For Your Consideration

While stock market participants are recovering from the bona fide temporary financial collapse yesterday, it is reasonable to turn our gaze to the unemployment rate figures released today. While increasing to 9.9% (due primarily to more people looking for jobs as their 99 week unemployment benefits run out), the press is reporting that employers added 290,000 new jobs.

Hmmm… What?

When these numbers are broken down, this narrative is subject to a certain refinement. For starters, 66,000 of the 290,000 are census workers- jobs that are not likely to last once census activities finish. Further, 188,000 were added solely by virtue of the “birth-death model”, a statistical model first utilized by the Bureau of Labor Statistics in June, 2003.

Accordingly, a case could be made that the economy really added 36,000 new non-farm jobs, not 290,000. And because we all know that statistical models cannot be manipulated, all is well. 

So today’s unemployment news, coupled with the market legerdemain yesterday naturally leads me to a cognitive dissonance- that “uncomfortable feeling caused by holding two contradictory ideas simultaneously”.

—

Hat tip to Zerohedge, by far the best advanced financial site available to mere mortals.

…to the show that never ends. As many of you have noted, I took a serious hiatus from posting. During my time away, I did a lot of writing, but was thoroughly unhappy with the results.  I’ve missed you, though and so, I am compelled to return to share a few more nuggets of joy while I still can.

Instead of taking this opportunity to discuss the ever-apparent “employer’s revolt” where “less bad” is not better or that cheap money is sowing the seeds of the next economic crisis or discussing the increasing (yes, increasing) global meltdown risk (irrespective of the results of the upcoming so-called “Wall Street reform” vote),

or even the new health care responsibilities “entrusted” to the I.R.S.,I really just wanted to share with you a quote from Abraham Lincoln from his address at Sanitary Fair, Baltimore, Maryland on April 18, 1864:

“We can not fail to note that the world moves… We all declare for liberty; but in using the same word we do not all mean the same thing. With some the word liberty may mean for each man to do as he pleases with himself, and the product of his labor; while with others, the same word may mean for some men to do as they please with other men, and the product of other men’s labor. Here are two, not only different, but incompatible things, called by the same name - liberty. And it follows that each of the things is, by the respective parties, called by two different and incompatible names - liberty and tyranny.”

It is sad state of affairs that many feel the only winning move is not to play and that “going Galt” (where one refuses to lend one’s genius to the world) is logically perceived as the most rational course of action. And while Publilius Syrus’ (a first century B.C. Syrian slave) maxim “Bonis nocet quisquis malis pepercit- Whoever spares the bad, injures the good” is currently out of vogue, its return will very likely be at once stunning, vicious and unexpected.

We can only be kept in cages we cannot see.

Once the bad are no longer spared, and a rational risk/reward equilibrium restored, Publilius Syrus will smile and we will all come to know (or remember) who John Galt really is.

The current credit crisis, how it affects the global marketplace and why it’s important to our entire economic system. Made so simple that a fourth grader can understand it.

Given our recent proclivity to nationalize financial “pain”, it seems that it’s only a matter of time before those very well-heeled hedge funds (and their very well-heeled investors) taken in the $50B Bernard Madoff ponzi scheme will formally request a bailout of their own. I suspect it will happen very shortly after January 20, 2009 and just might be one of the first national policy “tests” of our new President, Treasury Secretary and SEC Chairperson.

From this recent Newsday article, “There’s no doubt that hearings will be held on this, and some government aid is a very logical request,” said Robert Schachter, an attorney with New York-based Zwerling, Schachter & Zwerling, which is representing several Madoff victims. “If we’re bailing out Wall Street and the auto industry, maybe these individuals should be bailed out too.”

When the time comes, will you blame them for making this, using Mr. Schacter’s own words, “very logical request”? Especially in light of the SEC’s own press release on the issue which reads in part…

“The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them.”

Well if that isn’t a prima facie admission of negligence, I don’t know what would qualify….

In fact, read for yourself the SEC “Case Closing Recommendation” which plainly states that the SEC staff “found no evidence of fraud” as of November 21, 2007.

