies
I was discussing the US economy with my client “Eric” yesterday. He noted that many of the Democratic presidential candidates are talking about “two economies,” but that he does not see evidence of that fact. Given that Eric is a corporate attorney who earns approximately $400,000 per year, this does not surprise me. But I talk to all kinds of people on the radio every weekend and I have heard and experienced the voices of the two different economies. Without turning this into a political column, let’s discuss some of the facts.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
Tuesday, November 6, 2007
What does this have to do with ME?
My Muse likes to remind me that most of the things that occur in the financial world should boil down to one question: What does this have to do with ME? To that end, I want to answer that question as it pertains to the evolving story of Merrill Lynch, Citigroup and the credit crunch.
You may have heard that two CEOs are out of jobs -- E. Stanley O’Neal of Merrill Lynch and Charles Prince III of Citigroup. They both got canned because under their helms, their respective companies lost a boatload of money in mortgage-related securities. To better understand the ripple effects of this mess and what it’s got to do with you, we need to review what has happened.
For a long period of time, the Fed left interest rates low, which encouraged lots of people to borrow. Some bought houses or condos, while others refinanced and spent the proceeds on new kitchens. This period was highlighted by the expansion of lending parameters to include those who had previously had a difficult time acquiring mortgages, or so-called “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation).
The Wizards of Wall Street professionals created new ways to put cheap money to work and earn more than the cost of money borrowed. They created complex packages of mortgages or financial instruments based on mortgages, which they erroneously believed would help defray the risk of the risky loans. When housing prices were rising and interest rates remained low, everything was fine. But as the housing market dipped, the ability of some of the borrowers to repay their loans changed, causing delinquencies and defaults.
As soon as investors realized that there were significant problems with the loan repayments, it raised questions about the value of mortgage-backed securities and the credibility of the ratings that enabled the securities to be sold. As investors were spooked by the uncertainty about where credit losses were hidden, the lending business simply stopped, making it more difficult for companies and individuals to borrow. Additionally, for the companies holding the loans or the securities that were collateralized (backed up) by the loans, there was no stock exchange to determine value. Therefore, the companies kind of guessed about how much they were losing. As the real numbers have come in, the true losses were worse than expected, which caused 2 guys (so far) to get axed.
Now that you have the back story, here is why two super-rich, Wall Street execs losing their jobs actually might have something to do with you:
1) If you need to borrow money, the rules have changed. My friend Mike Raimi, President of WCS Lending, tells me that lenders are practically asking for DNA to qualify borrowers. If your credit is even a shade sketchy, it is very difficult to secure a loan. However, if you have sterling credit and you are applying for a conventional, not a jumbo loan (less than $417,000) there should not be a big problem.
2) The ability to borrow is like lubricant to the US economy. When it becomes more difficult for individuals and companies to borrow, it could stall business and consumer spending, potentially leading to a recession. The “R” word is never good for anyone, nor is it good for any asset class.
3) If you are an investor, markets are gyrating hourly on this news. This volatility can sometimes spook investors, but the main thing to remember is that being an investor of any type requires the ability to withstand ups and downs from time-to-time in order to enjoy the periods of rising asset values. Chances are, if you have a diversified portfolio, you should be able to weather the swings without fear or panic and instead you can approach volatile markets as a time to seize potential opportunities. If that is not the case, you have a strong indication that your allocation is out of whack with your risk tolerance.
You may have heard that two CEOs are out of jobs -- E. Stanley O’Neal of Merrill Lynch and Charles Prince III of Citigroup. They both got canned because under their helms, their respective companies lost a boatload of money in mortgage-related securities. To better understand the ripple effects of this mess and what it’s got to do with you, we need to review what has happened.
For a long period of time, the Fed left interest rates low, which encouraged lots of people to borrow. Some bought houses or condos, while others refinanced and spent the proceeds on new kitchens. This period was highlighted by the expansion of lending parameters to include those who had previously had a difficult time acquiring mortgages, or so-called “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation).
The Wizards of Wall Street professionals created new ways to put cheap money to work and earn more than the cost of money borrowed. They created complex packages of mortgages or financial instruments based on mortgages, which they erroneously believed would help defray the risk of the risky loans. When housing prices were rising and interest rates remained low, everything was fine. But as the housing market dipped, the ability of some of the borrowers to repay their loans changed, causing delinquencies and defaults.
As soon as investors realized that there were significant problems with the loan repayments, it raised questions about the value of mortgage-backed securities and the credibility of the ratings that enabled the securities to be sold. As investors were spooked by the uncertainty about where credit losses were hidden, the lending business simply stopped, making it more difficult for companies and individuals to borrow. Additionally, for the companies holding the loans or the securities that were collateralized (backed up) by the loans, there was no stock exchange to determine value. Therefore, the companies kind of guessed about how much they were losing. As the real numbers have come in, the true losses were worse than expected, which caused 2 guys (so far) to get axed.
Now that you have the back story, here is why two super-rich, Wall Street execs losing their jobs actually might have something to do with you:
1) If you need to borrow money, the rules have changed. My friend Mike Raimi, President of WCS Lending, tells me that lenders are practically asking for DNA to qualify borrowers. If your credit is even a shade sketchy, it is very difficult to secure a loan. However, if you have sterling credit and you are applying for a conventional, not a jumbo loan (less than $417,000) there should not be a big problem.
2) The ability to borrow is like lubricant to the US economy. When it becomes more difficult for individuals and companies to borrow, it could stall business and consumer spending, potentially leading to a recession. The “R” word is never good for anyone, nor is it good for any asset class.
