Is Your Fund Manager Smarter than a Yucca? September 30, 1999February 13, 2017 I am grateful to Jane Bryant Quinn for forwarding this gem: STOCKHOLM (Reuters) – A yucca plant is the latest investor on the Stockholm Stock exchange, issuing buy and sell orders on the exchange’s 16 most traded shares. Swedish artist Ola Pehrson has attached electrodes to the plant’s leaves and, through a sensor, can feel the plant’s growth with movements linked to a computer program tracking the 16 most active stocks. When the yucca’s stock recommendations perform better than the bourse’s general index, it is given water and light. If the plant fails to deliver profits, it stays dry and in the dark. The yucca is part of an exhibition by seven Swedish artists in Stockholm. But what if you don’t have a yucca plant? John Wilkerson: “I would like to know by how many percentage points my fund needs to outperform the comparable low-expense funds in order to equal or beat them. Like so many investors, I hope my selected fund will outperform even over time. While this is a questionable assumption, it would still be useful and interesting to have this calculation.” Good question. If — say — your fund has 4% in costs each year and mine has 1%, then your fund has to somehow make up that 3% difference. So if my fund matches “the market” before considering costs, your fund has to BEAT the market by 3% each year merely to equal mine. Which is harder than it sounds, because although 3% is “a small number” when it comes to most things — our swimming pool has 3% more water in it after a good rain (who cares?) — it is a HUGE thing when it comes to investments. Over time, investments in “the market” have been expected to grow, between dividends and appreciation, at 9% a year. These days, many of us expect a lot more, but I’m not sure that’s realistic. Anyway, to make the math simple, stick with that 9%. For YOUR fund to grow 3% faster is for it to grow one-third faster. Your guy has to run one-third faster just to keep up with my guy. Interestingly, the stock market investor who’s run the fastest over the years, Warren Buffett, owes his extraordinary success in no small part to his practice of minimizing taxes. (He also kept his costs ridiculously low — for the longest time, headquarters had a total of six people, including the boss. And those headquarters are not a penthouse suite of offices in Manhattan, they’re a modest affair in … Omaha.) As I have written elsewhere, if he had paid long-term capital gains tax on the growth of his fortune each year, rather than letting it compound year after year, he would have cut his long-term compounded growth from 26% or so to more like 18%. Instead of having $40 billion or whatever he’s worth by now (sorry, no time to look it up), he’d have barely $4 or 5 billion. Costs make a huge difference. As Buffett’s example proves, a few rare individuals CAN outpace the market by a wide margin and for a long time. But high costs and high turnover are rarely the way they do it. Which leads me once again to invite you to visit the new Personal Fund site, for those of you who haven’t. We just got a really nice endorsement from the Consumer Federation of America (“invaluable”).
Cool Stuff to Do September 29, 1999March 25, 2012 1. Call 1-800-578-7453. This you can do right away, and it will prove to you that the tobacco companies — Brown & Williamson particularly — truly love you. 2. Go see THE INSIDERS, a $70 million Disney effort starring Al Pacino. This you can’t do until November 5, but make a note to. It’s dynamite. It will prove to you that the tobacco companies — Brown & Williamson particularly — may actually deserve the lawsuits raining down on them. (I know, I know — but see it before you tell me I’m wrong about this.) 3. Click here to find the price your neighbor paid for her home. I checked my own home first . . . for which I thought I had paid $120,000 . . . and found that — yes! that’s right! — I had actually paid $105,000. Can you believe that? The Internet could find in seconds something that I — whose life it is after all — couldn’t quite remember. (The asking price was $120,000. I thought I had just decided to pay full price because I liked it so much. With this memory jog, I now remember I offered $100,000 and they came back at $105,000 and then I decided I’d better not haggle.) Then I tried an apartment on Central Park West in New York and came up with nothing until I reentered it as “West Central Park.” And then I tried a lot of other places and came up with nothing. The service is spotty, to say the least. But it’s still pretty cool.
Overlawyered.com September 28, 1999February 13, 2017 You know how some people love humanity but not people? Well, with lawyers I’m the reverse. I love them one-on-one; many of my best friends are lawyers. But taken together as a throng . . . well, I’ve long thought we may have too many of them. Whatever your take on this, I suspect you may find overlawyered.com engaging. Quoting now directly from the teasers for recent highlights: Oops! Calif. Gov. Gray Davis accepts a single eagle feather as a ceremonial token of Indian leaders’ esteem, but possession of even a single quill from a protected bird can send you to prison under federal law (Sept. 11-12) New York millionaire defendant Abe Hirschfeld hands out checks of $2,500 each to jurors who decline to convict him on tax fraud charges: was it reasonable doubt, or was it the miles? (Sept. 13) Michigan appeals panel finds flamboyant attorney Geoffrey Fieger engaged in “truly egregious” misconduct when he “insinuated, outrageously, and with no supporting evidence” that a doctor “‘abandoned'” his patient “to engage in a sexual tryst with a nurse.” (Sept. 14) Michael and me: radical filmmaker Michael Moore vigorously presses charges against ex-employee who, taking a leaf from the methods by which Moore himself won fame, follows him around with a video camera and disrupts his public appearances (Sept. 16) Slow down, it’s just a fire: Canadian court is latest to strike down physical fitness tests for firefighters as overly demanding and thus unfair to women (Sept. 17-19) Sting operation charges blind Seattle news dealer with selling cigarettes to underage buyer (Sept. 16) Charting the vast rise in issuance of law degrees since the 1960s (Sept. 20) Plus: Don’t you dare hug that hurt or crying child . . . Don’t expect money (even in Philadelphia!) if you get drunk and climb a high-voltage tower . . . and more. It’s all at overlawyered.com.
Shorting a Dying Stock September 27, 1999March 25, 2012 Chuck McDannald: “What are the implications of shorting a stock (currently $6/share) that is likely headed for bankruptcy? If it goes all the way to zero, I guess I get the whole $6, is that right? Or what if the company files for bankruptcy protection at some point on the way down? If I ‘know’ they are bankruptcy bound, everyone else does too, so would there even be any shares to short?” Well, the first thing to say is: shorting stocks is dangerous! “Likely to go bankrupt” isn’t the same as going bankrupt — and if something unexpected happens, this stock (whatever it is) could really jump. Why? Because everyone knows it’s a dog and the price, presumably, reflects that. The only people buying it may be very, very stupid people. But usually — not always — there are as many very, very stupid people selling, so they cancel each other out. Indeed, some very, very smart people may actually be buying this dog at $6 along with the very, very stupid people. Very, very smart people may on occasion see, or know, something that the rest of us — who are neither brilliant nor Brillo but to whom it’s obvious this stock is headed to zero — may not. So, point one: who knows. The next thing to say is that bankruptcy is often not the end of the game. If memory serves (sometimes it does, sometimes it doesn’t), a rotten little clothing retailer called the Gap went bankrupt a long time ago. But it emerged from bankruptcy — the stock never went to zero but got real close in 1988 — and today has a $30 billion market value. Or look at that rotten Apple that seemed pretty well headed for oblivion. Or at Chrysler that was once a total goner. So whatever dog you have in mind will PROBABLY go down, which is why people are selling it; but it just might surprise you, which MAY be why some people are buying it. Now that we have that part settled, here’s the other part. If you short it, you don’t WANT it to go to zero. If it does, you have to realize the short-term capital gain. (Gains on short sales are “short-term” even if you held the short for 100 years, because you sold the stock less than a year and a day after you bought it. In fact, you sold the stock, in this example, 100 years BEFORE you bought it.) So you might well see 30% or 40% of your profit taxed away. Heads you win 60% of your profit after tax, tails you lose close to 100% of your loss. Tough game. No, what you’d prefer to see is the stock languish for around $1 for years, as it bungles in and out of bankruptcy. That way, no tax is due. If you want to take a flier betting against this stock, you might be able to buy puts, so at least your risk would be limited to 100% of the cost of the put. But the problem with that is that the seller of the put is no idiot either, ordinarily, so it will cost you a pretty penny . . . and the stock might well hang on around 5 or 6 until long after your put expired worthless. You can make a lot of many betting on the short side, but very few people do, and the risks are enormous.
Less Amore, Fewer Morays September 24, 1999February 13, 2017 Kim Ness: “I promise not to make a habit of writing you, but when you bring up grammar, I find I cannot (a real word, although not used much any more) keep quiet. What about less taxes? Every time I hear a politician promise less taxes, I cringe. I think it ought to be fewer taxes… and that’s right if you count one tax, two tax, three tax etc. But what (most) politicians are trying to say is lower dollars paid in taxes, so that makes me think that maybe I’ve been wrong, and that less taxes is correct. Any thoughts? Less tax, lower taxes, fewer separate kinds of taxes (New York alone has, like, a million of them). No? Steve Williams: “You say: ‘Fewer is for things you can count — fewer calories, fewer airplanes, fewer hairs, fewer fat cats, fewer pundits, fewer pedants. Less sand, fewer rocks! Less money, fewer mutual fund choices!’ “You can’t count money?” Fewer wise-asses. But seriously, you rarely hear people say “one money, two monies, three monies,” whereas forest rangers are forever saying things like, “one tree, two trees, three trees.” So: fewer dollars, less currency; fewer scents, less perfume. Michael Rothstein: “Isn’t $90 $10 *less* than $100? Wouldn’t “$10 fewer” sound kind of dumb?” It would indeed. Ten dollars is less money than $100. And $90 is fewer dollars than $100. Anonymous: “As a retired English teacher, I am called to expand upon your usage lesson. ‘Less’ can also be used with things that can be counted if those things are considered one unit. An example: ‘Fifty thousand dollars is less than one million dollars.’ Question: what should the grocery-store signs read — ‘Ten items or less’ or ‘Ten items or fewer’?” “Ten or fewer,” but no grocery store wants to seem highfalutin. Less of a common touch, fewer patrons. Monday: Shorting a Dying Stock
Why Consider Mutual Fund Cost at ALL When It’s Already Figured into Performance?! September 23, 1999February 13, 2017 Greg Buliavac: “OK, I haven’t looked at your mutual fund cost calculator, but my question is, why do you need to consider the costs of a fund? Why don’t you look just at the performance numbers, since performance is calculated after costs are subtracted?” This is exactly the right question and a lot of you have asked it. We try to answer it in what I guess is too hidden a place on the Mutual Funds Cost Calculator site. (You reach it by clicking “more” on the first page.) Click here for a direct link. Two sections are most relevant: Because Predicting Costs Is Much Easier than Predicting Performance . . . and . . . But Don’t You “Get What You Pay For?” But if you have time, read it all and let me know what you think. Rodney Skidmore doesn’t buy it. He writes: “Give me an ‘expensive’ manager that delivers over a low cost manager that loses money, any day.” Absolutely! Of the 11,000 funds out there, please list for me, below, any 3 that will significantly beat the market over the next few years on an after-tax basis: 1. _________________ 2. _________________ 3. _________________ We’ll check back a few years from now, and you’ll probably be rich and I’ll probably look like an idiot. Even so, it’s just a lot harder finding these funds looking forward than back. Which is why instead of comparing a high cost manager that “delivers” with a low cost manager that loses money, I’d compare the high cost manager with a low cost manager that makes money — as so many do. It’s counter-intuitive that really bright guys and gals who work at it can’t fairly consistently beat the market, and by more than the extra 3%-a-year handicap, say, that a high-cost, tax-inefficient mutual fund might have to bear. After all, in a normal environment, where stocks may be expected to return about 10% a year, having to do 3% better than the pack to cover the added costs — just to wind up doing average, that is, after costs and taxes are deducted from an investor’s return — is merely to have to do 30% better than the rest. And why should that be hard? Well: it is. And, with a high-cost, tax inefficient fund, that merely gets you even with the pack. Actually to beat the pack, you have to do better still.
A Broken Clock That’s Right All Day September 22, 1999February 13, 2017 I was riding up Sixth Avenue and saw that billboard with the National Debt in bright lights spiraling $10,000 deeper into hock with every passing second. It’s an astonishing thing, really, to see the numbers whirring fast enough to add $10,000 a second. The right-most digit . . . the one-dollar bills . . . must be racing around at 10,000 increments a second, if they actually do it right. (Maybe they round to the nearest $1,000, so it grows $1,000 every tenth of a second. Still makes for a heck of billboard.) I’m not sure how many trillions of dollars ago it was erected; but this thing has been lighting up the avenue and making people feel bad for a long, long time now, 24 hours a day, 7 days a week, for years. And the point is: It stopped. It’s conceivable the sign was just broken the day I passed, but I don’t think so. The lights were as bright as ever, so the power was on. No, it had stopped. <Partisan hat ON> The Clinton/Gore budget of 1993 . . . the budget that received not a single Republican vote but that was designed to appease the bond market and get interest rates falling so employment could start rising so the deficit could start falling instead of rising . . . that budget worked. And the Democrats want to maintain the same fiscal responsibility to keep the economy growing responsibly. No gargantuan tax cuts right now, thank you; that’s what you do when you need to give the economy a boost, not what you do when the economy is booming and unemployment is low. <Partisan hat OFF> The point is: The National Debt Clock had stopped. And somebody, someplace, is scratching his head wondering if it’s worth trying to run the thing backwards, or better to just replace it with something else. With minor readjustment it could be a world population clock — 6 billion any minute now, up from 2.5 billion when I was born, and growing by a new Mexico every year. (Not a New Mexico, mind you — a new Mexico.) Or if it can be rigged to run backwards, it could be a Remaining Acres of Rain Forest clock. Or a Remaining Population of Atlantic Salmon clock. Or maybe it should just be turned into a billboard for Honest Tea. Tomorrow: Why Consider Mutual Fund Cost at All When It’s Already Figured into Performance?!
Double Taxation September 21, 1999January 29, 2017 What’s ordinarily thought of as double taxation of dividends is this: You own a company. It makes a profit. That profit is taxed once to the corporation, and then a second time when you receive it as a dividend. (Corporations have been prety aggressive in getting around this by finding ways to pay little or no corporate income tax, and by paying out little or no dividends. Many buy back their own stock instead, which in theory will give the value of your stock — and, especially, the value of management’s options — a little lift.) But there’s another double taxation of dividends that’s inadvertent and entirely avoidable. I referred to it last week. Lynn Smith: “You say: ‘I’m also assuming you are not accidentally double-counting as taxable gains appreciation from reinvested dividends. You’ve already paid tax on that portion of the growth in the value of your holdings. This is a common mistake.’ “I don’t consider myself a novice, but I’m not following your comment about double-counting. I’m taxed on it when I receive a dividend. The fact that I choose to reinvest that dividend income or just invest the same amount of regular old money has no bearing on whether its appreciation will be taxed. Both would be taxed equally when sold. What am I missing?” Say you put $10,000 into a fund and check “reinvest dividends.” Now 5 years later, it’s $20,000. This is just great, and congratulations. You sell. Some people make the mistake of entering $10,000 as their cost, $20,000 as their proceeds, and pay tax on the $10,000 profit. You, of course, have added to that original $10,000 cost the additional cost of all those additional shares you purchased by reinvesting your dividends — and on which you paid income tax each year. Let’s say you got and reinvested $3,000 in dividends and capital gains over the five years. Where some might accidentally show $10,000 as their cost, $20,000 as their proceeds, and pay tax on the $10,000 profit, you show a cost of $13,000 and pay tax on only the actual $7,000 previously-untaxed profit. The folks who declare a $10,000 gain are paying tax on the previously taxed $3,000 TWICE. Robert Doucette: “How do I figure out how much I would owe in Capital Gains from a mutual fund investment? I know how much was paid originally and how it is worth now, but every year we pay taxes on the funds in our taxable accounts? Surely we are paying the Capital gains on the installment plan?!?” Same deal. If you’ve been reinvesting the dividend/gains distributions, you have to keep track of them (or get the fund to send you a recap). Add all your reinvested dividends to your cost for the original shares, so you get a total of all you’ve paid for the original, plus the additional, shares. On the other hand, if you’ve been getting actual checks — and using them to pay the rent rather than reinvesting them — any gain in your account is taxable. It’s a gain on your original shares, which is all you have. If you paid $10,000 and sell for $17,000, that’s a $7,000 gain, plain and simple. Yes, if the fund distributed lots of dividends and capital gains each year, you did pay a lot of tax along the way. But whenever it paid cash out, it also lowered its net asset value per share. Shares you bought at $10 that rose $4 in net asset value to $14 and then paid out a $4 capital gains distribution are instantly, after the pay-out, back to $10. If you sell, there is no gain. Indeed, while it’s not always a great idea to buy shares in a fund just before a large capital gains distribution is paid, it’s not quite the disaster people warn of, either. Say you paid $14 Tuesday and the next day, Wednesday, you got a $4 taxable distribution. Well, if this is going to cause you a problem, just sell the shares — now instantly $10 a share after distributing the $4 — and you will have a $4-a-share loss to net out the $4-a-share gain. (Of course, if this were a load fund, or a fund with a surrender charge, you couldn’t be so cavalier about it.) Have I just left you more confused? Well then, enough mutual funds for a day or two. Tomorrow: A Broken Clock That’s Right All Day
How to Specify WHICH Shares of a Stock or Fund You’re Selling September 20, 1999January 29, 2017 But first a quick one: Remember Quickbrowse? Long-term readers were among the first to see it, and quite a few of you have used “Q-Page” to have this column delivered to you every morning. (To do that, just go down to the bottom of this column and click the Q-Page icon. Mornings when I’m late with it, you’ll get yesterday’s column again, but that’s my fault, not Quickbrowse’s.) Well, guess what. It’s lunacy, of course, but wasn’t Marc’s dog Looe excited when we got a write-up in Red Herring last week. And then — arf! arf! — a follow-up where one Red Herring reader thought Quickbrowse might be worth “ten to thirty million!” (Not that we noticed any checks attached to his e-mail.) If anything comes of this, Looe — whose photo, over my protest, has been removed from the Quickbrowse site — will be in filet mignon for the rest of his waggy-tail life. And now down to cases: John McInnis: “You say, ‘If you’ve been buying shares in a high cost fund all along, sell the shares for which you paid the highest price but keep those you bought way back when.’ My question is: how exactly do you do this? In the olden days, when dealing with a flesh-and-blood broker, you would send him a note saying something like ‘Please sell the 100 shares of XYZ purchased on 4/1/66 and not the ones I bought last week.’ Of course the shares are all the same to your broker and you, but this polite fiction was sufficient to hold the IRS at bay. Nowadays though, with online brokerage accounts, how do we effect this little charade?” Send the note anyway and keep a copy with your tax records. (Actually, since these are no longer the olden days, fax it and you won’t even have to make a copy.) You’re not likely to be audited, but if you are, and you have good records — along with clear instructions to your broker directing him to sell “the 300 shares versus purchase date 7/13/93” — it seems to me you’ve done your bit. (Don’t blame me if the IRS disagrees. I limit my liability in this to price you paid for this column.) But you raise a good point. An enhancement on-line brokers could easily add is an optional field in which to enter the VSP date (VSP = versus purchase). The deep discounter I use has “beginner,” “intermediate,” and “advanced” display modes. So why not offer a VSP field on the advanced display? If a client enters a date, the confirm and monthly statement he receives should both reflect that VSP date.
Where Can I Find a Good Romantic Mutual Fund? September 17, 1999February 13, 2017 Kevin Crawford: “The Cost Calculator is a great idea, but flawed. I found this out by typing in BARAX (Baron Asset Fund) and looking at your results. It said that other funds would do me better in the long run assuming all of the funds had the same return. The cost calculator does not seem to take into account that great fund management can make a big difference in the long run. And Ron Baron has certainly done that over the long haul (just not 1998, which for him was a complete disaster; but this year he is back on track). I would love to hear your thoughts on this and I need a really romantic resturant for NYC which I’m bringing my wife to in October.” Well, if you don’t mind its not being famous or wildly extravagant, try La Boite en Bois at 75 West 68th Street (212-874-2705). Cozy, authentic French without being snooty, and $100 should take care of the whole deal including the wine, tax and tip. I have no connection to it other than having eaten there. As to Ron Baron, the point of the Mutual Funds Cost Calculator is not that you should always ditch a high-cost fund for a low-cost fund (although generally that does make sense, especially where the cost difference is large and no taxes are incurred by doing so). But here’s what we do believe, and what study after study shows: Over time, costs matter. A great deal. Over time, most high-cost funds do worse than most low-cost funds. It’s easy to spot great fund managers looking backward. But how do you spot a Ron Baron before he’s got his track record? (A track record I’ll get back to in a moment, by the way.) And once he does have the record — will it persist? The longer the track record, the more confident you may feel in the fund manager’s exceptional ability. But look at the flip side of that. The longer the track record, the more of it is already behind the manager. You’ve missed all that. And then you have to wonder, hmmm . . . might this person, now that you’re finally satisfied of his or her skill and ready to invest — might this person have gotten a little fat and happy? Or cocky? Or might the “paradigm” have shifted? (Not that I have any better idea what a paradigm is than the next guy who pretends to.) Maybe this is a fund manager who was great in the old world, but now won’t be able to out-think younger tech-whiz managers? For example, no one would dispute that John Neff was a great fund manager. He had the added benefit, running the Windsor Fund, of Vanguard’s very low costs. But in the last few years of his management, having convinced even the most skeptical of his talent, his fund’s legendary performance actually became a little less legendary. As for BARAX, Morningstar shows its 10-year annualized total return at 13.91%. That compares with 17.28% for the S&P 500. I’m first to admit this has been a great 10 years for the S&P (and that BARAX was designed specifically to find smaller growth stocks). Still, $100,000 invested 10 years ago would have appreciated $267,500 in BARAX, versus about $390,000 in the S&P. So all that great stock-picking — and what some people regard as the extra risk of smaller-cap stocks — weren’t enough to beat the boring old cost-free “market” that the S&P more or less, sort of, represents. You would indeed, in this example, have left $122,500 on the table. Even with a well known, super-bright, respected fund manager like Ron Baron I’m not sure that it’s wise to ignore costs. There’s no denying costs weigh down performance. And they’re one of the few parts of the investing equation you can more or less control. And that’s the point of the Mutual Funds Cost Calculator. Bon appetit. Monday: How to Specify WHICH Shares of a Stock or Fund You’re Selling