….This has not gone unnoticed by the legal community as Phyllis Molchatsky has filed an “administrative claim” against the SEC for damages due to its alleged failure to protect investors.

Luckily for the SEC, like most government agencies, it operates under the doctrine of sovereign immunity, which means that for all intents and purposes, “the king and queen can do no wrong” and cannot be sued under most circumstances.

But such claims against the SEC will provide “cover” for the politicos who’ll support the notion of a Madoff claimant bailout. And thankfully for them, they don’t have to look very far for the potential sponsor of such a bill: Senator Frank Lautenberg of New Jersey, who entrusted his family’s charitable foundation to Madoff. According to the Senator’s attorney, Michael Griffinger, the extent of the foundation’s losses is not known as yet, but “that the bulk of its investments had been handled by Madoff.”

………

Still, I am struck by some of the most basic and glaring risk management deficiencies as the facts of this matter emerge…

In the risk analysis phase of the risk management process (once risks have been identified), assessments of potential impact on the firm are reviewed. If done comprehensively, both quantitative AND qualitative analyses are performed. Quantitative analysis deals with so-called “hard numbers” and includes a review of things like projections of loss, cost/benefit analyses and net present value calculations.

Well-trained financial “quants” on Wall Street get paid “the big bucks” to do these type of analyses, and their reports are usually quite impressive on paper.  The problem is that too many financial and business decisions are made on the basis of these “impressive” reports/projections alone.

Without a concurrent review of the qualitative risks undertaken, the risk analysis is INCOMPLETE and can lead to unforeseen and financially disastrous results as evidenced by the recent collapse of so many financial services firms.

Qualitative risks are by definition, difficult to define as they are not “hard number-oriented” and rely to a great extent on the experience, judgment and intuition of the members of the risk management team.

I think the primary reason I see almost no discussion of qualitative risk analysis undertaken is because IT IS HARD TO DO. It is also time-consuming. It requires a thorough understanding of the business, its processes, and its place in the physical, organizational and socioeconomic environments the business operates in. It requires people who are TRAINED IN RISK MANAGEMENT TECHNIQUES, not just financial wizards who can make a report read however management wants it to read. Finally, it requires corporate management support, which is notoriously difficult to get (and keep).

………

Despite the political grandstanding that is likely to happen when this matter is undertaken by Congress, we cannot legislate greed out of existence and scams like this will come to light in the future.

In Errol F. Moody Jr.’s discussion of “Investment Malfeasance and Breach of Fiduciary Duty” (which is an excellent read and is VERY highly recommended reading), he makes the case that for all intents and purposes, matters such as Madoff all come down to the same issue: “a failure to gauge risk”.

Clearly, the risks posed by Madoff were either not identified or analyzed properly by investors and a price for failing to properly manage risk shall be exacted.

The stack of stuff I want to share seems to be growing by the day… too much stuff and not enough time! So instead of writing fewer/longer pieces, here are a few succinct words of advice/counsel on each subject in one “omnibus” post. Hopefully, you’ll find a “nugget of joy” that’s of use to you and I can start to cut through my growing stack of stuff. So, let’s get to it…

1. Putting money in bank CD’s may seem like the safest choice today, but it might not be. You’ll be told that these things are “riskless”. They’re not. The one primary risk they don’t tell you about and that you retain (and it’s a biggie!) is inflation risk. Very simply. when the inflation rate is higher than the CD’s APR, you’re losing money. Historically, the one asset class which has a real return ABOVE inflation is equities. With stocks “on sale” at about 40% off, you might consider “buying low” today if you have the time to wait until the market recovers. I suspect that 10 years from now, you’ll wish you put every dollar you had in now.

2. Every personal insurance policy should be reviewed annually to make sure it still meets your needs. Take some time to do it. You might find that coverages can be eliminated, deductibles can be increased, insurers can be changed, etc. to reduce your insurance cost.