3) If you are an investor, markets are gyrating hourly on this news. This volatility can sometimes spook investors, but the main thing to remember is that being an investor of any type requires the ability to withstand ups and downs from time-to-time in order to enjoy the periods of rising asset values. Chances are, if you have a diversified portfolio, you should be able to weather the swings without fear or panic and instead you can approach volatile markets as a time to seize potential opportunities. If that is not the case, you have a strong indication that your allocation is out of whack with your risk tolerance.
Monday, November 5, 2007
Mother Merrill and You
My girlfriend who works at one of the big Wall Street firms asked, “Do you think people who are not in this industry really care about the Merrill Lynch story?” I thought the same thing after appearing as a guest on the new Fox Business Network last week.
The hosts, Liz Claman, formerly of CNBC and David Asman, who moved to FBN from Fox News Channel, started the conversation with a discussion of Merrill Lynch’s impending (now already-announced) firing of Chairman and CEO E. Stanley O’Neal. While the chatter focused on the ins and outs of why the board let him go (tops on the list of reasons was the $8.4 billion write-down due to losses associated with the sub-prime debacle), I could not help thinking: what can the rest of us take away from this situation?
Unfortunately, I did not think about this during the interview, so I have saved it for an article. I think the most interesting part of the story is that O’Neal and his Board fell for the oldest trap in the investment book: they piled into a strategy long after it had seen its heyday and ignored the risks that were associated with big gains.
O’Neal sought ways to improve the earnings of the somewhat stogy firm, which led him to enter the murky subprime/collateralized debt obligation (CDO) market. The board liked the results when the trades were winners--it’s like the guy who bragged to me about the money he made after purchasing technology stocks in the beginning of 1999. The whole year I had to hear from him on the radio show. By the spring of 2000, the tech bubble started to collapse and all of the sudden the calls stopped.
Liz Claman noted that since O’Neal took the helm of Merrill, the stock had increased 60%. But investors and boards have very narrow time horizons when it comes to accepting the pain of losing. Since the beginning of 2006 through October 30, Merrill’s stock price had declined just under 1%. Obviously the broader market was up during the same time and some of Merrill’s rivals, including Goldman Sachs, Morgan Stanley and JP Morgan Chase have enjoyed returns of 91%, 43.5% and 24.7% respectively over the almost two-year period.
When the news of the losses exceeded $8 billion, O’Neal stood up and delivered the grim details. In fact, he is one of the few Wall Street CEOs who took personal responsibility for losing money. There was no blaming a rogue trader or a flawed computer model, just one man, saying publicly, “I’m responsible”.
I’m less impressed with Merrill’s board. Sure, they held O’Neal accountable and fired him (his exit compensation is valued at about $161.5 million), but only when the strategy went awry did they not like the risks that had been assumed. In my mind, the questioning should have taken place not after the losses had occurred, but when the firm was earning record profits in the exotic debt market. A board member might have asked O’Neal and his team to quantify the risks inherent in the strategies, because as every investor knows, rarely do we get the rewards without risks.
So what can you learn from Merrill? Beware the temptations that draw you into a new strategy and of course, mind the risks that may deliver outsized returns and losses at any given time.
The hosts, Liz Claman, formerly of CNBC and David Asman, who moved to FBN from Fox News Channel, started the conversation with a discussion of Merrill Lynch’s impending (now already-announced) firing of Chairman and CEO E. Stanley O’Neal. While the chatter focused on the ins and outs of why the board let him go (tops on the list of reasons was the $8.4 billion write-down due to losses associated with the sub-prime debacle), I could not help thinking: what can the rest of us take away from this situation?
Unfortunately, I did not think about this during the interview, so I have saved it for an article. I think the most interesting part of the story is that O’Neal and his Board fell for the oldest trap in the investment book: they piled into a strategy long after it had seen its heyday and ignored the risks that were associated with big gains.
O’Neal sought ways to improve the earnings of the somewhat stogy firm, which led him to enter the murky subprime/collateralized debt obligation (CDO) market. The board liked the results when the trades were winners--it’s like the guy who bragged to me about the money he made after purchasing technology stocks in the beginning of 1999. The whole year I had to hear from him on the radio show. By the spring of 2000, the tech bubble started to collapse and all of the sudden the calls stopped.
Liz Claman noted that since O’Neal took the helm of Merrill, the stock had increased 60%. But investors and boards have very narrow time horizons when it comes to accepting the pain of losing. Since the beginning of 2006 through October 30, Merrill’s stock price had declined just under 1%. Obviously the broader market was up during the same time and some of Merrill’s rivals, including Goldman Sachs, Morgan Stanley and JP Morgan Chase have enjoyed returns of 91%, 43.5% and 24.7% respectively over the almost two-year period.
When the news of the losses exceeded $8 billion, O’Neal stood up and delivered the grim details. In fact, he is one of the few Wall Street CEOs who took personal responsibility for losing money. There was no blaming a rogue trader or a flawed computer model, just one man, saying publicly, “I’m responsible”.
I’m less impressed with Merrill’s board. Sure, they held O’Neal accountable and fired him (his exit compensation is valued at about $161.5 million), but only when the strategy went awry did they not like the risks that had been assumed. In my mind, the questioning should have taken place not after the losses had occurred, but when the firm was earning record profits in the exotic debt market. A board member might have asked O’Neal and his team to quantify the risks inherent in the strategies, because as every investor knows, rarely do we get the rewards without risks.
So what can you learn from Merrill? Beware the temptations that draw you into a new strategy and of course, mind the risks that may deliver outsized returns and losses at any given time.
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