Top Ten September 15, 2000March 25, 2012 Rats. We had an event that went so late last night, I missed doing a column. So, for those who missed David Letterman . . . The “Top 10” rejected Gore-Lieberman campaign slogans, as presented by Vice President Gore on “The Late Show with David Letterman” last night: 10. Vote for me or I’ll come to your home and explain my 191-page economic plan to you in excruciating detail. 9. Remember America, I gave you the Internet and I can take it away. Think about it. 8. Your vote automatically enters you in a drawing for the $123 billion surplus. 7. With Lieberman on the ticket, you get all kinds of fun new days off. Vote for us, we’re going to work 24/6. 6. We know when the microphone is on. 5. Vote for me and I will take whatever steps are necessary to outlaw the term, “Whazzzup.” 4. Gore-Lieberman: You don’t have to worry about pork-barrel politics. 3. You’ll thank us in four years when the escalator to the moon is finished. 2. If I can handle Letterman, I can handle Saddam Hussein. 1. I’ll be twice as cool as that President guy in the “West Wing.”
Avoid that 10%-20% Retirement Surcharge September 14, 2000February 15, 2017 Jim McElwee: “Before I retired two years ago, one of my plans was to spend my time managing our money rather than handing one or two per cent to a financial planner or institution for the same task. Fortunately, before I could foul things up, I read enough of your stuff to convince me that the same principles (careful allocations and low-cost funds) that had carried me to relative financial security were the very principles I needed in retirement. I’m much more of a bicyclist now and much less of a hands-on-each-day investor. Thanks.” Nice to hear. Nothing against the folks who would take 1% or 2% of your assets each year; but what too few people understand is that, in the normal course of things, 1% or 2% of your assets is easily 10% or 20% of your expected return — especially if, as is often the case, that 1% or 2% is not deductible. What if I told you that for just 1.5% of its value each year, I would advise you (with no guarantees of being right) on whether to sell, hold or refinance your home. On a $200,000 house, that would be a $3,000 annual fee . . . rising as your home appreciated, and then doubling if you bought a second home. Are you rushing for your checkbook to send me the first $3,000? No? Well, it’s pretty much the same thing.
Found Money! September 13, 2000February 15, 2017 Rick Mordesovich: “This is the site to find all the unclaimed money that is owed to you or your family. Several folks at work yesterday (at play?) found over $500 was owed to their family members. Maybe you have money coming as well…I want 10%!!!” ☞ OK, so it’s not quite as easy or thrilling as Mark Twain’s $50 on the side walk in San Francisco (“I have made hundreds of thousands of dollars in my lifetime. But the most glorious money I ever got was a $50 bill I found on the sidewalk in San Francisco.”), but it could be worth a quick look. Happy hunting. Are you registered to vote? A lot of people do mean to vote, they just never get around to registering. Because, well, how do you even do it? Easy! Just choose your state (from the lower of the two pull-down menus), and click GO. And hey: Where will you BE November 7? Unless you’re certain to be in town, act now to get an absentee ballot.
Feedback on the Issues of Our Day September 12, 2000January 27, 2017 INVESTMENT CLUBS Joe Devney: “I started an investment club with my brothers and sisters a couple of years ago. Investing was an alien concept in our working-class community, so when we reached adulthood none of us knew anything about the stock market or other investment vehicles, and left our retirement decisions in the hands of our employers or our unions. “I’ve educated myself over the last several years, and decided to bring my brothers and sisters aboard with the club. I avoided some of the problems you mentioned in your column by keeping the monthly investment amount low ($10, but in practice everybody contributes more) and by giving the club a fixed lifespan of five years — we each get a modest windfall at the end, so there is little reason to bail early. And I keep emphasizing that the main purpose of the club is education: if we lose money, we are just paying for our lessons. What we learn about how investing works can be applied to our activities outside the club. “Because we are scattered across the country, we have our discussions via e-mail. And I publish a monthly newsletter for the members and a few other relatives. It includes a family news section that is unrelated to investing, partly to encourage people to read the newsletter — they may go on to the other articles after they read about who took a road trip or that a baby has started walking. “At the moment, our investments are worth less than we paid, mostly because one of our holdings (Inacom) went out of business. But the club is still doing its job of teaching us how investing works, and we may yet see a profit when we cash out in 2003.” DON’S CHALLENGE Don Hurter: “This is for any readers who think or claim that they can beat ‘the market.’ “On January 2, 2000, the first day with open markets of this millennium, I invested exactly $10,000 in a Total Stock Market index fund (the Wilshire 5000 index at Vanguard), to establish a performance baseline for all other investments, real or hypothetical. From this fund I can see, firsthand, how ‘the market’ is doing (minus, of course, Vanguard’s small operating expenses), and compare any other investment to that fund’s year-to-year results. (One can get these values without actually buying into a mutual fund, but I did it for honest-to-god investment reasons as well.) “Now, I put forth a challenge to anyone who thinks they can ‘beat the market’. I’ll let you invest more of my money if you are willing to back up your claims, with the following two conditions: 1. If you fail to beat the market (i.e. the Wilshire 5000), then you pay me the difference so that my investment still equals the market’s results. 2. If you DO beat the market, you get to keep half the surplus. “In a nutshell, folks who claim they can outperform the mean aggregated results of all the other investors should be willing to put their money where their mouths are. The penalty for failure is simply to pay up the difference, and accept the humility. The pay-off for success is virtually unbounded. So who out there with ‘a plan’ is willing to accept these rules and show me how good he is?” Hmmm. Something tells me that if this ever caught on, the “taker” of your challenge would not have to offer 50% of her added value to attract money. If someone with the resources to make good the guarantee offered “market performance plus 10% of any surplus,” every indexer in the world would clamber to move his money to that deal. But just because people aren’t certain they can beat the market, and are unwilling to give you 50% of the added gain if they do, doesn’t prove there aren’t folks who probably can. . . THE $20 MILLION DAY TRADER Name Withheld: “I recently joined a small day trading firm (was previously working in fixed income/cmbs at Daiwa Securities and I’m otherwise steeped in the No Free Lunch school of thought). Of the 15 co-workers in the firm, I’m one of two who have not turned a positive return consistently to date. To be more precise regarding consistency, at one extreme, there is a trader that has had just 5 losing days so far this year. At the other extreme, there are three of the most successful traders who made at the low end $5 million and the high end $20 million gross during 1999 trading Nasdaq stocks exclusively, and using their own capital. The more successful traders — as measured by total dollars — have a much lower win/lose daily ratios than Mr. Consistency referred to before. My Consistency makes about $2000 on a typical day. This amount seems to be uncorrelated with his total equity. It’s simply a reflection of his trading style. It is difficult to conclude that something other than abnormal returns are being achieved here. Perhaps my Ivy League MBA, and CFA credentials have something to do with being one of the losers (so far) in this group. My point is that market timing is probably possible, unless we are the millionth toss of the coin that turned up its millionth consecutive head.” My own preferred market beater is the person like Warren Buffett or Peter Lynch or Michael Price who is brilliant, focused, hard-working, bombarded with the best ideas, and intent on finding good value. Market-beating speculators make me nervous, because “this shouldn’t be possible.” It’s one thing to be one of the first to taste a Krispy Kreme donut and take a bet that this thing could become really big. Or to keep your head and buy Citicorp at $10, when all about you are losing theirs. It’s quite another to just approach the market like a video game and make money at it. But assuming Frank’s information is accurate, I’d offer these thoughts. 1. Envy. (Is that an emotion and not a thought? And an incomplete English sentence, in any event? OK, how about this: Envy, envy, envy, envy, envy — give me $20 million. Me! Me!) 2. Skepticism. There are risks here. a.) In a different kind of market, Mr. Consistency might find himself losing $2,000 a day. Would he quickly quit? Or keep losing, certain his edge would return, until he had given much of it back? b.) Might any of these guys be using leverage? If so, what would one of those freak days in the market — down 23% in a single day in October, 1987 — do to their capital? Or how about freak events with a specific stock (Emulex, which was down 60% in hours on a hoax)? Of course, if they were short, those events would have just made them fabulously more rich. 3. Grudging admiration. Listen, to some extent this really may be like video games. I remember 20-odd years ago, when Touch-Tone phones were new, visiting a friend who was an institutional salesman. His job was to service the fund managers and the like with ideas and information (and jokes), so that they would direct business his way. “Oh, come on,” I needled him. “How do you know whether a stock’s going up or down.” “Haven’t got a clue!” he shoot back, “but I have the fastest fingers on the street.” Without looking away from me, he sent his right hand lunging for the phone keypad behind him and dialed a number in less time than it would take most of us even to think of the number, if we remembered it at all. When there was news, or a new research, my friend’s clients often heard it from him first — because he could remember all their phone numbers and dial faster than anyone else. They knew he had no clue whether stocks were going up or down; they didn’t have much of a clue, either. But he was first; they liked him; and they were happy to send commissions his way. Day trading is different, but here, too, being really fast helps. So does having an intuitive “feel” for the market. The first one to spot an anomaly in the market may be able to grab off that tiny pricing inefficiency — and it’s gone. When news comes out, being first to nail 5,000 shares of some stock that slower-witted or -fingered folks might take 15 seconds to realize might be tangentially affected . . . and then being smart enough to get out with a quick $5,000 profit a minute or two later once the stock has bumped up a point . . . well, I’m not saying some people can’t do this. Even without news, some people may be able to “read” the ebbs and flows of the market nimbly enough to dance in and out with a profit. 4. Not me. Realistically, this has nothing to do with investing. And even if it did, obviously, most people playing this game do not do well. If anything, the rare winners that Frank sits among all day are most day traders’ competition. Yes, you could quit your job — a job that is almost surely more productive for the world than day trading — and try your hand at this. (You could also learn to count cards and become a full-time black jack player.) But the chances are very good that, even devoting your whole life to it, you would not do very well — even with an Ivy League brain and an MBA and a CFA (Chartered Financial Analyst) certificate hanging on your wall. The real question: are any of Frank’s associates Democrats? Would they like to help me out with a big check?
Feedback on the Lesser Issues September 11, 2000February 15, 2017 THANKS, TOM Tom O’Connor: “Clearly, the solution is for you to host the first presidential debate, here on your website. Gore would be happy because you work for his party, and Bush would be happy because very few people would see it. No need to thank me.” Tomorrow, feedback on Investment Clubs. Today, feedback on some lesser issues. (See: August 21 and August 30.) ABORTION Eric Batson: “I was a high school debater in the late 60’s, and the statistic that still sticks with me was the deaths of women after illegal abortions. Five thousand women a year died (beyond the number that would normally have been expected), and many more were rendered sterile by post-abortion infections. Given that there were 500,000 to 3,000,000 illegal abortions annually back then (the most accepted number was 1,500,000), prohibition was obviously ineffective — but caused 5,000 excess maternal deaths. Right-to-life means death for thousands of adult women, with only a speculative effect on the number of fetuses not aborted. As unsettling as it is, we have to keep abortion safe and available.” THE ENVIRONMENT Parks S: “If the rest of the world that we have to compete with had to abide by the same rules we would place on ourselves at some expense, fine. But they won’t. It’ll be another unfunded mandate placed on businesses and/or individuals that ultimately gets paid by individuals. There will be no hardship borne by the government here, of course. They will grow merrily along. Any additional costs it incurs will be borne by — ah, you’re getting ahead of me — individuals.” So basically, Parks, you’d like to see us adopt Third World environmental standards so as to be able to compete on an even footing? My own thought is that rather than regress to lower standards, or even just maintain the (rather successful) status quo, we should keep lifting our standards — sensibly, not zealously or mindlessly — at the same time as we lean gently but firmly on our trading partners to follow our lead, albeit from much lower levels. (It may not entirely surprise you to know that Mexicans, Canadians, Japanese, and our other major trading partners actually have some concern for the environment as well, even if, as you say, it may be a lower priority than it is for us.) As for us individuals having to bear the cost, that’s true. But do you ascribe any value to breathing cleaner air? To the lower risk of cancer from pollutants? To being able to eat the fish you catch in a stream or drink water from your tap? To knowing that slightly fewer species may have gone extinct? If so, the benefits to individuals, while hard to measure exactly, may outweigh the costs. That’s certainly the intention, anyway. THE MINIMUM WAGE Tim: “All this talk about the Minimum Wage made me wonder: How do you think this country would be different if minimum wage laws didn’t exist?” A little less prosperous . . . an even wider gap between rich and working poor. A little less kind, less fair, less gentle nation. Parks: “I see signs at the local McDonalds saying that they are hiring ‘entry’ level people at $6 an hour which is more than the minimum wage. Why not let the market decide instead of the government?” It largely does. But for those who are least powerful and have no collective bargaining power, this serves as a useful floor. And because it applies to all businesses, they can all afford to live with it. If you made it voluntary, no one could hold the line in times of high unemployment . . . if competitors started paying less, they’d have to pay less, too, or be at a competitive disadvanatge. Granted, it’s more complex than this, and there are issues of foreign competition. But that’s why it’s $5.15 headed we hope to $6.15 — not $15. FAMILY AND MEDICAL LEAVE ACT Parks, again: “Most Republicans fear the camel’s nose under the tent that that bill started. Get a left-leaning business-bashing President and Congress and watch ‘unpaid leave’ get changed to ‘paid.’ (In fact, hasn’t this already been floated by the left?) Not paid by the government that enacted it, of course. An unfunded mandate (a tax by any other name) foisted upon businesses.” I don’t know whether paid family leave has been proposed, but I see your point. Next thing you know workers will be demanding paid sick leave. Hell, some crazy day they’ll start expecting paid vacations! But you seem to be suggesting that the interests of businesses (and, mainly, I guess, of business owners — us investors) are, ipso facto, more important than the interests of working people. Why? (And aren’t many of us both working people and investors?) Clearly, if business is not healthy, we all suffer. But so long as no one business is unilaterally disadvantaged — so long as all must play by the same rules — where is the harm? You would probably be among the first to point out that the extra cost of paid Family and Medical Leave — very small, but real — would at least theoretically be passed on to consumers. So investors (except in industries that faced strong foreign competition — read on) would not suffer. It comes down to . . . would consumers want to pay an extra penny knowing that, in their role as workers (many consumers also work), they or their kids or other loved ones might have this added benefit themselves? My guess is that most would consider this a reasonable deal, just as most probably do not resent whatever tiny portion of their phone bill goes to paying for the group life and health insurance that phone company employees may enjoy. Or how about this: Would we really want to make our electric bill infinitesimally smaller by removing the cost of safety standards in coal mines? The government has an important role in imposing standards like coal mine safety and family leave provisions, because often no one company can afford to institute them unilaterally (or at least believes it cannot afford to), yet as a group, they all could do it just fine — and might even want to. The one place I’d agree there’s some downside is in industries that face significant foreign competition. If paid Family & Medical Leave raised a company’s costs by 10% or even 1%, it would put that industry at a competitive disadvantage that our superior technology might not fully be able to overcome. Profits might suffer. But I don’t think paid Family & Medical Leave would cost nearly that much. And, in any event, I don’t think it’s imminent. Your e-mail was the first I had heard of it. THE SURPLUS: CUT TAXES OR PAY DOWN THE DEBT? Paul Stewart: “Washington never met a dollar it didn’t want to spend $1.10 of and start future programs that keep on soaring in cost. Would I like to pay down the debt? Absolutely. Will it happen? No confidence.” I hear you, but I disagree. Because we have a surplus, we are RIGHT NOW paying down the national debt, shrinking the supply of publicly-held Treasury obligations. The Democrats propose continuing to do that. The Republicans, who I believe were wrong in calling for a balanced-budget amendment but right in insisting we do what we can to pay down the debt, seem now only to give this lip service. The reasoning seems to be: Let’s not pay down the debt, because . . . well, we wouldn’t. So let’s commit a big chunk of the surplus to a tax cut that goes mostly to the wealthiest among us. By contrast, the Democrats are saying, and much of the public seems to be agreeing — YES, when times are good, we should be squirreling away resources (in this case, paying down our debt) so we’re in stronger shape when, inevitably, rougher times come. It’s straight out of Aesop’s Fables. The Democratic leadership gets it; the Republican leadership just keeps pushing to cut Steve Forbes’s taxes. EDUCATION Paul: “We don’t need to spend more money. And certainly not more strings-attached Federal money. The public schools will improve when people can walk out of them the same way businesses are forced to improve. I think a lot of a religious private schools would actually spring up. Of course, they would be non-union with no featherbedding and eternal job security. Whoops–there’s the rub.” Well, you’re right on this one. My old high school — an excellent “country day” school is nonunion, competes vigorously to be the best in New York — and probably is. Of course, tuition is $19,000, plus the cost of getting there, books, and so on — all in, perhaps $20,000 more than Bush’s proposed $1,500 voucher. And the school is completely full (in part with scholarship students), and so would have no room to absorb any appreciable number of the 94% of kids — or some number like that — who are in public school. The first problem with widespread vouchers, as I think I said in my column, is that first you have to give them to the millions of parents who already have their kids happily in private and parochial schools. Where are those billions going to come from? Raising taxes? Cutting the defense budget everyone now wants to raise? But even if you limited the vouchers only to the parents of kids in failing inner city schools, the second problem is: where are those kids, with their $1,500 vouchers, going to go? The private and parochial schools are already pretty full. And starting great new private schools with small class sizes and great teachers and terrific physical plant just can’t be done with the revenue from very modest vouchers. That said, the idea of competition and choice and charter schools and magnet schools, and standards and real incentives of the type Gray Davis rammed through as soon as he was elected Governor of California — these are all great, and widely supported among Democrats. Take a look at the numbers on charter schools. There were none, I think, or essentially none, when Clinton/Gore came into office. Now there are hundreds and hundreds, with federal encouragement to charter thousands more. In California, under Gray Davis’ plan, performance is posted on the Internet. Schools that perform at the bottom get closed, principals at failing schools get fired. Teachers at schools that do well are rewarded in some cases with school-wide bonuses of an eye-catching $25,000-per-teacher. There’s much more to it than this — a huge summer school program not just for kids, but for teachers and principals — but the point is: yes, Democrats want competition and incentives. But we also want to spend money to renovate terribly dilapidated schools, lower the student-teacher ratio, and pay teachers enough to attract and keep really good ones. Bush would spend a lot less, to make room to lower Steve Forbes’s taxes. ENDANGERED SPECIES Passed on from someone at the World Wildlife Fund: GEORGE W. BUSH ACCEPTS TROPHY HUNTING AWARD WASHINGTON, DC, September 5, 2000 (ENS) – Despite pleas from animal protection organizations, Texas Governor George W. Bush has just accepted the “Governor of the Year” award from the Safari Club International, a trophy hunting group that promotes the slaughter of exotic and endangered species, including elephant, rhinoceros, leopards, polar bears and crocodiles. The Safari Club helps its members find businesses that guide big game hunting expeditions around the world. The club also offers prizes to hunters who kill more than 300 different species. The organization is a defender of “canned hunts” in the U.S., in which the animals are confined to small fenced-in areas. Most of the animals shot in canned hunts are rare species sold to dealers by zoos and are often so tame they do not run away from humans, reports People for the Ethical Treatment of Animals (PETA). I’m not saying no one should be allowed to slaughter exotic and endangered species for sport — a man’s man’s gotta have a little fun in this crazy world. But to accept an award from this group? People wonder why Bush polls better among men than women. It’s a hunter/gather, football thing, I think. Men are wired to be hunters. Kill the buffalo to put meat on the table, kill the rhino to show you can do it, tackle hard, talk tough and don’t apologize. Women are wired to be gatherers. Protect the family, worry about education, worry about health care (“are you warm enough?” “wear your rubbers!” — the only time a man would ever thus caution his son is when he doesn’t mean footwear). Men have traditionally, I think, been more likely to start wars and relish contact sports. So the perception may simply be that W. — even though it’s Gore who climbed Mount Rainier recently and Gore who went to Vietnam — is just more of a man’s man. And this award from the Safari Club is one more trophy for his wall. HEALTH CARE Paul: “I’d feel a lot better about trying some more of these Great Society-type things if they didn’t have a history of running amok and having nine (thousand) lives.” I’d feel better too. But not so much better that I wouldn’t try to provide everyone decent health care. We seem to be the only industrialized country that fails to. Yes, our care is the envy of the world for those fortunate enough to be able to afford it. And yes, not everyone can have the best care. If a certain hospital is considered “the best,” not everyone can go to it. If a certain surgeon is ranked #1, not everyone can have him perform the by-pass. And if a new machine or drug comes on the market, not everyone can be the first to get its benefits. But decent care for all our citizens? Democrats are deeply committed to finding a way to do this. GUNS “Granted the NRA is wacko, but I really believe that law-abiding citizens owning guns is a deterrent to crime.” Could well be. No one is talking about preventing law-abiding citizens from owning guns. (One proposal would limit purchases to one a month; so a couple could wind up owning no more than 24 guns by the end of the first year. But if 24 guns in a home aren’t enough, proponents of this restriction might argue, “there’s always next year.”) I still owe you a column on this one. Tomorrow: Investment Clubs, a Challenge, and Traders who Make $2,000 a Day
Maybe I Should Give This Genius $20,000 September 8, 2000February 15, 2017 Edward Gardere: “Everyone has a theory and I am one who does not share specifics but will say that I look to technical analysis first to find potential stocks and then I use fundamentals to find value. Since February 1999 my portfolio on Marketplayer.com (name is holdenll) has a return of 130% vs the S&P return of 20%. This has been a method that has developed over time. You can see that by viewing a chart of my return vs the S&P which is also at this website. (NOTE: I have shorted stocks here but I would not do this in real life as I would use put options.) I use the puts because I believe you should be able to play downtrends as well as uptrends. My father asks if this is a ‘real’ money portfolio. I say no and he says ‘oh well, so what?’. Check out www.marketplayer.com. I have two portfolios. One is called holdenll…the other is excellent.” ☞ Well, at 130% a year, you should be able to run $2,000 in a Roth IRA into $43 million in 12 years, and to $2 trillion in 24. Sounds good to me. And please remember the little people — like your free web site providers — when you do. (And heck, that was with just one $2,000 IRA contribution.) Dickson Pratt: ” When I was younger I tried all sorts of schemes (options!, futures!) and consistently lost money. My biggest gamble was on the stock of the biotech company I worked for but our clinical trials failed and the spectacular collapse of the stock brought down the whole biotech market for years to come (and with it my fortune, such as it was, as well as my retire at 40 dreams). “Eventually, however, my ability to lose money was simply overwhelmed by my ability to save and live frugally (in the manner of “the Only Investment Guide…”). At one point I was saving 50% of my gross salary of $53,000, the most I ever made in my entire career so I wasn’t exactly raking it in. And with the serious money, the 401(k) and IRAs, I always chose a diversified mix of stock mutual funds, 100% invested all the time, and fiddled with them rarely although I tracked them frequently for the sport of it (I like to ‘race’ mutual funds). “You know the result: I retired at 45 and continue to live frugally except that now instead of working for money my money works for me. The message is clear: slow patient investing for the long term works, beat the market schemes do not.” Jerry Avillion: “I glad that losing $15k makes you so happy. I’d be more than willing to say ‘You were right’ for a mere $10k (ok, $8k but that’s my final offer).” Keith Fette: “If I can’t turn your $10,000 into $15,000 in one year, you’ll hear those magic words [“you were right”] again. What the hell, here’s one on the house: Buy 100 shares of a solid tech stock, say, Adobe, and sell a barely out of the money call that expires in a month. When the call expires or is assigned, do it again. On a $12,000 investment, you generate about $900-1000 per month. But I must admit I share your guilt feelings over not suffering for the money.” ☞ “A solid tech stock” — need I say more? Oh, well, I suppose I need to say a little more. I will try to cover the topic of covered calls again soon. For now, let me just suggest it’s not a bad thing to do, just not as good a thing as some people assume at first blush. Dorf: “Mark Twain said in his autobiography (paraphrasing), ‘I have made hundreds of thousands of dollars in my lifetime. But the most glorious money I ever got was a $50 bill I found on the sidewalk in San Francisco.’ So much for money ‘earned’ being more satisfying!” ☞ Mark Twain got it exactly right, as usual. The hierarchy of money, from lowest to giddiest, runs: inherited, self-made, found.
A Novel Mutual Fund Fee Structure September 7, 2000February 15, 2017 Easier Archives: No, I haven’t added the search capability to the Archives yet, and yes, I know it would be easy if only I could ever get around to it. But in the meantime, Marc Fest has added Quickbrowse View to the Archives. You’ll see it up at the top. Just click on it, and you’ll then be able to click all the archived columns you want — just pick off the ones that interest you — and then click the blinking Quickbrowse button that appears. Try it. It’s very cool — and can be easily added to any site. George Hoffer: “What do you think about the fee structure of the Royce Select Fund, a mutual fund which invests in the kinds of undervalued, overlooked stocks you espouse? They state: The Fund’s expense structure is an all-inclusive management fee that will vary in direct relation to the Fund’s performance. The performance fee will equal 12.5% of the Fund’s pre-fee total return, and is payable only after negative returns have been recovered — during periods of negative performance, no fee will be paid. This all-inclusive fee is the only ordinary expense that shareholders will incur. “The minimum investment is $50,000 and it says an investor must have a net worth of $1.5M before investing (how do they tell if you do?)” Well, the easy question first: They know your net worth is that high because you say it is. As to the fee structure, I sort of like it. It’s certainly smart from Royce’s point of view. Say the market for the kind of small-cap stocks this fund targets will appreciate at 10% a year. And say Royce’s stock picks do no better or worse than average. In that case, net of transaction costs, Royce will actually do a little worse — maybe 9.75%. (Royce cannot be blamed for this. If Royce buys a stock that rises 10% and then sells it, his 10% gain will be nicked by brokerage commissions and spreads, and by the possible cost of “moving the market” if his buying and selling affect the price.) So maybe the market is up 10% a year compounded for the next decade and Royce Select Fund, if it does no better or worse at picking stocks, is up 9.75%. Your fee on this works out to a not-low 1.22%, leaving you with a net gain — before whatever taxes the fund may have exposed you to — of 8.53%. In a small-cap index fund, you would have gotten closer to the full 10%. Of course, the point of investing in the Royce Select Fund is to beat the market, as Royce certainly may. Say the market compounds at the same 10% a year, but that Royce is able to compound at 15%. That is a very superior result. Now the fee works out to 1.875% — very high — though you net a still terrific 13.125%. If you’re persuaded Royce can do this, then Royce Select is a good deal — unless there are other funds that you think can perform as well that don’t charge high fees. (There are scores of top-flight mutual fund managers out there.) Chuck Royce’s well-reasoned investment philosophy and long experience are appealing. And I love the premise of this fund — finding small stocks, possibly overlooked, that have the potential to do well. But that would not be so different from, say, the Royce Low-Priced Stock Fund (RYLPX), which gained a whopping 22% in 1995 and 1996 (but the S&P 500 gained 37% and 22%) . . . which grew a fine 19% in 1997 (versus a finer 33% for the S&P) . . . and which eked out a 2% gain in 1998 (the S&P eked out 28%). RYLPX did beat the S&P in 1999 (28% to 21%) and is way ahead this year. But overall, if you’d invested $10,000 at the start of 1995, you’d have had $28,000 or so, pre-tax, on July 31 — versus $34,000 or so in an S&P index fund. After tax, the index fund would have put you even further ahead. Had this Royce fund had the same fee structure that the newer Royce Select Fund offers, Royce fees would have been much higher, lowering your return and widening the advantage of the index fund still further. There are two reasons I can think of Royce might have come up with this structure — both of them good, from Royce’s point of view. The first is that Royce believes he can compound your money at a high rate, and is willing to bet on his superior ability. Admirable. The second is that, even if privately he doesn’t think he can outperform the market, such a fee structure could have sufficient appeal to attract a lot of money. So even if the fund did perform only average, or sub-average, his fee income would rise — not because the rate rose, but because he had more money under management on which to levy it. (Royce Select intends to stop accepting new investors once it reaches $150 million. But all those investors could keep investing new money, so, along with appreciation, this could become a $1 billion fund in a few years. Presumably, the Royce folks hope to attract the first $150 million as quickly as possible, and this fee structure may help them do it.) I like the premise of the fee structure — it aligns Royce’s interests with its investors’ interests. But 12.5% is more than I’d want to pay. If Royce does really well, you’ll come out ahead despite the higher fee. If Royce does “average,” you’ll be paying a higher fee than you need to for average (index) performance. And if Royce underperforms, the lower fee will be little consolation. I suspect that over a long time horizon, and especially after tax in a taxable account, you might well come out ahead in a broad index fund. (Note: There is a 2% fee if you bail out of Royce Select before three years have elapsed.)
I Give a Young Genius $20,000 to Beat the Market September 6, 2000February 15, 2017 Easier Archives: No, I haven’t added the search capability to the Archives yet, and yes, I know it would be easy if only I could ever get around to it. But in the meantime, Marc Fest has added Quickbrowse View to the Archives. You’ll see it up at the top. Just click on it, and you’ll then be able to click all the archived columns you want — just pick off the ones that interest you — and then click the blinking Quickbrowse button that appears. Try it. It’s very cool — and can be easily added to any site. This is a true story, and not designed to make you hate me. A couple of years a go I got an e-mail from a very bright young guy — a graduate student with the kind of clarity, gumption, technical skills and instinct that I might have had at his age if I had been a little brighter and had ever managed to master higher math. (And also if, someplace deep down, I didn’t feel a little guilty making money too easily. Like anyone else, I want easy money; but on some deeply neurotic level, I feel as if I need to suffer for it.) This young man, in short, had the tools and the passion, and — through the expenditure of a tremendous amount of hard work — had built a proprietary “model” that, with an impressive degree of confidence, predicts swings in the market. We had actually corresponded on a couple of other topics prior to this — he had invented a device to keep plastic soda bottles from going flat after you opened them — and I was fairly blown away by the way he handled himself. This guy was 23? A 40-year-old should be so professional. (The soda bottle device fizzled, but that’s neither here nor there.) Anyway, over a period of a few e-mails, he described his market-beating model, which he had been putting to good use for friends and family, and on which he was basing a nascent market newsletter. “Oh, please,” I wrote back. “You cannot predict swings in the market.” “Can, too,” he wrote back. I am giving you the executive summary. My e-mails were actually long and dismissive. His were longer, respectful, and brilliant — to the limited extent I could understand them. And the net of it all is that I figured — never dreaming it could make me $1 million — I would give him a chance to “prove” it to me with real money. I figured, in the first place, that, heck, he might even be able to do it. Second, that if he failed, I’d have the great satisfaction of being right. (The three sweetest words in the English language: “You were right.”) And third, this was a way to give a bright young kid a boost. So I authorized him to lose as much of my money as he wanted trading puts and calls on the market, up to a strict limit of $20,000. Part of me wanted to exploit this young man’s talents to make me rich. Part of me wanted him to fail dismally, to affirm my view of the impossibility of timing the market, no matter how smart you are. My ego exceeding even my avarice, I can’t say I wasn’t actually, on balance, rooting for myself to lose money. I began to get e-mails from him and his wife like this one: Date: 09/24/1999 2:23:09 PM Eastern Standard Time Andy, in spite of our deep fear of this market, I placed a call trade for you near the close yesterday. I placed it using our model which evaluates calls assuming equal volatilities in all strike prices. It turns out that the volatilities are much lower right now on the out-of-the-money calls, so today we sold the first position for a $1400 loss and opened a very sizeable and risky position in the Oct 700 calls, which are a better deal when you combine the model’s historical results with the present situation in which in-the-money calls are disproportionately expensive. I don’t have a confirmation yet, but the trade was to buy 15 Oct 700 OEX calls @ 5 1/4 or better. At first, I was smugly relieved to see, the results were anything but spectacular. Here is another actual e-mail a few weeks later — blanking out only the name of his newsletter lest I appear to be touting it: Date: 11/05/1999 7:46:45 PM Eastern Standard Time Andy, our [market newsletter] is doing very well, and our model is up 11.7% for the prospective period (since 7/15) vs. -2.8% for the S&P 500. I am disappointed and frustrated, however, with our performance in your account, in which we have lost greater than $1,800 trading options. In spite of our best attempts not to do so, we have second-guessed ourselves when contemplating options trades for your account. We did not buy calls for you on our last buy signal, for example, because our signal’s waveform wasn’t exactly perfect, and we were shaken by losing money on our last trade in your account. If it is acceptable to you, I would like to try something that requires a little less thought. Specifically, when the model is long, I’d like to be 200% long S&P 500 depositary receipts (i.e. 50% margin), and when the model is short, I’d like to be 100% short SPY (no margin). This will leave less room for any brains/fear to get in the way between our model and your account. I hope that this does not degrade your confidence in our model. If the model’s current success continues, we will very likely be seeking financing to expand our business in the early part of 2000, and it would be very nice to have your support. I allowed as to how I had never had much faith in the model to begin with, and that so long as I didn’t lose more than $20,000, he was free to do whatever he wanted. Little did I dream that within a few short months he’d have run my stake up to nearly $1 million! Little did I dream it, and little did he do it. His e-mail: Date: 04/20/2000 11:18:57 PM Eastern Standard Time Andy, things haven’t turned out as well as we had hoped, to say the least. We are very close to being down $20,000, close enough that any further trading would probably be a desperate act. Our beloved model, which so soundly beat the S&P from July through December, has been mostly dormant this year, occasionally stirring to give us a piece or two of really bad advice and then going back to sleep. We’re down 17% YTD, and about 9.5% worse than the S&P; we have been stopped out on both of the last two signals in our futures trading. Our performance in your account has also been affected by my own unjustifiable optimism in the model, such that I have not consistently sold to cut our losses when I should have, for which I apologize. At this point there are only a handful of possibilities concerning our model: 1. Our good returns were due to random chance, and the model never worked at all. 2. Our model worked for a while, but doesn’t anymore, because a. the nature of one/both of our variables has changed b. different psychological patterns are emerging c. it was calibrated to a strong bull market / lookback error / etc. d. Things Fall Apart. 3. Our model STILL works, and the long time between recent signals interrupted by completely WRONG ones indicates a period in which investors are not acting in a uniform fashion as they usually do, etc. We are hoping, of course, that the answer is closest to #3, but only time will tell, and even if we again soundly beat the market for the year, I doubt many subscribers will be lining up to renew for such an unreliable system. My wife and I are probably going to turn our fledgling enterprise into a standard retirement planning/basic asset allocation sort of firm for at least long enough to recoup our losses. We still believe that if it is possible to time the market, it MUST be by this kind of psychology-based approach. We recently did a thorough analysis of the interrelation and persistence of numerous short- to long-term trends since 1950, and found, in a nutshell, that while short trends persist, medium ones don’t, and long trends persist, but exactly which trend one should be paying attention to shifts from month to month and year to year such that any resulting system would require a great deal of daily interpretation and “intuition.” It’s no wonder the promise of a purely mathematical model was so enchanting. I’m sorry that the pie in the sky turned out to be plastic sushi — very attractive until you try to bite into it, and then you’re out a couple of teeth. In short, things could hardly have worked out better. I had heard those three sweet, sweet English words — “you were right” — and it hadn’t even cost me the full $20,000. There was about $5,000 left. I view this $15,000 as one of the routine costs of running this site on your behalf, to help spare you the folly of trying for easy money with some brilliant market-timing scheme. I began by saying this column was not designed to make you hate me. And, yes, I did that in part to build a little suspense into the tale . . . but also because I fear that many of you do hate someone who ends every story, like this one, with boring, slow-but-steady, no-free-lunch, live-beneath-your-means advice. The good news is that slow but steady does win the race, and that this is why, having steadily contributed “the max” to my Keogh Plan in the 70s and 80s, there’s enough left over to keep this $15,000 hit from hurting. Tomorrow: A Novel Mutual Fund Fee Structure
Could This Really Be Optimal? September 5, 2000February 15, 2017 Easier Archives: No, I haven’t added the search capability to the Archives yet, and yes, I know it would be easy if only I could ever get around to it. But in the meantime, Marc Fest has added Quickbrowse View to the Archives. You’ll see it up at the top. Just click on it, and you’ll then be able to click all the archived columns you want — just pick off the ones that interest you — and then click the blinking Quickbrowse button that appears. Try it. It’s very cool — and can be easily added to any site. I went to an intriguing site, finportfolio.com, and set up a test portfolio with four stocks: MSFT, MCK, IDXC and HCBK. (I originally had eight, but the site did not recognize the four smallest.) I bought some hypothetical shares in each without thinking too much about how to divide up my hypothetical funds. I then clicked to have finportfolio.com “optimize” the portfolio. I had read that by using sophisticated techniques, it could re-weight a portfolio to increase its expected performance without increasing its risk. Finportfolio.com chugged around for a few seconds, performing the kind of calculations that would have taken Mathematicus himself 400 years to complete with slate and chalk, and concluded that I could lift my expected return from 14.83% to 37.43%, without adding risk. Wow! I could achieve this dramatically better mix, it told me, by dropping two of the four holdings altogether and cutting back the third from 25.68% to 13.30%. That way, MSFT would be 86.70% of this small but optimally balanced portfolio. To wit: Current Weight Optimal Weight Expected Return 14.83% 37.43% Volatility 32.25% 32.25% HCBK 35% 0% IDXC 24.82% 0% MCK 25.68% 13.30% MSFT 14.50% 86.70% My first thought was that this is really remarkable technology. To think that we now have Modern Portfolio Theory models at our fingertips! My second thought was that this is a little scary. Because it appears so authoritative — displayed to two decimal places, no less — one might easily jump at the chance to put its results into action. But can it really make sense? Will the volatility of a portfolio containing MSFT alone (well, virtually alone) really be no greater than that of a more diversified portfolio? In an even more stunning display of what we can now do instantly and for free that Mathematicus would have labored a lifetime over — and that would have defeated his slower-witted half brother Arithmeticus altogether — a visitor to finportfolio.com gets to click on the horizontal axis of the “Efficient Frontier” graph (not shown here) that accompanies the optimization table. Click to the left or right, and you adjust the level of acceptable volatility . . . and see the optimal portfolio weightings change instantly as you do. Basically, the more volatility I am willing to accept, finportfolio.com tells me, the more MSFT should dominate the portfolio. If I am willing to make it 100% MSFT instead of “just” 86.70%, the expected return rises yet a hair more, from 37.43% to 37.74%. Or, if I want the absolute lowest possibly volatility with this combination of four stocks, the model says I should weight them this way: Current Weight Optimal Weight Expected Return 14.83% 25.20% Volatility 32.25% 26.94% HCBK 35% 21.54% IDXC 24.82% 8.11% MCK 25.68% 17.14% MSFT 14.50% 53.20% Notice that now the volatility figure drops to 26.94% — less risky than the 32.25% in my current mix — and that this reduced volatility comes at the sacrifice of some expected return. With this mix, I should not expect the phenomenal 37% annual return of the prior mix. The model says I’d nonetheless be improving dramatically on my current mix, raising my expected return from 14.83% to 25.20% But how does it know? Of course, it doesn’t know. What it does is use assumptions based on the past performance of these stocks to do some very sophisticated, brilliant, and Nobel-prize winning calculations to arrive at its expected results. But it still doesn’t know. If it did, it could simply optimize (for example) the S&P 500 index, weighting not by market cap, as S&P does, but by Modern Portfolio Theory black-box magic, and come up with a Nobel-prize-winning index fund that significantly outperforms the index with no more risk. You can be sure people have thought of this and tried it. Where is it? And why wouldn’t most pension fund managers and bank trust department managers, who have long had access to these computer models, not have generally beaten the market as a result? Years ago I got to co-host a PBS Documentary called “Beyond Wall Street” that devoted a half hour to each of eight amazing money managers (all living and working somewhere other than New York City). One of them was Barr Rosenberg, outside San Francisco, a brilliant pioneer in much of this quantitative analysis, and who had the kind of computer software, hardware, and global data network that would could turn the average banana republic into a junior superpower. And do you know what? Some years he had done very well, other years not so well — just like you or me. Overall, I was fully persuaded he was smarter and more capable than I’ll ever be . . . but I was not persuaded he could, even with all that fire power, beat the market by much, if at all. Finportfolio.com is fun to play with, and I happen to think MSFT stock may do quite well going forward. (Hope so: I own some LEAPS.) But that sort of judgment may be nearly as unreliable coming from a black box as from a human brain. Tomorrow: I Give a Young Genius $20,000 to Beat the Market
Risk Grades September 1, 2000February 15, 2017 Tuesday, I suggested you might enjoy fooling around with ValuEngine.com. Today, for those of you unaccountably at work or in the house on one of the last days of summer, I thought you might enjoy fooling around with this: riskgrades.com. (Thanks to Mark Centuori for pointing me to this one.) Or click here to learn how to spot a fake press release (thanks to Toby Gottfried). I, for one, am going outside to play. Happy Labor Day!