3. Every small-business owner should review their insurance program annually as well. If your business operates on a 10% operating margin and you save $10,000 in premium, the savings was not just $10,000- The real savings is $100,000 in gross sales you didn’t have to make just to pay the insurance premium.

4. The “annuity vultures” are out in full force. They usually take the form of “investment advisors” working for insurance agencies and especially prevalent in poor economic times, such as today. They prey on your fears that you’ll run out of money before you die which they cryptically call “longevity risk”. There’s 3 main reasons you should shun: 1. These are extremely complex insurance contracts. Most come with a 200-300 page prospectus. Unless you read and understand all those terms and conditions, be ready to get hurt. 2. Annuities are guaranteed by the issuing insurer- want to make any bets on which insurer(s) are going to survive? 3. COSTS. Depending on the insurer and the particular product being promoted du jour, the underlying costs of the annuity are outrageously high. Remember, the agent needs to be compensated for selling you this complex contract. You’re the one paying the freight.

5. If you have a private disability (DI) policy, look to increase your “elimination period” (which is a essentially a deductible measured in time, not dollars) to decrease your cost. I recently changed the elimination period on one of my DI policies from 30 days to 90 days. When the policy was originally written, I could barely afford to be without an income for 30 days. Blessedly today things are a little bit different. I saved over 25% in making this one change.

6. Our preconcieved notions and the media shape perceptions of risk. Do you really think that Congress knows how to “fix” the economy? Do you really have faith in their stewardship? Should we allow government to grow or would you prefer that industrious, entreprenurial Americans be tasked with our economic recovery?

7. Turn off CNBC. Stock market-timers have to be right not only once, but twice. Even Warren Buffett can’t do it. The stock market-timers “Hall of Fame” is an empty room.

8. Remember, it’s all relative. All assets are being repriced. Globally. There’s no place to hide. Forget U.S. Treasuries with their 0.01% interest rate. Invest in your own education. You want security? Look in the mirror. It’s the only place in this world that you’ll find it.

9. Worry only about the things you can DIRECTLY control. Everything else will take care of itself and you’ll save yourself a lot of heartache.

10. Continue to fund your 401k. If enough people opt-out, these tax deferred programs will go away and that’s not a good thing.

11. If you’re in business (or work for one), don’t forget to advertise and market the goods and services you provide. Your competitors aren’t and it’s a great time to steal market-share from them.

12. You may have noticed the increase in advertising by gold sellers, I know I have. Before buying, understand that gold has a ZERO expected rate of return, as it produces NOTHING. Gold has no intrinsic value, only the value we ascribe to it. You’re also going to need to buy A LOT of it to make it “worthwhile”. Where you gonna put it all?

13. Taking medications (legal ones, that is)? Want to try to save some dough? Live in NJ? Try www.njdrugprices.nj.gov for an online prescription drug registry. Prices for a one month supply can vary widely, even within the same zip code. It works surprisingly well.

14. According to John Montgomery, Founder and Portfolio Manager of Bridgeway Funds, there have been nine bear markets since 1940. The average time for the stock market to “recover” to its previous high is 13 months (excluding this current bear market). 13 Months- a little over 1 year. Of course, this time may be different but know that historically speaking, if you can keep your head when everyone has lost their’s, you’ll be well-rewarded.

15. THIS IS NOT THE GREAT DEPRESSION, PART TWO. We do not have 25% unemployment and the only thing we stand on lines for are HDTVs, not bread! Don’t “buy” the doom and gloom the media is “selling”. It’s all meant to manipulate.

Go live your life. Smile and be grateful.

Back in 2002, I was spending my time full-time educating myself as to the academic underpinnings of markets. I was uncomfortable investing with alleged financial experts without having a basic understanding of the language of and the basis for their investment ideas and techniques.

One of the very first things I learned was that according to academic research, over 95% of all investment returns was determined by your asset allocation. It should not surprise that a portfolio of 80% stocks and 20% bonds has a greater *EXPECTED* return over time than a portfolio constructed of 60% stocks and 40% bonds, yet this simple illustration eludes many.

Of course, because the 80/20 portfolio has higher EXPECTED returns, (by most commonly used risk measures) it is also more “risky” than the 60/40 portfolio.  One can slice and dice these portfolios (US vs. International Stock, Large vs. Small Stock, Growth vs. Value Oriented), but that is not the subject for today.

What I wanted to share was some insight and assistance in choosing an equity percentage from some of the finest academic-oriented financial authors, both of which I have listed in the Reading Room.

Authors William Bernstein (WB) and Larry Swedroe (LS) have published some guidelines relating to this issue. Both agree on two major points:

1. Determine your maximum tolerable percentage loss from the following tables,
2. Use the LESSER of the amounts shown to determine your maximum equity exposure.

Maximum      Maximum
Tolerable      Equity
Loss             Exposure
———- ……  ———-
5% …………….. 20%
10% …………… 30%
15% …………… 40%
20% …………… 50%
25% …………… 60%
30% …………… 70%
35% …………… 80%

This first table deals with a “stomach acid test“. If your heart starts palpitating at a 10% stock market loss, according to the first table, your maximum equity exposure should be no more than 30%. However, the “stomach acid test” is only the first gauge- we need to think in terms of time.

Accordingly, a person needs to consider the time horizon as to when funds placed in the stock market need to be “repatriated back” for use as originally intended. Both authors have a slightly different take on this issue as shown in the following table:

.                     Max Equity
Investment     Allocation
Horizon           WB … LS
———- ………. —– … ——
1 year ………. 10% .. 0%
2 years ……… 20% .. 0%
3 years ……… 30% .. 0%
4 years ……… 40% . 10%
5 years ……… 50% . 20%
6 years ……… 60% . 30%
7 years ……… 70% . 40%

So, if you need the money that you’ve invested in the stock market in four years, William Bernstein recommends no more 40% allocated to the stock market. Larry Swedroe is much more conservative, advising no more than a 10% stock allocation.

My personal belief is that Swedroe is right, as four years is simply not enough time for the stock market to recover ground in the event of a severe downturn. You may need to sell at a most inopportune time (like today), negating the market’s historical long-term benefits. Of course, you would lose the opportunity for gain if the market trends higher over that hypothetical four year period.

So when you hear/read about those people “soon to retire” who now have to postpone retirement due to the state of the U.S. stock market today, ask yourself: Were these people getting the “right” advice on asset allocation?

It appears they were not.

Regulatory risk is usually considered as a change in laws and/or regulations that will materially (negatively) impact a business or a business operation. In some cases, it can also refer to noncompliance with governmental regulations, such as in environmental liability exposures. But today let’s consider the soon to be announced $700B “Wall Street” bailout in terms of regulatory risk.

Many view the economic circumstances we are suffering through today as the natural culmination of events which started in 1977 with the passing of the federal law entitled “Community Reinvestment Act” and will end in the crescendo of debt our grandchildren will not have finished paying off.

The CRA was drafted as a high-minded and well-intentioned regulation intended to encourage banks to “help meet the credit needs” of the communities in which they operated and were to include low and moderate-income neighborhoods.

The CRA worked as intended for the most part until 1995, when the Clinton administration enacted certain updates to the Act which, in part, included a provision allowing the securitization of sub-prime mortgages (which were then “guaranteed” by Fannie Mae and Freddie Mac). These revisions further required the banks to offer “equal access” to lending and essentially forced the banks to make loans they, in all probability, would not have made absent these new requirements.

*As a minor historical footnote, it is ironic to note that in 1997 Bear Stearns became the first company to securitize the subprime mortgages and sell them to other financial institutions. As you probably recall, they were the first domino to fall.

So viewed through this historical lens, our economy is now bearing the cost of regulatory risk.

I found (an admittedly politically charged) video to help with following the “bouncing ball” if you have 10 minutes to spare. After about 4:00 minutes, the video digresses into more politics than explanation…

What began as a well-intentioned government mandate has unhinged our economy in ways we have just begun to experience. And as we stand on the precipice of another government mandated “solution”, I am justifiably concerned that while well-intentioned, this new legislation will contain some new regulatory risk that will rear its ugly head in the future.

