Trovena Weblog

Just a Little Return Makes a Biiiiiiig Difference

DFA's Weston Wellington helps put long-term compound returns in perspective.

- Christopher

March 31, 2010

The Millionaire Next Door

The Chicago Sun-Times recently reported that Grace Groner, a long-time resident of Lake Forest, Illinois, passed away in January at age 100, leaving a $7 million bequest to her alma mater, Lake Forest College. Although Groner lived in one of the country's wealthiest communities, she hardly fit the profile of a trust-fund socialite. An orphan at age twelve, she was cared for by neighbors and attended college, earning an English degree in 1931. She went to work as a secretary for nearby Abbott Laboratories in Chicago where she worked for forty-three years. She never married, never owned a car, and lived for much of her life in an apartment before moving to a tiny one-bedroom house willed to her by a friend.

Her $7 million estate was the fortuitous result of a lifetime characterized by frugality, simplicity, and a large dose of good luck. She had purchased three shares of Abbott stock for $60 each in 1935, reinvested the dividends, and never sold them. Over the subsequent seventy-five-year period, her three shares multiplied to well over 100,000, and her $180 initial investment grew over 38,000-fold to approximately $7 million.

Wall St. Out of the Gambling Closet

Well, many of you who know me have heard me say that Wall St. firms are really analogous to casinos. Like Vegas casinos, these firms (Merrill, Smith Barney, Goldman....etc.) don't really care if you make money.

They merely want you to take a bet so they can take a small piece of the action (on billions of transactions of course) After all, if gambling or stock picking worked, they would be sitting at terminal or card table with you taking their own advice.

Finally, they have taken off their disguises and are entering the casino fray in earnest...

- Christopher

Whether Bonds or Touchdowns, They're Still a Gamble
Firm Engineers Vegas Wedding Between Wall Street and Sports Betting

By ALEXANDRA BERZON

M Resort

The betting area at M Resort was designed to look like a trading floor.

LAS VEGAS—Investors are sometimes accused of treating the stock market like a casino. Now, one Wall Street firm wants to treat casinos like the stock market.

Bond-trading specialist Cantor Fitzgerald in March took over the management of sports betting at the M Resort, a new 390-room hotel and casino on the Strip's southern edge.

Read the full article here....

Why We Prefer Inaction and Loss Aversion to Action and Gains

Below is a link to an interesting article that helps to explain why people had trouble acting on the obvious opportunity that last March's low equity prices presented investors.

The article says that golfers make fewer birdie putts than par putts (adjustments are made for distance and other factors) and at the professional level cost themselves millions in winnings. Apparently, the fear of a bogey is greater than the desire to get a birdie. So, even though both putts mean the same to the golfer's score, they embarrassment of the bogey (loss) is much more motivating than the pleasure of the birdie. (gain)

The authors also cite a study of blackjack players which documents that the greatest cause of sub-optimal play is not taking additional cards that you should. In other words, doing nothing in order to avoid loss was preferred to taking additional cards to win the hand.

I personally met with dozens of investors during the March period who, while aware of the opportunity in the market and for the need for change in their own portfolio, could not "pull the trigger". In their minds, no matter the state of their own portfolio, doing nothing was the preferred course of action.

I took it personally at the time that these folks couldn't move forward with my recommendations. Now that I've read this article though, I realize it had more to do with human nature than my communications skills.

-Christopher

Investing Lessons from Golf and Blackjack Players

By Robert Huebscher

The Lehman bankruptcy, which occurred a year ago today, was the nadir of a financial crisis brought on by excessive risk-taking throughout the investment industry.  Naturally, reigning in risky behavior has been in vogue since, and regulators are hard at work trying to do just that wherever possible. Sometimes, however, the problem is not too much risk, but too little. Indeed, research confirms that individuals are hard-wired to avoid certain risks at crucial times—even when, in so doing, they impose costly economic penalties on themselves.

Read the full Advisor Perspectives article "Investing Lessons from Golf and Blackjack Players" »

A Big Step in the Right Direction

This isn't law yet, but it has overwhelmingly passed a vote in an influential House committee.  If this bill passes, and is signed into law, it will restrict 401(k) advice to independent advisers, taking away the ability of commissioned brokers from charging high fees in these plans.  The high fees has long been one of our criticisms of many 401(k) plans.  Unfortunately, they are pitched to employers as plans that will not cost the employer any administrative fees.  Of course, the revenue is then collected from the high cost investment options given to the employees.

