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Latticework Wealth Management, LLC

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Latticework Wealth Management, LLC

Category Archives: Bernanke

A New Paradigm for Investing on 50 year-old Investment Advice Available on Amazon.com

03 Tuesday Dec 2013

Posted by wmosconi in alpha, asset allocation, Bernanke, beta, bonds, business, Consumer Finance, Education, Fama, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, Individual Investing, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, Markowitz, math, Modern Portfolio Theory, MPT, Nobel Prize, Nobel Prize in Economics, portfolio, rising interest rate environment, rising interest rates, risk, Schiller, Sharpe, sigma, statistics, stock prices, stocks, volatility, Yellen

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alpha, asset allocation, Bernanke, beta, bonds, business, consumer finance, economics, education, Fama, Fed, Fed taper, Fed Tapering, Federal Reserve, finance, investing, investments, math, Modern Portfolio Theory, MPT, Nobel Prize, Nobel Prize in Economics, personal finance, portfolio, portfolio management, Schiller, Shiller, statistics, stocks, volatility, Yellen

I am happy to announce that I have published another book on Amazon.com.  I have decided to make it FREE for the rest of the week through Saturday, December 7th (it normally retails for $4.99).  The book is another installment in my A New Paradigm for Investing series.  In this particular book, I focus on the use of Modern Portfolio Theory (MPT) as the primary tool by Financial Advisors to recommend portfolio allocations.  The theory is over 50 years old, and most of its assumptions have been shown to be less and less useful.  I explore the reasons why in my text.  I have tried to write in such a manner that you do not need a degree in mathematics or statistics to understand its contents.  Futhermore, you do not need to know about the intricacies of MPT in order to follow my logic.  You would find the same information in a college textbook but in a condensed format.

Note that this book is available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Amazon.com prime members can borrow the book for FREE. I have provided a link below to make it easier.   My email address is latticeworkwealth@gmail.com should you have any questions/comments/feedback.

The book is:

1)      A New Paradigm for Investing:  Is Your Financial Advisor Creating Your Portfolio with a 50 Year-Old Theory?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00FQQ0CKG/ref=sr_1_1?s=books&ie=UTF8&qid=1381520643&sr=1-1&keywords=a+New+paradigm+for+investing+by+William+Nelson

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wealth Report @wsjexperts – Wall Street Journal #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

How Can Investors Survive in a Rising Interest Rate Environment? – Updated

30 Saturday Nov 2013

Posted by wmosconi in asset allocation, bank loans, Bernanke, bonds, business, Consumer Finance, Education, Fed, Fed Taper, Federal Reserve, finance, financial advisor fees, financial planning, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, LIBOR, math, MBS, personal finance, portfolio, rising interest rate environment, rising interest rates, risk, statistics, stock prices, stocks, Suitability, volatility, Yellen

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asset allocation, bank loans, Bernanke, bonds, Fed, Fed taper, Fed Tapering, Federal Reserve, fixed income, fixed income securities, interest rate swaps, interest rates, investing strategies, investments, LIBOR, MBS, portfolio management, retirement, rising interest rate environment, rising interest rates, syndicated bank loans, volatility, Yellen

I probably get this question asked of me more than any other these days, especially by retirees.  Investors were once able to place money into bank certificate of deposits (CDs) or into money market funds and easily earn more interest than the rate of inflation.  Unfortunately, the financial crisis of 2008 changed all that in a major way.  While the events surrounding the dark days of the close of Lehman Brothers, the bailout of AIG, and the nearly $800 billion TARP program, were not the sole cause of this phenomenon, they certainly did not help.  The Federal Reserve (Fed) led by the chairman, Ben Bernanke, had to lower interest rates to avoid the credit and liquidity crisis of that time period.  The Fed brilliantly avoided a meltdown and depression.  The side effect is that financial market participants have gotten used to low interest rates.  You will hear the term “taper” thrown about now.  The Fed is not going to raise interest rates yet; rather, they are going to slow their purchase of Treasury instruments and mortgages on the open market.  They are not raising the Fed Funds rate (do not worry about what that is exactly), but, since they were buying approximately 70% of all US Treasuries issued, bond market investors are worried that this demand/supply imbalance will naturally cause interest rates to rise (interest rates have already gone up).  Well, if interest rates will be higher, shouldn’t that be better for bond investors?

An urgent side note to all investors is as follows:  “Beware of financial professionals that recommend dividend stocks or other equities as replacements for your fixed income allocation”.  What I mean by this is that the volatility of stocks is far greater than bonds historically.  Yields may be very low in money market funds, US Treasuries, and in bond mutual funds now.  However, your risk tolerance must be taken into account at all times.  While it is true that many dividend-paying stocks offer yields of 3% or more with the possibility of capital appreciation, there also is significant downside risk.  For example, as most people are aware, the S&P 500 (which represents most of the biggest companies in America) was down over 35% in 2008.  Many of those stocks are included in the push to have individual investors buy dividend payers.  With that being said, stock market declines of 10%-20% in a single quarter are not that uncommon.  If you handle the volatility of the stock market, there is no need to be concerned.  However, a decline of 10% for a stock paying a 3% dividend will wipe out a little more than 3 years of yield.  Individual investors need to realize that swapping traditional bonds or bond mutual funds is not a “riskless” transaction, meaning a one-for-one swap.  The volatility and riskiness of your portfolio will go up commensurately with your added exposure to equities.  Sometimes financial professionals portray the search for yield by jumping into stocks as the only option given the low interest rate environment.  While your situation might warrant that movement in your portfolio allocation, you need to be able to accept that the value of those stocks is likely to drop by 10% or more in the future.  Are you able to handle that volatility when looking at your risk tolerance, financial goals, and age?

The short answer is no to the question posed at the end of the first paragraph.  Before we can answer that question and look at some investment strategies and potential purchases, we need to review how a bond works.  Any bond is simply an agreement between two parties in which one party agrees to pay back money to the other party at a later date with interest.  All bonds have what is referred to as credit risk.  Credit risk is simply the risk one runs that the party who owes you the money will not pay you back (i.e. default).  What is lesser know is interest rate risk and inflation risk.  These two risks are usually missed because investors tend to think that bonds are “safe”.  Interest rate risk relates to the fact that interest rates may rise, while you hold the bonds.  Inflation risk means that inflation may increase to a level higher than your interest rate on the bond.  Thus, if the interest rate on your bond is less than inflation, your purchasing power goes down.  The prices of goods and services go up faster than the interest you earn on the bond.

How do bonds work in terms of prices?  Most bonds are issued at a price of 100 which is referred to as par.  Corporate bonds and Treasury notes/bonds are usually sold in increments of $1,000, and municipal bonds are sold in increments of $5,000.  The value of a bond is calculated by taking the current price divided by 100 and then multiplied by the number of bonds you own.  Bonds are sold in the primary market (when first sold to retail and institutional investors) such that the coupon (interest rate) is equal to the current interest rate prevailing in the marketplace at that time (sold at par which is 100).  Bonds can be bought and sold after that issue date though.  If interest rates rise or fall after issuance, how does the price of a bond adjust?  If interest rates go up, bond prices will go down.  If interest rates go down, bond prices will go up.  Why?  It is referred to as an inverse relationship.  Think about it this way.  If you own a bond that has a 6% coupon and interest rates rise to 8%, will you be able to see that bond to other investors?  The answer is no if you decide to hold firm to a price of 100.  Why should another bond investor buy a 6% bond when he/she can just buy a bond with very similar characteristics as yours and earn 8%?  The only way that you can sell your bond is to lower the price such that the bond investor will earn 8% over the course of that bond’s life until maturity which is when the company or other entity has to pay the money back in full).  Luckily for you, the process works in reverse as well though.  If interest rates go down to 4%, you have the advantage.  If you hold a bond with a 6% coupon as in the aforementioned example, bond investors will pay more than 100 in order to get that higher interest payment.  How much more?  Bond investors will bid the price up until the bond earns an equivalent of 4% until maturity.  Why is this important to you as an investor today?

Let’s take a quick look at history.  Most financial professionals are not old enough to remember or have been in business long enough to remember the interest rate environment back in the early 1980s.  In the early 1980s, interest rates on bonds were incredibly high compared to today.  The economy was stuck in a rut of higher inflation and low or no growth which was called “stagflation”.  How high were interest rates?  The interest rate on a 3-month Treasury bill was 16.3% back in May 1981, and the prime rate topped out around 20.5% soon after.  For more information on the interest rates of this time period, please refer to this link:  http://www.mbaa.org/ResearchandForecasts/MarketEnvironment/TreasuryYields&BankRates,1980-83.htm. The Federal Reserve chairman back then, Paul Volcker (Fed chairman prior to Alan Greenspan and the same gentleman as the so-called “Volcker rule” of today), instituted a monetary policy based upon the teachings of the famous economist, Milton Friedman, from  the University of Chicago.  Friedman was really the start of monetarism.  Monetarism is simply the effect of the money supply in any economy on interest rates.  In general, as more money in the economy is available, interest rates will go down.  As less money is available, interest rates will go up.  Why?  Think about it in this manner.  If you have to get a loan from a family member and you are the only person asking for a loan, chances are your interest rate will be lower than if that same family member is asked by 15 different individuals.  So the Fed of that time period began buying all types of bonds on the open market.  The hope was that, as the money supply grew, interest rates would fall.  As interest rates fell, it would give more incentive to companies to take out loans to buy equipment and build plants and also to incent consumers to take out mortgages and buy homes or purchase consumer goods with credit cards.  Needless to say, the policy eventually worked.  It started what most refer to as the great bull market in bonds in roughly 1982.

There are only two ways you can make money when you own a normal bond.  First, you earn money from the coupon paid over the life of the bond.  Second, in a falling interest rate environment, you earn money by selling your bonds at a higher price.  Therefore, you can earn money from interest and capital gains.  In a rising interest rate environment, you can only earn money from the coupon.  What individual investors, and some money managers even, fail to realize is this simple fact of finance.  The yield on a 3-month US Treasury bill today is roughly 0.06%.  No, that is not a misprint!  The yield on these bills has gone down over 16% over the past 30 years or so.  The bond market has never seen such an extended period of falling interest rates.  Now interest rates did not fall in a straight line, but the trend has been toward lower interest rates for decades now.  That anomalous occurrence is coming (has come) to an end.  What can individual investors do then?

There are a number of things you can do to deal with the specter of rising interest rates.  I do not recommend any specific securities to purchase.  However, these investment strategies are something to consider.  They are as follows:

1)       Purchase an ETF that invests in floating rate fixed income securities

Investors are accustomed to bonds issued with a fixed coupon.  Yes, that is the most common.  However, there are other bonds that have an interest rate which is variable over the life of that bond.  Why would a company want to consider this?  There are two reasons why.  The first reason is that some companies need to borrow money from financial market participants constantly and for short periods of time.  The second reason is that certain companies that have liabilities which float over time.  Why?  They may have revenues that float over time as well.  It is much more complicated than that, but I do not want to get too bogged down into the details.  The most commonplace is a financial instrument known as commercial paper (CP) which is an example of the first reason.  CP is any financial instrument with a maturity of up to 270 days.  Firms, such as General Electric or Goldman Sachs, will sell CP to institutional investors for purposes of raising working capital.  It might be to pay short-term bills, or it might be to fund operations until money comes from previous sales at a later date.  Whenever CP is issued, the current interest rate prevails.  There are ETFs out there (only a few right now though, such as the iShares Floating Rate Note ETF – Ticker Symbol:  FLOT) that invest in CPs or other variations thereof.  The ETF will hold these fixed income securities with very short maturities.

2)      Purchase a target maturity bond ETF

 

When you purchase a bond mutual fund, you are pooling your money with other investors.  You do NOT own the bonds that the mutual fund invests in.  The mutual fund firm will calculate the value of their bond holdings each day and divide it by the number of shares outstanding to arrive at the net asset value (NAV) of the mutual fund.  The mutual fund will allow mutual fund investors to buy additional shares at that price or sell shares at that price.  Isn’t that just semantics and really is the same thing?  Absolutely not!  When you own a bond mutual fund, the holdings of the mutual fund are constantly changing.  You will see an SEC yield quoted and a weighted average maturity (WAM) of the bond mutual fund show in years.  If interest rates rise and you need to sell, the NAV of the bond mutual fund will go down.  Since the bond mutual fund needs to earn as much interest for its bond investors as possible, they will constantly take new inflows from investors, interest payments, and principal payments to invest in bonds issued today.  Therefore, the NAV of the bond mutual fund has to go down.  Since you are never holding the actual bonds to maturity, in a rising rate interest environment, you will receive interest payments from the bond mutual fund, but the value of the bonds held by the bond mutual fund will fall gradually, ceteris paribus.

 

Since interest rates have been falling for so long, most individual investors do not know this.  How do you combat that?  Well, BlackRock and other ETF providers have developed a new type of ETF which is based upon a target maturity.  How do they work?  You can purchase an ETF that might be in existence for five years, for example.  The ETF will invest in bonds with five years to maturity and then disband the ETF after five years.  Thus, as a bond investor, you are only subject to default risk.  As you will recall, default risk is the risk that an entity will not pay back the principal and interest on the bond.

 

3)      Purchase a floating rate instrument directly with a credit enhancement

There are fixed income securities sold which have interest rates that are set very frequently.  One of these instruments is known as a put bond or floater.  Put bonds or floaters are fixed income securities that are sold with an interest rate that is “reset” (i.e. adjusted to reflect current interest rates) on a periodic basis.  For example, they might be reset daily, weekly, or monthly.  Therefore, if you own a floater and interest rates go up, you will earn that new interest rate.  If interest rates go down, you will earn that interest rate.  You do not lose your original principal.  The interest rate is always chosen such that the floaters will sell at par.  Now owning a floater that is tied directly to a company, non-profit, charter school, municipality or other entity is a risky proposition.  You are subject to the credit risk of that entity, and they might default.  However, you can get around being exposed to the credit risk of that entity.  It is possible to purchase floaters (most are actually issued this way) which have a credit enhancement.  A credit enhancement is something that the obligor (i.e. the entity that issues the bonds and needs the money) purchases.  The types of credit enhancements are not that important; the concept is more significant for individual investors.  A floater with a credit enhancement means that, if the obligor defaults, the entity providing the credit enhancement will pay the principal and interest then.  Banks and bond insurers offer credit enhancements.  Therefore, when you purchase a floater with a credit enhancement, you are essentially exposed to the credit risk of the entity providing the credit enhancement and not the issuer (i.e. obligor).  Yes, you still have credit risk.

With that being said, there are floaters out there which have a credit enhancement from Bank of America, JP Morgan, US Bank, Wells Fargo, or Assured Guaranty.  The interest rate will be lower than the interest rate that the company itself would be able to get by accessing the bond market directly.  However, it will save you the time of trying to do a credit analysis of a small manufacturing firm with $50 million in annual revenues.  You can contact a middle market or larger full service brokerage firm to see if they offer put bonds or floaters for sale.  If they say no, but they offer Auction Rate Securities (ARS), it is not the same thing at all.  ARS have very different characteristics which rear their ugly head during liquidity crises like the financial crisis of 2008.

4)      Purchase mortgage back securities (MBS)

 

MBS may have a bad name from the financial crisis of 2008.  I am not referring to MBS that invest in subprime loans.  Subprime loans are speculative in nature.  I am talking about mortgages issued to individuals with good credit scores.  You can purchase an MBS issued by GNMA (Ginnie Mae), FNMA (Fannie Mae), or the FHLB (Freddie Mac).  The GNMA is a government sponsored enterprise (GSE), and FNMA and FHLB are sometimes referred to as “quasi” in nature.  These MBS essentially purchase thousands of mortgages that meet certain requirements in terms of size of the loan and credit of the borrower.  The mortgages are pooled together and sold to investors.

These securities are essentially pass through instruments.  Pass through instruments mean that the principal and interest payments flow through to the owners of the MBS.  Why might you want to own these?  In a rising interest rate environment, people with mortgages will not refinance their mortgages.  Why would you get rid of your 4% 30-year fixed rate mortgage and change to a 5% 30-year fixed rate mortgage?  As interest have been falling over the past several decades, it has been advantageous to refinance ones mortgage to a lower rate.  There are bond mutual funds that invest in MBS.  However, they fall subject to the same phenomenon that I mentioned above.  You are investing in a pool and do not own the MBS directly.  If interest rates go up and you need to sell that bond mutual fund, the NAV on the bond mutual fund will go down.  You can inquire at your local brokerage firm about MBS.  Now if your broker or Financial Advisor talks to you about collateralized mortgage obligations (CMOs) being the same thing basically, that is not the case.  CMOs do offer different characteristics which may be attractive, but they are much harder to analyze.

 

5)      Purchase bank loan ETFs with a floating rate

Most corporations borrow money from banks with a floating interest rate.  The interest rate adjusts at certain points and is calculated as a spread over some benchmark interest rate.  The most common benchmark is LIBOR and specifically 3-month LIBOR since many bonds reset quarterly.  Banks will package these loans together and sell them as syndicated loans to various interested institutional investors.  The advantage of these securities is that the interest rate will move up in a rising interest rate environment.  Additionally, most corporate treasurers will enter into an agreement, called an interest rate swap, to change the corporation’s payments into essentially a fixed interest rate.  The complexity of the interest rate swap is not important to discuss in great detail.  The point is that the corporation will then have a fixed interest payment and knows how much they will have to pay over time.  Thus, there will be no surprises if interest rates spike.  Therefore, you are exposed to the credit risk of the corporation for each bank loan.  Remember though that there is diversification in each of these syndicated bank loans because the ETF’s investment advisor will buy many bank loans to diversify the default risk of any one corporation.  One example of an ETF is offered by PowerShares and is called the PowerShares Senior Loan Portfolio ETF (BKLN).  A number of closed-end mutual funds offer similar products.  However, you should always be aware of the management fee assessed by the advisor overseeing the investments.  The expense ratio for many of these closed-end mutual funds is significantly above 1% which tends to offset the benefit of owning such a security because your investment returns will be lower as a result.

6)      Consider purchasing bonds issued by international firms or different countries

 

International firms and different countries have bonds that sell at different interest rates.  The nice thing about these bonds is that they are affected by different factors or the economy may be in a different stage than the US.  It is akin to the multiverse concept of Mohammed El-Erian of PIMCO.  El-Erian tells investors that the global economy is not simply something that is changing in one direction or in one way.  Rather, he states that different countries or regions can be moving in the same or opposite directions at any given time.  Furthermore, bonds issued outside of the US provide diversification to your investment portfolio.  It is the concept of not “having all your eggs in one basket”.  It is one other option for you.  There are countries which are in the process of lowering interest rates, so you can benefit from the interest rate payment and capital gains then.

 

One other thing you can do is to just reduce your duration.  Duration is simply the time it takes for your bonds to mature.  Under normal market conditions, bonds with shorter maturities have lower interest rates than bonds will longer maturities.  Believe it or not, that is not always the case though.  When short-term interest rates are lower than long-term interest rates, bonds with shorter maturities are less sensitive in terms of price movement than longer maturities.  I do not consider this an investment strategy really.  It is just a way of lowering risk.  As previously mentioned, when you hear financial professionals speak about searching for yield in other ways like investing in dividend stocks or MLPs (master limited partnerships), that is not investing in fixed income securities.  Given your risk tolerance, you should have a set allocation to fixed income securities.  You might decide to replace some of that allocation with a higher level of other stocks or other instruments.  However, that is a choice, and you are normally increasing the risk of your portfolio.  I am not saying that is good or bad.  I am simply saying that implementing this strategy comes with tradeoffs.

A New Paradigm for Investing Available on Amazon.com – FREE for Thanksgiving Holiday

27 Wednesday Nov 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, math, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, statistics, stock prices, stocks, Suitability, volatility, Warren Buffett, Yellen

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bonds, Charlie Munger, consumer finance, economics, education, Fed, Fed taper, finance, financial advisor fees, Financial Advisors, financial planning, financial services, free books, interest rates, investing, investment advisory fees, investments, retirement, stocks, volatility, Warren Buffett

Greetings to all my loyal readers of this blog.  In keeping with the Thanksgiving spirit, I have decided to make my first two books absolutely FREE for the rest of the week.  These two books on Amazon.com are available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Please feel free to check out the titles below.  I have provided links to make it easier.   My email address is latticeworkwealth@gmail.com.

The books are as follows:

1)      A New Paradigm for Investing:  Can Your Financial Advisor Answer These Questions?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00F3BDTHW/ref=sr_1_1?s=books&ie=UTF8&qid=1381107823&sr=1-1&keywords=A+New+Paradigm+for+Investing+by+William+Nelson

2)       Spend 20 Hours Learning About Investing to Prepare for 20+ Years in Retirement

http://www.amazon.com/Learning-Investments-Prepare-Retirement-ebook/dp/B00F3KW9T2/ref=sr_1_1?s=books&ie=UTF8&qid=1379183661&sr=1-1&keywords=William+Nelson+Spend+20+Hours

The first book listed is normally $9.99 but available for FREE until November 30th.  The other book is normally $2.99, but it is also FREE for the same time period.

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wealth Report @wsjexperts – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

You Purchased a Stock: Now What?

27 Sunday Oct 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial planning, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, statistics, stock prices, stocks, volatility, Warren Buffett, Yellen

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$WU, asset allocation, bonds, business, Charlie Munger, equity, equity selection, finance, individual stocks, investing, investments, momentum stocks, portfolio, stock pickers market, stockpicking, stocks, value investing, Value Masters, Warren Buffett, Western Union

One of the questions that I have been asked is about individual stocks, and, more specifically, how to monitor developments after the purchase.  Now I have mentioned before that I strongly recommend that you do not start off trying to buy individual stocks.  ETFs and index mutual funds are a better way to start off investing and will generally garner you higher returns in the long-run.  Why?  Well, please continue reading, and you will see how I approach the decision to purchase a stock and when I decide to sell.  Now my method is strictly my own, but you will see it closely mirrors Warren Buffett’s style of investing.  There are many other market participants that use a variation of the Buffett and Graham paradigm.  Moreover, there are literally tens of thousands of portfolio managers, hedge fund investors, research analysts, and others that value stocks every second of every day in response to company, economic, and geopolitical news.  Once you see how much work it takes, I am hopeful that you do NOT try it to begin with.

Before delving into the process of following a stock after your purchase, I will go through the steps I take prior to a purchase.  I strive for a turnover of 15-20%.  Turnover measures how long an investor holds a particular stock.  A turnover of 100% means that an investor holds a stock for one year.  Thus, my turnover equates to a holding period of 5.0 to 7.5 years.  So if I am willing to hold a stock for that long, I better make sure I am confident that it is a good investment.  How do I start?  I have a list of stocks that I am interested in purchasing.  If I decide to possibly invest, I go through a lengthy process.  Now I am not recommending any security.  However, I want to put some meat surrounding the discussion.  Therefore, I will talk about my process in terms of my decision to purchase Western Union (WU).  Western Union is now my top holding.  Should you buy WU?  Maybe so.  Maybe not.  You must do your own homework and not take my word for it.  As a show of good faith, I encourage you to look at my Twitter account:  @NelsonThought.  I have been posting information about WU for several months, so I am not “cherry-picking” to make me look good.  Let’s begin.

Regardless of where I get my ideas of stocks to analyze, I start off my analysis by learning everything I can possibly get my hands on.  You would be amazed at how much information is out there.  Prior to deciding to even value WU, I took a number of steps.  First, I read the last three annual reports for WU.  What do I focus on?  The most important part of any annual report is a section called Management Discussion & Analysis (MD&A).  MD&A is indispensable because management has a chance to be open and honest with investors.  Now when you purchase a stock, you should view yourself as a fractional owner in the actual company.  You do not own a piece of paper that says you have x number of shares.  You own a claim to the future cash flows and dividends of that firm.  Contained within the MD&A is management’s discussion is a review of the most recent financial developments, their strategy, and what management thinks is the future direction of the company.  WU’s management team talks a great deal about emerging markets.  WU relies upon the wiring of money between individuals.  The most important, growing income stream comes from immigrants sending money back home to their families.  For example, did you know that 30% of the Gross Domestic Product of El Salvador comes in the form of these remittances?  Wow!  That fact always gets to me.  Obviously you can see that the emerging markets are a great way for WU to grow earnings.  Additionally, WU has a huge market share in the correctional system.  If family members or loved ones of prison inmates need money to purchase items behind bars, they can use WU to transfer money into their accounts to buy food, hygiene products, and even other items like TVs and radios.  WU’s management speaks at length about these opportunities, and they also focus on growing their network of facilities that provide their services.  There is a “network effect” for WU.  The more money transfer centers there are, the more people in general will use their services.  For instance, if a local WU outlet is right near your house, and you need to wire some money to an individual or business, you are more likely to use it.  Well, if you need to wire money to a friend, and the nearest WU outlet is 50 miles from that person, WU is probably not a good option for you.  Therefore, it makes sense for WU to provide good incentives to build up their network.

Now I really focus on MD&A going back in time because management is telling you what they intend to do in the future.  Think about it in these terms.  Have you ever had a friend who tells you that they are going to quit working and start a business?  I know that I have.  More often than not, when I see that person in several years, they tell me that they are still working but they are starting the business soon or they found a better business to start.  It is great to have ideas, but, unless you act upon them and do it, there really is no point.  Well, the same scenario happens very often with a business.  Management might describe great plans to grow the business back in 2010.  If they never speak about it again, or they have new and better ideas when you read the 2012 annual report, that should be a red flag for you.  Now changing strategy is sometimes warranted, but management should be transparent with you.  If a strategy is no longer relevant, or it did not work out, they should explain why.  It is only fair.  You own the stock; you own part of the company.  Always take the time to compare prior MD&A with current MD&A.  This technique can save you a lot of time.  Why value a stock if management does not seem to know what they are doing?

After you feel comfortable with management and still have strong beliefs that the business is well-positioned, you can look at the financial statements of the company.  Every publicly traded company is required to file financial statements with the Securities and Exchange Commission (SEC).  The reports are called 10-Ks on an annual basis and 10-Qs on a quarterly basis.  The SEC even has a website that you can go to when you look for them.  It is called the EDGAR system can be found here:  http://www.sec.gov/edgar.shtml.  The financial statements will include the income statement, balance sheet, and statement of cash flows.  Which part is most important to me?  Well, that is a trick question.  I go to the back of the financial statements and look at the notes to the financial statements.  Do not feel bad if you got the question wrong.  When I pose the question to undergraduate students during presentations that I give, I have never had a finance student give the correct answer.

 Why do I say the notes?  For one, I have an accounting undergraduate degree, so I am interested in them.  You can always get financial statement ratios and earnings expectations online, but they rarely incorporate information from the notes.  Now the notes to the financial statements tend to be boilerplate to begin with.  The accounting firm that audits the financial statements of a firm will explain that the company used generally accepted accounting principles (GAAP) and disclose the accounting methodology utilized when GAAP allows different choices.  After all these disclosures, you will find lesser known items.  The second reason why I look at the notes to the financial statements is to see if there is something I do not understand.  What do I mean by this?  You may remember the downfall of Enron.  The downfall of Enron was right in plain sight all along.  Enron had a disclosure “buried” in the notes that talked about Special Purpose Vehicles (SPVs).  What is a SPV?  I still really have a vague understanding, but here are the basics without getting too technical.  A SPV is a separate legal entity that is set up to own assets and incur liabilities.  It is really like a subsidiary of a company but, since it is a separate entity, the assets and liabilities of the SPV are not required to be reported on the company’s balance sheet.  What?  This phenomenon is called off-balance sheet reporting.  Essentially it is a way to not disclose liabilities.  Think about it in terms of the federal government.  The federal government does not consider future Social Security and Medicare benefits to be necessary to be reported in the current budget.  Thus, the $50+ billion of future payments of benefits is not reported; only think tanks talk about it periodically.  Now I do not want this to be a political discussion.  That is not my intent.  I simply bring it to your attention as a more familiar example of this topic.  Thus, Enron had liabilities that it had to repay in the future, but, if you only examined the financial statements, the future payments were not on the balance sheet.  The auditors did not look too closely.  Why?  I liken it to this.  No one wanted to raise his/her hand and say what is this SPV thing.  In general and in business, people do not want to look uninformed or “dumb”.  If you see something in the notes to the financial statements that you do not understand, I would suggest that you pass on the purchase of that stock.  When I look at the notes for WU, there is nothing that bothers me in particular.

After I look at the notes, I focus on the statement of cash flows, balance sheet, and then the income statement.  I look at them in that exact order.  Now I do not prepare a model at this point to value the company.  Rather, I do some calculations in my head.  Is the company actually generating cash from the operations of the business?  Does the company have enough assets to invest in the business?  Are earnings coming from sources that will either never occur again or have nothing to do with its core business?  These are very vital questions to ponder.  Why do you not value the company at this point?  Now I really have a number in mind for what the stock is worth, you still need to compare that to the sub-industry and industry that the company operates within.

As one reader commented, he was probably going to use this discussion to cure his insomnia ailment.  Hopefully you made it this far.  Are we having fun yet?  I promise we will get to the discussion of how to follow a stock after making a purchase, but I need to lay the foundation to ensure that my method makes sense.  Not that it is right, but the logic of the paradigm is plausible.  As it relates to the sub-industry and industry, I perform what is referred to as a SWOT analysis.  SWOT stands for Strengths, Weaknesses, Opportunities, and Threats.  Now I already know the S and W part from my review of MD&A and the review of the financial statements issued by the company.  The O and the T refer to the industry and competitors.  The main competitors in this space to WU are MoneyGram International and Euronet Worldwide.  How does WU match up against these two?  These two companies are smaller than WU, but bigger is not always better.  These two firms are constantly innovating and trying to make inroads into the niche of WU.  They are referred to as firms within the sub-industry.  The industry as a whole is the financial services industry.  Now WU is able to grow significantly in the emerging markets because the banking industry is not very developed in these countries.  It is easier at this point to simply pick up a wire transfer at a Western Union outlet than to open a checking accounting.  I can assure you that banks have noticed taking note.  Banks are trying to come up with ways to make it easier to open an account and simply have the money deposited there.  That is the most common way to look at the industry.  Now sometimes it is easier to ignore other developments, but I try to take everything into account.  Did you know that you can make wire transfers at most Wal-Mart stores now?  That development might be a game-changer.  Think about it this way.  Why should you go to WU when you can simply do your normal shopping at Wal-Mart and then send your wire transfer?  Remember that there are a plethora of Wal-Mart stores, so they already have a built in “network effect”.  They are a definite competitor even though they are technically in the retail industry.

After my entire analysis, I was confident that the purchase of WU would be a good investment.  How do I go about valuing any stock?  As I mentioned previously, I use a method that Warren Buffett has perfected over the years.  Trust me, I am no Warren Buffett.  If I were as good as Warren Buffett, I would not be writing this blog.  However, his method (coupled with Phil Fisher, David Dodd, Charlie Munger, Bill Ruane, and a few others) makes sense to me.  Think about stocks like bonds.  Bonds are much easier to value.  Why?  They are a promise to pay back money loaned to them.  The only return from a bond held to maturity comes from the coupon.  The coupon is simply the interest rate.  As an aside, you will hear coupon over and over again.  Where does the term come from?  Back in the older days, when you would purchase a bond, the company would give you a certificate that actually had coupons.  When a payment was due from the company, you would take the coupon to your local bank and get your money.  The bank would collect all the coupons and present them directly to the company.  This was prior to the introduction of computer systems to monitor who owned which bond.  That is why you will hear the term coupon.  Anyway, the interest rate of the bond does not vary over time.  A bond is worth a set amount that you will receive upon maturity and the periodic interest payments, but you need to remember that the payment is fixed.  What if interest rates fall?  If you purchased a bond that had a 6% coupon and the prevailing interest rate for the same type of bond rises to 8%, how are you able to sell the bond?  Why would I buy your bond if I can simply buy one with an 8% coupon?  You can sell me that bond by lowering the price.  A corporate bond is usually issued in $1,000 increments, so, if interest rates rise, you can simply lower the price to make its return equivalent to owning an 8% percent bond.  This is what is referred to as an inverse relationship.  It works the same way in reverse if interest rates fall.  If prevailing interest rates fall to 4%, you can afford to charge what is referred to as a premium because buyers in the marketplace cannot find a better opportunity with your 6% coupon.  Therefore, you can charge more than $1,000.  How does this relate to stocks?  Stocks are nothing more than bonds with variable cash flows.  Now if you ignore the fact that owning a bond makes you a creditor and holding a stock makes you an owner of the firm, you really need to value it in the same way.  However, it is infinitely more difficult.  Why?  You do not know how the company will fare in the long-term.  Will the strategies work out, will they be executed properly, will another competitor overtake the company, or will a new technology displace the service provided by the company?  I have already talked about the competitors of WU, banks knocking at the door, and the “invasion” of Wal-Mart into the space.  All of these elements cause the future earnings of WU to be unknown and variable.  I am still confident with the prospects of WU, so I move to valuing the company and approach it in the same manner as I would a bond.

To me (and many others), a stock is only worth what a company can earn in the future.  If you have a friend that has a business idea but you can see that it is unlikely to work, would you invest in the firm?  Probably not.  When I look at WU, I see that it is likely to earn money far into the future.  What are earnings?  You will hear many different terms because there are many different types of market participants and other stakeholders.  I focus on a concept called owner earnings.  Owner earnings are a combination of Free Cash Flow (FCF) and changes in Plant, Property, and Equipment (PP&E) and working capital.  FCF is simply the cash that comes from ongoing operations of the firm.  However, you need to remember that the firm needs to make future investments in technology and other items.  Thus, when you look at depreciation of PP&E which is only an accounting convention, the company may need to make more or less investments into the business in order to keep competing.  Additionally, the company needs cash to simply pay current bills that come due which relates to working capital.  If you calculate FCF and adjust for PP&E additions and working capital, you come up with owner earnings.  Once you calculate owner earnings, you know that the firm will be able to grow owner earnings over time.  If they cannot grow owner earners in the future, you probably would not be at this point in the analysis right now.  Well, you also need to remember that these earning will occur in the future.  Why is this important?  Think about loaning $100 to a friend for a year.  If he/she tells you that they will pay you the $100 back sometime next year, you will most likely want more than $100.  For one, you automatically know that under normal economic conditions, it will cost more than $100 to buy the same amount of products or services next year.  Additionally, you could have bought something else with the $100 and enjoyed it right away.  This is the concept of utility.  For example, you could have purchased 5 or 6 Blu-Ray discs and enjoyed watching these movies.  You are forgoing that consumption because you loaned out the money.  In order to make it worth your while, you might tell your friend that you will loan him/her $100, but you want them to pay you $110 next year.  This will compensate you for inflation and delaying your consumption.  The same economic principle applies to the purchase of stocks.  You could spend your money, or you could invest in another stock.  Therefore, you will only purchase a stock if the price will increase satisfactorily in the future such that you can make money.  You need to discount these future owner earnings.

How do you discount the owner earnings?  I come up with my financial model at this point.  I determine how much WU will earn over the next five years, the five years after that, and then for the rest of its existence.  Once you have calculated the next five years, you need to remember something.  If a certain company is earning what is referred to as “excess profits”, other firms will come into the market and try to do the same thing because it is lucrative.   Additionally, there might be other technological advances which make the wire transfer business of WU less attractive or obsolete, which is even worse.  Thus, I assume that WU will grow at a certain rate for five years, a lower rate for the next five years, and then a growth rate similar to the general economy forever.  The last part is somewhat of a plug figure.  Most stock analysts will say that WU (or any other company) cannot keep growing at high rates forever, it will eventually grow owner earnings very similar to GDP growth in perpetuity.  Now I use an assumed growth rate of 3.5% which is higher than the domestic economy because WU has a significant presence in the emerging markets which are growing at a faster clip.  Now that I have a stream of owner earnings, I need to discount them to the present.  The discount rate is a subject of much debate.  I use a rate of 7% or the equivalent of the yield on the 10-year US Treasury.  Other investors will use a higher rate.  I won’t get into a debate about the proper discount rate to use.  I simply follow the advice of Warren Buffett.  Here is a link to see his rationale:  http://www.sherlockinvesting.com/help/faq.htm.  If I discount that owner income stream back to the present at that discount rate, I come up with what is referred to as an intrinsic value.  Intrinsic value is a concept that was coined and explained at length by the father of value investing, Benjamin Graham.  The intrinsic value is what I think WU is worth right now given the current business environment and likely future prospect.  Now since I am fallible and the future is uncertain, I use the margin of safety concept also introduced by Benjamin Graham.  I take the intrinsic value figure and reduce it by a certain amount.  For WU, since it is in a somewhat stable industry and finance is my background, I use a margin of safety of 20%.  Therefore, I multiply my intrinsic value figure by 80% (100%-20%).  If the current stock price of WU is lower than my calculation, I am inclined to buy.  The intrinsic value I get for WU is significantly above the current stock price.  I purchased WU at $14.24 average cost, and it now trades at $18.36 as of August 9, 2013.  I still hold the largest portion of my portfolio in WU because I see the intrinsic value of WU as being higher than that presently.

As you might imagine, this entire process took me roughly 55-60 hours.  Surprisingly, there are many stock analysts that may say that I was not thorough enough.  An example would be the famed hedge fund investor Bill Ackman.  I am willing to bet that I spent more time prior to the purchase of WU than you will spend on financial planning over the course of your lifetime.  I do not mean this in a condescending manner.  I only point this out to simply show why the purchase of an individual stock is not right for everyone.  I tend to refer to myself as a “dork”.  I am passionate about investing, and I love to perform this type of analysis and calculations.  If you are not willing to put in that type of time to do your homework, I would stop at this point.  I will repeat again that ETFs and index mutual funds are much better choices for individual investors.  If you would like the chance to beat the index averages, I would rather see you invest in actively managed mutual funds or separate accounts than try your hand at selecting individual securities.  With that being said, I will now turn to what I promised to in the beginning.  Please forgive me for what might seem to be a circuitous route.

I intend to hold WU for a long time.  I have a set intrinsic value, and I am willing to stick to holding the stock through all the “visiccitudes and vagaries” of the stock market.  My emotional intelligence is higher than most investors.  I view investing as an intellectual exercise.  The money is secondary.  As soon as you start focusing on the money, you may be tempted to sell your stock if it falls in price significantly for what might seem like no apparent reason.  If I need to wait for 5-10 years for WU to reach its intrinsic value, I am willing to do so.  Does this sound like fun?  Well, it is to me.  Unfortunately, this has really nothing to do with what you read in most financial news publications or see on financial media.  However, you need to remember that I am an investor in the company and not trading pieces of paper.  I can confidently say that the way investing is portrayed in the financial media is much more akin to speculation.  My suggestion is to go to the casino if you want to try to double your money.  You will have more fun.  Investing in stocks to gain significant riches immediately is a fool’s game in my opinion.

What do I focus on after the purchase?  The first thing I do is to read all the earnings transcripts of the firm.  After each quarter, the company will file a 10-Q with the SEC and announce financial results to the public.  Management will then talk to analysts on an earnings call to recap the quarter and then answer questions from a selected group of research analysts.  I try to see if the earnings results match up with MD&A and if management uses any “excuses”.  An example of a typical excuse is the weather.  If a retail outlet has depressed earnings, they tend to use bad weather as an excuse at times.  It may be likely, but, more often than not, it is a way to hide poor execution by management.  Any particular quarter should not affect your intrinsic value calculation much.  In the short-term, there can be developments that affect earnings for a temporary time.  I do not worry about quarterly earnings, but I am interested in how the company is doing.

The second thing I do is to keep up with general economic conditions.  I visit the Bureau of Labor Statistics (BLS) website on a periodic basis.  The link is as follows:  http://www.bls.gov/.  The BLS is the agency of the government that monitors and releases economic statistics like GDP growth, new housing starts, the trade deficit, and a lengthy amount of others.  I focus on leading indicators, but I also am interested in the so-called lagging and coincident indicators released by the BLS.  Why do I pay attention to this?  I do so for one primary reason.  I am very confident in my calculations of future owner earnings for WU.  However, I usually extend that to include a three-part probability exercise.  For example, the likely path of owner earnings for WU is definitely affected by the current/future state of the economy.  I have a percentage for normal, boom, and bust scenarios.  The normal part gets the highest weight, and I then attribute different percentages to the other two.  Now I will admit that these are very subjective, but they are imperative.  How does the calculation work?  Well, I assume that WU will earn more money if the economy does better than expected or less money if the economy enters a recession.  Therefore, I multiply these scenarios by three different percentages.  For example, I currently weight my estimates of future owner earnings by 80% normal, 15% boom, and 5% bust.  Therefore, if the state of the economy changes or its future trajectory, I alter the percentages.  Since WU relies so much on remittances across borders, if global growth slows significantly, I need to weight the stream that assumes a recession much higher.  Using this approach, I do not have to recalculate owner earnings for WU again.  I simply use the three different scenarios and weight them differently.  Trust me, it saves a lot of time.

The next thing I do is to follow the developments of competitors.  I read the earnings transcripts of these firms, do a cursory review of financial statements, and look at how the industry is possibly changing (for better or for worse in terms of WU’s positioning).  It is extremely valuable to be constantly testing your investment thesis.  You need to be ready to admit that you made a mistake.  You can lose a lot of money otherwise.  I can attest to that via Best Buy (BBY) and Citigroup (C) stock holdings in the past.  With that being said though, you need to do that without referencing the case laid out by speculators.  If someone tells me that WU will have a bad third quarter, I really do not care.  I am willing to ride out stock price volatility because I know that WU is worth more than the current market price.  The advice from speculators relates to traders of stocks (owning pieces of paper) and not investors.

I also follow market developments.  Although I do read the Wall Street Journal and Financial Times, I try not to get too hung up on the current news of the day.  You can get in trouble that way by feeling itchy and pulling the proverbial trigger and selling in a panic.  I commented on this in more detail in a previous blog as it relates to the entire stock market.  The link is as follows:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/.  I tend to put more weight in The Economist, Barron’s, Bloomberg Businessweek, and trade journals.  I even read a few publications that seem unrelated but can make all the difference.  One great source is the Harvard Business Review.  This magazine is technical and “heavy duty”, but it can be a great way to identify mistakes that WU management is making or how they are behind the curve when it relates to business strategy.  This information helps me to determine whether or not my calculation of future owner earnings is correct and will come to fruition.

My next technique is a little odd to some.  I have found that I can learn a great deal about investing from other disciplines.  In fact, I will devote an entire post to the name of my firm.  I use what Charlie Munger, whom I lovingly refer to as Warren Buffett’s sidekick, calls the latticework of mental models.  This approach is to acknowledge that ideas from other discipline are germane and pertain to investing.  A perfect example is psychology.  There has been an explosion of ideas in the disciplines of behavioral finance and behavioral economics.  These fields do not assume that market participants are rationale.  Humans have innate biases and make consistent mistakes.  As an investor, you can use this to your advantage.  The one adage along these lines comes from Warren Buffett:  “Be fearful when others are greedy and greedy when others are fearful”.  If everyone is telling me that WU is going to the moon, I start to question my investment thesis.  Now as a contrarian investor, if everyone is selling WU for reasons that are temporary or are related to general market selling, I perk up and even look to add to my position.  You can read more about the latticework of mental models in an excellent book by Robert Hagstrom called Latticework:  The New Investing.  I use the concept of complex adaptive systems from biology, and the concept of nature searching for equilibrium from physics all the time.  In fact, there is an entire website that you can learn a great deal from.  It is called the Sante Fe Institute.  This think tank is not devoted to investing at all, but they are looking for common themes among different disciplines.  Take a look; I promise you will not be disappointed:  http://www.santafe.edu/.  I now will turn to the little talked about decision to sell a stock.

I think about WU in these terms.  If I come across another investment opportunity that is better than WU, I will sell WU.  If management or the state of the economy changes, I will sell WU.  If you are in a tax-deferred account (401(k), 403(b), Roth IRA, etc), you do not need to worry about taxes.  However, my individual stocks are in a taxable account.  While taxes should not guide your sell decision, you must take them into account when deciding if another opportunity is truly better.  Why?  You should only care about terminal values.  If you sell WU and buy another stock, that purchase should increase the value of your portfolio in the future.  That makes sense intuitively.  However, your mind can play tricks on you.  What if I am expecting to earn 9% a year from WU and another stock comes along that I can earn 13%?  Should I sell WU and earn the 13%?  The answer is that it depends.  Here is a typical scenario.  Let’s say I now own $20,000 of WU and purchased WU with an original investment of $10,000.  Thus, I have a $10,000 capital gain that is now subject to a 20% capital gains tax.  If I decide to sell WU and receive $20,000, I have to pay $2,000 ($10,000 * 20%) to the federal government come tax time.  Let’s look at the scenario in terms of expected yearly results.  If I sell WU to earn 13% in another stock, I am really only investing $18,000.  If I decide to keep WU, I still earn the 9% and avoid a capital gains tax.  What happens at the end of the year?  If my scenario holds true, I will have $21,800 ($20,000 + $20,000 * 9%) in my brokerage account at the end of a year if I earn 9% from owning WU.  If I decide to sell WU and buy the other stock, I will have $ 20,340 ($18,000 + $18,000 * 9%).  Yes, I earned 13% on my new stock, but I have a lower amount in my brokerage account.  Why is this a common phenomenon?  Well, most people file their taxes and pay any capital gains tax from their checking account.  The money does not come out of the brokerage account directly.  Your net worth goes down overall, but your brokerage account “misleads” you into thinking you made a great selection because you earned an extra 4% by owning this other stock.  In fact, you would need to earn 21.1% in order to have $21,800 in my brokerage account by being able to pay the capital gains tax and then have the same terminal value as I would by simply holding WU and earning 9%.  If you ever wondered why Warren Buffett holds onto Coca-Cola (KO) and American Express (AXP), taxes factor in greatly.

Now for all of you readers that are not asleep, I appreciate you bearing with me.  As I mentioned before, investing is not meant to be fun or exciting.  It is only fun and exciting if you like the intellectual challenge.  For all of us “dorks”, we go through this analysis because it is truly fun to us.  For most people, they would much rather not spend 60 hours finding a stock to buy and then 20-25 hours per year following your stock after the purchase.  Luckily, you can own an ETF or index mutual fund and likely match my investment return in WU or even beat it over the long term.  For more information on the style of Warren Buffett, I refer you to the following series of books by Larry Hagstrom (mentioned him before):

1)       The Warren Buffett Way

2)       The Warren Buffett Portfolio

3)       The Essential Buffett

4)       Security Analysis by Benjamin Graham the sixth edition

You will note that my investing style is similar to Warren Buffett, but I have incorporated elements from other famous investors and from other disciplines.  I will never be another Warren Buffett.  However, I can strive to use a similar investing paradigm.  Hopefully this discussion was helpful in thinking about one possible way to monitor your stock purchases.  Yes, it is a great deal of work and time consuming.  You will have much better investment results though, if you know as much as you can about your stock.

When It Comes to Your Investments, Are You Smarter than a 14 year-old?

12 Saturday Oct 2013

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That is a great question.  I will save you the suspense and give you the answer.  You are as smart as a 14 year-old when it comes to your knowledge of your investments.  What 14 year-old teenager am I referring to?  I am referring to myself.  I started investing when I was 13 back in November 1987.  (If you do the math, you can figure out how old I am).  After spending a year studying the financial markets, I had amassed quite a bit of understanding.  How does this relate to you?  Well, if you have been following my blog, I have not revealed any information that I did not already know by then.  Now my writing style has improved and I have incorporated innovations introduced after 1988, the topics I have written about are not that complicated.  Before you continue reading, I would like to state at the outset that I was not some sort of child prodigy when it came to finance.  I was good at math and retained what I learned.  I am no genius and have no delusions of grandeur.  As I sometimes tell my friends, “If I really knew what I was talking about, I would be running a $10 billion hedge fund”.

With that being said, you also have the good fortune of learning from approximately 25 years of mistakes in investing and misunderstanding about the financial markets and the impacts of exogenous and endogenous events.  I could go on and on about my mistakes; however, I will mention a few here.  First, I had the opportunity to invest in two shares of Berskshire Hathaway Class A (BRK.A) stock back in 1991 when it traded a little above $8,700 per share.  Of course, Berkshire Hathaway is the company run by the famous investor Warren Buffett.  As of August 5, 2013, BRK.A’s closing stock price was $177,300 or a bit over $350,000 if I would have purchased those two shares back in 1991.  Why did I miss out on this opportunity?  I did learn everything I could about Warren Buffett once my economics teacher talked about him and his investing paradigm.  It really made sense to me from the start.  Unfortunately, I pass up on purchasing the shares because I would only be able to own those two shares and one other mutual fund.  As a young man, I was hyped and yearning to pick a number of different investment choices.  Best Buy is one of the best performing stocks in the financial markets and trades over $30 now.  I purchased Best Buy about 7 years ago and paid $42.  I did sell quite some time ago, but I took a huge capital loss.     Second, I wrote a paper during my MBA program that talked about the risk management procedures of Citigroup.  As I look back on that paper written in 2005, it is curious to note that, besides AIG, Citigroup went through the pain of learning the limits of risk management and it had a bailout of epic proportions.  I guess my paper was not the best in retrospect.  Finally, I had a terrible habit of picking the current “hot hand”.  I tended to switch my mutual fund holding way too often when I was in my teens.  It was really attractive to calculate how much money I could earn in a mutual fund that made 20% per year.  Wow, I could double my money in less than four years!  As you always see now, past performance is not indicative of future returns.  I really ignored that statement and invested many times based upon hopes and extrapolation instead of rational thought.  My emotions got the best of me.

I did have quite a few wins along the way.  For example, I was invested in the famous Fidelity Magellan mutual fund when it was run by Peter Lynch.  Peter Lynch is a legend among mutual fund managers.  At one point in time, Fidelity Magellan had more assets than any other mutual fund in the country.  Oddly enough, that was its eventual downfall.  Another example would be that I was able to learn how to successfully manage my father’s 401(k) portfolio from 1988 to the present.  I have seen many bull and bear markets and never had his eventual retirement portfolio take a significant hit in terms of poor returns.  My experience investing over the last 25 years has shown me that there will be many times when the financial pundits say this time is different, new industries are going to blow away the Old Economy, or that news events should cause investors to reallocate investment portfolios dramatically.  Even though I have been investing for 25 years, there have been very few seminal financial market events, the global economy may be different but the laws of finance and economics still hold (or they eventually bring prices back to earth), and new industries tend to bring more innovation and tools for existing, mature industries.  An illustration would be the early Internet companies lost money and burned through enormous amounts of cash.  However, the technologies they introduced allowed existing businesses to use the Internet in unique ways to either generate additional revenue or improve productivity.  A direct example would be how airplanes revolutionized leisure and business travel, but the airlines have been a wealth-destroying industry.  On the other hand, there are a myriad of business that used the services of airlines.

My overall point is that if you take one hour per week for about four months, you will be able to get through the five books I recommended on investing.  Additionally, you can spend another 30 minutes looking at a few financial websites just to increase your knowledge of investment products, finance terms, and keep abreast of news in general.  As a reminder, the list of five books can be found here:  https://latticeworkwealth.com/2013/07/23/spend-20-hours-learning-about-investments-to-prepare-20-years-of-retirement-2/ .  As another reminder, some recommended financial websites can be found here:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/ .

My entire goal with this blog is to save you lots of time.  Rather than being bombarded by disparate information regarding the financial markets and how to approach investing, I am trying to give you a shortcut.  I am hopeful that, if you have a roadmap that is clear, you will be more motivated to learn about investments and eventually become more comfortable with the process of building an investment portfolio to meet your financial goals, while ensuring that your emotions do not get the best of you.  At the end of the day, many individual investors pay fees to financial professionals to save themselves from enemy #1.  Who?  I mean that sometimes individual investors act rashly and keep buying and selling stocks and bonds at inopportune times just because a bad news event comes along or via peer pressure.  Remember that, if you have read all my previous posts, you are more than likely in the 90th percentile of individuals understanding of how the financial markets work.  Keep in mind there have not been that many posts to my blog, so I hope you realize that it is not as painful as you might have once thought learning about managing your investment portfolio and the financial markets is.

As an aside, please feel free to reach out to me if you have a recommendation for a topic I can discuss.  Please remember that this is a website geared toward individual investors who are novices or have not been investing for too long.   Thus, I am not looking to discuss how one might use ARIMA modeling to understand how macroeconomic variables affect the financial markets or individual stocks/bonds.  I appreciate you keeping it relatively simple.  With that being said, if enough people contact me in regard to one specific topic, I will definitely take a closer look.  Thank you in advance for your participation and time thinking about what would be more useful to you.  Furthermore, I am hoping that I cover topics that apply to everyone.  If the collective investment intelligence of the group steps up a few notches, I will cover the topic.  Please send me an email:  latticeworkwealth@gmail.com

A New Paradigm for Investing Available on Amazon.com

11 Friday Oct 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, Modern Portfolio Theory, MPT, NailedIt, NASDAQ, personal finance, portfolio, risk, statistics, stock prices, stocks, volatility, Warren Buffett, Yellen

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I am happy to announce that I have published another book on Amazon.com.  The book is another installment in my A New Paradigm for Investing series.  In this particular book, I focus on the use of Modern Portfolio Theory (MPT) as the primary tool by Financial Advisors to recommend portfolio allocations.  The theory is over 50 years old, and most of its assumptions have been shown to be less and less useful.  I explore the reasons why in my text.  I have tried to write in such a manner that you do not need a degree in mathematics or statistics to understand its contents.  Futhermore, you do not need to know about the intricacies of MPT in order to follow my logic.  You would find the same information in a college textbook but in a condensed format.

Note that this book is available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Amazon.com prime members can borrow the book for FREE. I have provided a link below to make it easier.   My email address is latticeworkwealth@gmail.com should you have any questions/comments/feedback.

The book is:

1)      A New Paradigm for Investing:  Is Your Financial Advisor Creating Your Portfolio with a 50 Year-Old Theory?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00FQQ0CKG/ref=sr_1_1?s=books&ie=UTF8&qid=1381520643&sr=1-1&keywords=a+New+paradigm+for+investing+by+William+Nelson

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wealth Report @wsjexperts – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

A New Paradigm for Investing Available on Amazon.com

06 Sunday Oct 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, NailedIt, NASDAQ, personal finance, portfolio, risk, statistics, stock prices, stocks, volatility, Warren Buffett, Yellen

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asset allocation, bbc, bbcworld, bloomberg, bonds, budgeting, Buffett, Charlie Munger, cnbc, cnbcworld, consumer finance, economics, economist, Fed, Federal Reserve, Govtshutdown, investing, investments, Mungerisms, NailedIT, Naileditoftheday, NBCNightlyNews, personal finance, portfolio, retirement, Shutdown, stocks, theeconomist, Wall Street, Warren Buffett

I am happy to announce that I have published two books on Amazon.com that are available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Please feel free to check out the titles below.  I have provided links to make it easier.   The books explain how to select a Financial Advisor, and I provide a list of five books which can help you learn more about investing, respectively. I explain issues about investing as an individual in plain language and without the jargon normally associated with the financial markets. Please feel free to contact me should you have any questions/comments/feedback. My email address is latticeworkwealth@gmail.com.

The books are as follows:

1)      A New Paradigm for Investing:  Can Your Financial Advisor Answer These Questions?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00F3BDTHW/ref=sr_1_1?s=books&ie=UTF8&qid=1381107823&sr=1-1&keywords=A+New+Paradigm+for+Investing+by+William+Nelson

2)       Spend 20 Hours Learning About Investing to Prepare for 20+ Years in Retirement

http://www.amazon.com/Learning-Investments-Prepare-Retirement-ebook/dp/B00F3KW9T2/ref=sr_1_1?s=books&ie=UTF8&qid=1379183661&sr=1-1&keywords=William+Nelson+Spend+20+Hours

The first book listed is normally $9.99 but available for a limited time at $7.99.  The other book is normally $2.99, but I dropped it down to $0.99 for the rest of October 2013.

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wealth Report @wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

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