Good day, boys and girls!

While the stock market is trying to figure out what it wants to be when it grows up and the media is hyping the panic game as shown in the graphic below, it might be helpful to close your eyes, take a step back, a deep breath and relax. (Double-click on it twice for a better view)

Many people have asked me how I have my personal investment portfolio constructed. I usually defer the answer, explaining that each portfolio must be put together on an individual basis and what is right for my circumstances and risk tolerance will most assuredly not be correct for theirs. As you can imagine, that answer, while true and correct, is not that helpful.

I recently came across a posting at Vanguard Diehards Investment Forum in which financial author and advisor Rick Ferri introduces a sample portfolio called the “Core Four”, which I think is probably the best starting point for new and seasoned investors alike. It is especially helpful for seasoned investors who might’ve lost their way and have a mish-mosh of inappropriate investments hodge-podged together that they have acquired though the years.

The “Core Four” outlines a 60% stock / 40% bond strategy and, as financial author Taylor Larimore has noted, has the following characteristics:

• It is globally diversified;
• It is very low cost;
• It is very tax friendly (tax efficient); and
• It is very easy to understand.

For those of you interested in percentages the “Core Four” strategy outlines the following:

• 35% of the total invested assets in the U.S. stock market (not individual stocks);
• 15% of the total invested assets in world stock markets (excluding the U.S.);
• 10% of the total invested assets in U.S. commercial real estate trusts (not sub-prime); and
• 40% of the total invested assets in the U.S. bond market (typically investment grade or “better”).

While my personal portfolio differs in some areas (for example, I take on more small equity and value risks than what’s present in the “Core Four” because I understand the risks I am taking), this is a superb launching point. You would be well-served to take the time and read the four pages of posts contained in the link above.

So, before you spend another night up worrying about your financial future, take some time to educate yourself. If you have any specific questions about the “Core Four” strategy, let me know and I’ll try my best to answer them.

Recalling a prior post (which recalled the “Death of Equities” from a prior era) is instructive if you can keep your wits about you. While pop psychologists and new agers repeat the oft seen “Danger + Opportunity = Crisis” it isn’t quite so. Risk is real. Market risk is real. And what we are seeing in the markets these last few days is the repricing of that risk.

“These are the times that try men’s souls” a phrase written over 200 years ago by a founding father, Thomas Paine, who knew a thing or two about risk. In his December 23, 1776 discussion of the our recent declaration of independence from Britain, he wrote about panics:

“Yet panics, in some cases, have their uses; they produce as much good as hurt. Their duration is always short; the mind soon grows through them, and acquires a firmer habit than before. But their peculiar advantage is, that they are the touchstones of sincerity and hypocrisy, and bring things and men to light, which might otherwise have lain forever undiscovered.”

Yes, our world is changing below our feet, but that doesn’t mean the end result is ruin. The market is gripped in panic, but it appears our final capitulation bewitching hour is nigh. I suspect this because the media has finally called the bottom with this gripping headline: ‘The World As We Know It Is Going Under‘.

Which to my eyes looks like this headline from AUGUST, 1979:

OK, as of today, the Fed has said to Lehman, “NO SOUP FOR YOU!“, and they are now at the mercy of a bankruptcy court. Merrill Lynch ceases to exist as an independent investment bank and will be swallowed up by Bank of America.

Now, we are witnessing the potential of the bankruptcy of AIG, American International Group. This potential collapse is so breathtakingly overwhelming it is difficult to find the words to express its impact.

As of the moment of this writing, the Fed is trying to help orchestrate a $100 BILLION DOLLAR “bridge” loan package to give AIG time to sell assets to stave off bankruptcy and it is EXACTLY this moment that we come to understand the magnitude and utter failure of AIG management who should not have allowed things to escalate to this point. I think in the future there will be entire business management classes and curricula devoted to the study of events surrounding this epic failure.

But the talking heads are missing the point. It doesn’t matter if/how financing for AIG gets arranged today or tomorrow, the damage is done. Credit analysts in the bond markets have marked AIG’s bonds to junk status and the rating agencies have put AIG on “credit watch negative”, which is a precursor to severe ratings downgrades. In essence, perception is reality and many smart people do not expect AIG to survive as it exists today.

But the biggest problem doesn’t rear its ugly head until January 1, 2009 when AIG’s reinsurance treaties expire. Reinsurance is essentially insurance for insurance companies. If the company cannot negotiate renewal of its reinsurance treaties, it  cannot survive as an insurer and will be forced to terminate all in-force policies, citing loss of reinsurance. This is the insurmountable issue as I see it today.  The question of the day is: What reinsurance companies will be willing to “belly up to the bar” for AIG?

Prudence dictates that individuals AND businesses review their exposure to AIG. This is not just an academic exercise. I would urge a review of insurance policies in force as soon as practicable. For individuals that may mean annuities provided by American General, life insurance policies and/or auto policies with 21st Century or AIGDirect. These matters and questions should be reviewed and discussed with your agent. For corporate risk managers or financial controllers: I would direct your insurance broker(s) to provide an assessment of exposure and immediately begin the remarketing of coverage in the event the unthinkable occurs.

That being said, there probably is only ONE person alive who has the gravitas with regulators, capital markets, and reinsurers to “right” the AIG ship: the deposed ex-Chairman of AIG, Maurice “Hank” Greenberg. I believe that only his direct stewardship will assuage these parties. Let’s see if the AIG board has the brass b@lls to bring him back.  Of course, that exposes another long term personnel risk management issue for AIG: life after Hank. But that is an issue for another day. Today is the day AIG needs its Chairman back.

These are truly momentous times. I, for one, will keep my eyes on January 1, 2009 and hope for best (but plan for the worst).

Quick Update as of 4:45PM EST: It appears that Mr. Greenberg has been rebuffed by AIG management (video in link). In this interview today, Mr. Greenberg (who was ousted from AIG over 3 years ago) was asked what “went wrong” and from his perspective, “what happened?”

Mr. Greenberg replied, “I think several things. I think risk management controls either disappeared or were weakened. There wasn’t attention being paid to the accumulation of risk. I felt there was a determination to grow without the right controls in the financial sector of the business. Many things went wrong.”

Now that the US taxpayer is now bailing out Fannie Mae, Freddie Mac and the home-debtor speculators (not to mention all the banks that are being liquidated by the FDIC) it might be a good time to ask this question: Who’s going to bail out the US taxpayer?

But wait, there’s more!  Why not bail out Lehman Brothers as well?

It just wouldn’t be “fair” if Lehman is denied the bailout status Bear Stearns, Fannie Mae, Freddie Mac, the banking industry and the home-debtor speculators have been afforded by our elected politicians from *BOTH* sides of the aisle.

It’s absolutely laughable that after 18 years at the Fed, ex-Chairman Alan Greenspan is warning not to use the Fed as a “magical piggy bank“. There apparently is no shame left in America.

In fact, why don’t we just nationalize the entire financial pornography services industry like our pols want to do with our health care industry? I’d wager there’s more fraud and wrong-doing in the financial services biz than in health care.

The US taxpayer might get a fairer shake then.

In a prior post, I mentioned that the US government debt is not $9 trillion as is most commonly reported by the main-stream press, but $53 trillion. Some of you asked for an outline of the difference:

It’s ugly. And it doesn’t include the most recent bailout numbers. Perhaps it would be better if Congress took off the next 4 years so we could catch up with the damage done.

Just because something is simple, does not make it simplistic, which almost always is used to connote something negatively. And just because you like to keep things simple, does not make you a simpleton. I am amazed at how some people want to overdo the simplest of things, as if by employing the complex strategy the outcome will be better than if a relatively simple strategy was utilized.

It’s kind of like writers using “five-dollar” words, when using “one-dollar” words are sufficient to get the point across. Perhaps it’s an ego thing: the writer feels superior when their audience is forced to use a thesaurus (!) or google an unknown word.

Recently I was asked by one of my friends to help him deploy a financial strategy for a short term goal (which I’ll generally define as one that is less than 5 years away). In this case, the “goal” date for using the money was 4 years away. If you remember this previous post, I commented that it’s absolutely necessary to consider the time-frame for when the funds will be needed.

Failing to do this very basic concept can lead to poor (or disastrous) results.

Monies allocated to equities for short term goals are generally considered *unsuitable* as you may need to liquidate at the “wrong” time, say in a declining market. The inverse is also true, if money is allocated too conservatively for a longer term goal, you run the risk of not having “enough” money after the effects of inflation are considered. It’s these type of issues that the so-called “financial professional” world uses to prey on an financially uneducated populace.

The (unstated but essential) message: You *need* them to figure this stuff out for you because you can’t do it on your own.

It’s not true, of course: anyone with a high school senior math education can follow the basic concepts “along at home”. And despite the pleadings of the financial planning community to the contrary, financial planning is *not* an exact science. Heck, I’m not even sure it’s an “art”; more of a *discipline* than either an art or science.

…zzzzZZZZZzz…

… oh no, there I go again… Sorry about that. Let’s get back to the issue at hand: How did we decide to deploy capital for a 4 year time horizon? Bonds. Absolutely *not* sexy, but they get the job done and are appropriate and suitable for the task at hand.

First, we have to make sure that the investment is low-cost as every dollar confiscated in fees by the investment “professionals” reduces the investment’s total return. (Stunningly simple concept, isn’t it?)

Second, we have to make sure that the investment is internally diversified, meaning we want to hold many bonds to reduce the default risk of any one bond issuer defaulting on its obligation to repay.

Third, the bonds have to be of the highest quality, reflecting the bond issuer’s ability to repay. We need to preserve and protect capital, so “junk” (also known as “high-yield”) bonds were not suitable.

Fourth, we’d like to match the average duration (which is essentially, a measurement of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows) to the goal time-frame: in this case, 4 years.

So, following the 4 steps above leads us to the obvious answer: we were looking for a low-cost, mutual fund of high quality bonds with an average duration of 4 years.

Checking out Vanguard Group, my favorite mutual fund family for DIY investors, two bond mutual funds were reviewed: Vanguard’s Short Term Bond Index and their Intermediate Term Bond Index. As of today, the Short Term Bond Index holds 900 bonds and has an average duration of 2.5 years. Intermediate Bond Index holds 968 bonds and has an average duration of 6 years. Both funds have an overwhelming majority of their holdings in bonds that are rated “A” or better and both have an expense ratio of 0.18%, making them *very* low cost.

So, let’s recap:

1. Low-cost? Check.
2. Diversified? Check.
3. High quality holdings? Check.
4. Duration of 4 years? Uh-oh.

Darn. Everything was going so well until we got to #4.

Fret not, here’s the easy solution: We can “blend” the two funds together to get to our desired average duration of 4 years. The math worked out like this:

1. Short Term Bond Fund duration is 2.5 years * 60% (0.6) of the total invested = 1.5 years; and
2. Intermediate Term Bond Fund duration is 6 years * 40% (0.4) of the total invested = 2.4 years.

By investing 60% of the money in the Short Term Bond Fund and the remaining 40% in the Intermediate Term Bond Fund, we essentially have created a portfolio that has an average duration of 4 years. (Actually 3.9 years, if you want to get “technical” on me!).

One more thing: please be aware that bond fund durations are subject to change over time. You may need to adjust the “blend” as circumstances dictate.

But using this “simple” solution to invest for a short term goal, you’ll achieve better results than many of your friends. Of course, there is the possibility I could be wrong

With oil prices currently at around $125 per barrel, it is difficult to believe the US government’s calculation that inflation is currently at 3.98%.

It occurred to me that if our wages were indexed to the price of oil, perhaps it wouldn’t be so bad. So, imagine if you will, that you were making $100,000 when the price of a barrel of oil was $100. (which happened “way back” between February and March of this year).

The cost per barrel has increased 25% in roughly 3 or so months. Now imagine, if you will, your salary increasing by the same percentage. In our hypothetical example, you are now being paid $125,000 today for the same job you were doing in February.

Sweet!

It could almost make you wish for $200 per barrel pricing.

To be very specific, what happens to a life when it ceases being a relentless pursuit of money? I think back to my church confirmation classes and remember being taught that the “love” of money is the root of all evil. But we’ve learned that money is nothing more than a storehouse of value and a method of exchange. In today’s world, it’s nothing more than ones and zeroes contained in a computer database/ledger. It also begs the question: Who’s in charge or control of the “ledger”?

Our money can “disappear” at any time- as it has in America before. Does anyone remember confederate currency? Because it was a fiat currency (meaning it had no intrinsic value, just like our current dollars) and was backed by a government that ceased to exist, confederate currency collapsed and had no value at the end of the Civil War. Those who were “rich” by confederate currency standards were left penniless. I guess the moral of that story is having “more” shouldn’t necessarily make you feel more secure and that you should never assume the unlikely is impossible.

Actually, the disappearance of money doesn’t even need to be so draconian or dramatic as followed by a governmental collapse. Inflation is a hidden danger and stealth destroyer of monetary “wealth”. Inflation is the general level of prices over time. I like to think of it as a general *increase* in the cost of a “basket” of goods and services over time. For example, I would need $661.92 in 2007 dollars to buy what $100 could buy in 1965, the year I was born. A loaf of bread cost a whopping 21 cents then- compare that to today!

Reasonable people ask why this is. It’s because our money supply is manipulated by a financial cartel in the form of the Federal Reserve. As more dollars are injected into the money supply and “made available”, the value of the dollars already existing in circulation *falls*. Therefore, you need increasing amounts of dollars to buy the same amount of goods and services over time.

Recently I was referred to a 60 Minutes segment about David Walker which was broadcast originally back in March, 2007. Don’t know who David Walker is? Don’t feel bad, neither did I. Up until March of this year, he was the US government’s top accountant, the Comptroller General of the Government Accountability Office. He pegs our national debt at $53 TRILLION dollars, not $9 TRILLION and paints a picture of our country’s economic future so grim, it’s as compelling as it is utterly chilling. I consider it a “must see”.

I’m left pondering whether the “endgame” plan is the bankruptcy of the United States (with its corresponding debt default and monetary collapse) to “make way” for something new- I believe George Herbert Walker Bush (41) called it a ” New World Order”.

Wouldn’t that be a hoot? I wonder how the people who spent the entirety of their lives in the sole and relentless pursuit of money are going to feel?

Well, just a flurry of activity today, isn’t it? I’m going to be away on vacation until late April/early May so I wanted to commit a few ideas that I’ve been mulling over lately to the site before I either forget them or get caught up in other things. Some concepts I have “in development” as of today that’ll have to wait for my return:

1. A line item breakdown of variable annuity costs - OUCH!

2. Why stock market timing is a bad (but pervasive) idea;

3. A discussion of “senior” seminars and the art of the “sale” - beware the siren call of the “free” steak dinner!;

4. The allure of fixed index annuities and when they are suitable;

5. Long Term Care Insurance Objections (and rational responses);

6. Within every small business owner lies the soul of risk manager;

7. Moral and ethical obligations of a fiduciary;

8. Legal considerations of the sale of securities by “captive” financial advisors/insurance agents;

9. Exploration of the concept of “Personal” Enterprise Risk Management;

10. How to reduce health insurance premiums through exposure analysis;

11. Matching bond fund durations to meet a 1-5 year financial need;

12. “If investing *isn’t* boring, you’re doing it wrong”; and

13. An exploration of personal risk control techniques.

Just a little “light” reading, huh? Also, if you haven’t already done so, please consider registering your email address (or send me an email at md at marcd.com and I’ll register for you!) so that the site updates will be forwarded automatically to you by email. Consider referring a friend to the site - we need more friends! Thanks again for your support and I’ll see you in about a week.