To quote the last line of the article, "it's about time that Wall Street stop viewing workers' 401(k) accounts like a gold deposit to mine."

This brings the working/investing public one step closer to having freedom and independence in how their 401(k) assets are invested.  Currently, most plans have a limited set of mutual funds for plan participants to choose from.  In most cases, the investment selection is limited to inadequate due to a number of reasons:

1. The funds offered have high expenses.  Whether this is due to broker related commissions or the high cost of active management varies.  In many cases, it may be both.
2. The breadth of funds is not complete to construct a well diversified portfolio, especially in the small cap, international, international small and emerging markets.
3. The fund choices usually consist of actively managed funds.  There is considerable academic evidence that active management does not add value over a passively managed portfolio, especially over the long term.

We applaude companies such as Northrop Grumman, which offers employees the option to invest their 401(k) assets independently through the Schwab Personal Choice Retirement Account (PCRA).  This option effectively turns the employee's 401(k) assets into a self-directed brokerage account.  Employees may invest in stocks, bonds, no-load mutual funds or hire an independent Investment Adviser to assist them with the investment of these assets.

Here's the complete story in the Investment News:  "House committee approves bill that restricts 401(k) advice to indie advisers"

Journalist Request: Essentially a question of tax diversification

Here was the reader question that was asked by Raj Sharan, a financial writer for the Christian Science Monitor:

"I currently contribute about $20,000 a year tax deferred into a 401(k). My employer does not contribute. Since in the future (I'm 2 years from retirement) I'll roll this over into an IRA, would it be better to pay taxes now on the $20,000 and just invest in a regular account? Otherwise, when the money is withdrawn from an IRA, I'll be paying taxes on the entire investment as regular income, not just on the capital gains. I'm assuming that my tax bracket will be the same at retirement. A Roth 401(k) seems like a better deal, but my employer doesn't offer one."

Most investors, after relatively little study of investing, realize that diversification is an important principle.  "Don't put all your eggs in one basket!"  Pretty simple, right?  Of course, loading up on tech stocks in the late 90s aside, most investors get this on some basic level.  True diversification of non-correlating asset classes, without biases towards large U.S. stocks, is rare however.

Even if investors truly understand the principles of investing, another type of diversification has to be considered, especially as investors approach retirement:  Tax Diversification.

So, here is my response to the question:

The origin and rise of the 401(k)

Let's say you are 65 years old.  Which sounds like more money?

• $455,140 now, or
• $3,000 per month for life.

It wasn't too long ago (if one generation counts as "not too long ago") when pensions were considered the default retirement plan for most Americans.  Work for a good company, get your gold pen at retirement (if you're retired, what do you need a fancy pen for?), and sit back while the pension money rolls in.  This is where the phrase "seniors on a fixed income" originated.  Between Social Security and pension income, their income was not expected to increase much over time.  Conversely, inflation during the 70s and early 80s far outpaced any increase that they could expect in retirement income.  Sadly, standards of living were ravaged.

In the 1980s, an obscure piece of tax code, section 401(k), ushered in the largest and most popular retirement plan for an entire generation of Americans, and perhaps more to come.

How does the recent decline in the market impact retirees or near retirees?

The following question was recently posed by a reporter:

What kind of advice are advisors offering clients who are either retired (especially those who have recently retired) or who are preparing to retire shortly, who may have just experienced a big drop in the value of their financial portfolios, as well as possibly a drop in their home values. Beyond telling people to pare spending or continue to work, is there any good advice you can offer to people in this situation?

It's a valid question, and one of great importance to many. This topic is something that I have been addressing in a course I teach at UCLA and in presentations around the country.  If I may, let me take a moment to frame the issue.

I'm gonna help some folks jump start their RETIREMENT!

The National Association of Personal Financial Advisors (NAPFA) has teamed up with Kiplinger's Personal Finance Magazine to offer "Jump Start Your Retirement" days.  I will be a volunteer NAPFA advisor this Friday, January 25, taking questions from Kiplinger readers and the general public about their retirement planning or any other financial planning matter.  I am taking questions "virtually" through the chat room that they are setting up for the day.  My time slot is 10:00am-11:00am pacific time.  So, get online and shoot me a question!

Here's the press release from NAPFA: