Year: 2000

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

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:

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:

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

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!

Michael Joy: “A group of employees of Nationwide Insurance are starting an investment club that I am considering joining. (I’ve actually gone to one of the meetings.) What are your thoughts on investment clubs?”

I think investment clubs are “good for America” because they’re part of the overall fabric that attempts to allocate capital sensibly . . . and the more people who are part of that fabric and feel a stake in it, the stronger we are.

They’re also, potentially, fun, stimulating, and a place to build friendships.

At the end of the day, however — “the day” here being metaphorical, and covering, say, a 10-year span — you will likely do no better than, and very possibly worse than, you would have done in an index fund.

Certainly in any given month or year you might significantly outperform the indexes. But I doubt your club can do it over the long run. Even the Beardstown Ladies, who sold millions of books based on their wildly miscalculated results, found that, at the end of the day, they did considerably worse than the averages.

There’s also the potential for disharmony with your fellow club members, either socially (have you noticed how annoying some people can be?) or for tax reasons. You’ll want your club’s partnership agreement to allow pro-rata withdrawals in stock as well as cash, to allow you to exit without generating a taxable gain; and to be able to withdraw your share of certain positions to take a tax loss even if others don’t want to, or to use a big winner to make your 25th college reunion gift.

Bottom line: If you’d enjoy it, by all means join the club. Otherwise — the occasional cater-waiter job? — put the same time into earning something extra to invest.

My own feeling is that on what are perhaps the three most highly charged issues separating much of America — abortion, guns, and gay rights — there really are solutions, if only the direct-mail folks didn’t have such a strong interest in fanning the flames.

Abortion. No one likes the idea of abortion. But prohibition worked no better for abortion than it did for alcohol. It did relatively little to keep young women from making this agonizing choice, it just made it even more agonizing — and dangerous. And so I keep coming back to the compromise that the late Carl Sagan and his wife Ann Druyan suggested several years ago in PARADE. Basically, they looked at what differentiates human life from any other, and concluded it was only the capacity for human thought. In every other respect, a cow is just as miraculous a creature — and we slaughter and devour cows routinely, even though we have no need to. (I’m not so crazy about doing that, either, incidentally. But I wouldn’t ban it.) So, Sagan and Druyan suggested, why not determine the point at which human brave waves manifest themselves — around the sixth month — and say that beyond that point — but only beyond that point — abortions should be restricted to extraordinary circumstances (e.g., when the life of the mother is at risk). Those who believe a one-day-old embryo is sacred should absolutely not take a morning-after pill; but neither should they impose their beliefs on others.

Guns. Few favor banning guns. But why on earth can’t we agree to treat them with the same degree of responsibility as we do automobiles? With some safety regulation and licensing/registration requirements? I know I owe you a column on the Second Amendment, and it’s coming. So let me hold off on this one.

Gays. And then there’s the gay thing, which for many is simply a matter of following what they’ve been taught in the Bible. (They do not, however, seem to regard football as an abomination, even though touching pigskin is clearly proscribed as an abomination; or to want to stone non-virgin brides in the public square until dead, as is also required.) Logic is no match for faith, so here’s what I have long proposed: Let us stipulate that for two people of the same sex to “lie down together” is unnatural. That it is perhaps even an abomination before God — if they’re straight. OK? Let’s agree! STRAIGHT PEOPLE SHOULDN’T DO THAT! But let’s also agree that for two of God’s millions of gay and lesbian children, it’s the most natural thing in the world. Indeed, what is unnatural is to try to force them to live loveless lives of loneliness and dishonesty.

Wouldn’t this compromise work? It’s a sin for straight people to have gay sex.

But religion aside, what about the law?

Here’s one side’s view:

“We do not believe sexual preference should be given special legal protection or standing in law.” — Republican Party 2000 Platform

I have full confidence that the Republican Party will get it in due time. Maybe even pretty soon. But they sure don’t get it yet.

For starters, it’s not a “preference,” which suggests a choice — red wine or white tonight, sir? The term most thoughtful people have come to use is “sexual orientation,” which suggests something more fundamental.

Still, it’s true: People do bristle at the idea of giving anyone special rights. So do I.

But consider these questions:

Is it a special right to be able to visit your life partner in the emergency room? If so, no one should have that right.

Is it a special right to receive Social Security benefits after the breadwinner dies? If so, no surviving spouses should receive benefits.

Is it a special right for a widow or widower to inherit his or her partner’s property tax-free? If so, the estate tax should hit the surviving member of all couples, not just gay couples.

Is it a special right not to be discriminated against solely on the basis of one’s “status”? (“Irish need not apply.”) If so, it should be legal to fire / not hire / not serve, anyone for being who they are — black, Catholic, disabled — not just gays and lesbians.

Is it a special right for two loving adults to enjoy intimate relations in the privacy of their own bedroom? If so, no one should be allowed to do that, except strictly as needed, and in the most peremptory way, to reproduce. George W. Bush supports the Texas sodomy law under which his running mate’s daughter could be sent to prison.

Is it a special right to be protected by hate crimes laws? If so, none of the traditional targets should be protected. George W. Bush was willing to sign a hate crimes law after James Byrd, Jr. was dragged to death behind that Texas pickup truck — but only if the phrase “sexual orientation” were removed. The KKK/neo-Nazi types are way out of line going after Jews and blacks, the reasoning seems to be. But gays . . . well, that’s a different story.

Gore sees it differently. He supports the Hate Crimes Prevention Act and the Employment Nondiscrimination Act and has promised to appoint a commission to recommend the best way to give the same economic benefits to gays and lesbians as to anyone else.

“The cause we celebrate tonight,” he told the 1998 Human Rights Campaign dinner, “is not some narrow special interest. It is really the cause that has defined this nation since its founding: to deepen the meaning of fundamental fairness … to build a good and just society on this bedrock principle: equal opportunity for all, special privilege for none.”

That’s why even a lot of my Republican friends are voting Democrat this year.

Tomorrow: Should You Join an Investment Club?

I don’t think it will help you beat the market over the long run. After all, you’re competing against people who have tools at least this powerful, some of whom have a staff of analysts who do all kinds of research that you probably can’t (when was the last time you chatted with top executives of one of the companies you own shares in?) — and they don’t beat the averages over time, for the most part, either.

Still, if you own stocks, I think you’ll have a great time exploring the free tools at ValuEngine.com. Boy, have we ever come a long way from the days of people making charts on graph paper or going to the library to look something up.

FIXED LINK

Sorry about Friday’s link to Forbes. I fixed it, but until Saturday it was pointing to the wrong article. The topic: whether to invest through mutual funds or build your own. Here it is again.

FREE PALM

Doug Gary: “DLJdirect has the Handspring Visor offer again. This time it is with an opening account deposit of only $1,000. You have to keep the $ there for six months earning a good money market rate — no other requirements. If one wants a Palm-related product, this is an instant 18% extra return on one’s money. Here’s the link.”

NO GUTS

So it turns out that I get a small plaque on a wall of plaques at a hospital. Asked how I want it to read, I send back: “Thank You for Not Smoking.” This apparently throws the development staff into a bit of a quandary. All the other plaques are “in memory” or “in honor” of someone, or else just “dedicated by” the donor. Do I really want my plaque to say this, they wonder?

A little irreverence in a good cause? A little levity to cheer people up? Or would this offend people, ruining the overall “tone” of the wall?

Ultimately, I chicken out. It will be a plaque more or less like all the others.

But if only we could do a better job helping today’s teens avoid this beguiling addiction, we’d need dramatically fewer hospital beds down the road. Smoking obviously should remain legal. But in Canada, half of every side of the cigarette pack is being devoted to the naked truth: things like vivid photos of lip cancer. How’s the Marlboro man gonna sell that? (Actually, the Marlboro man is long dead of lung cancer.)

PHONE HOME

Steve Coultas: “Your readers might be interested to know about BigZoo, a company that charges 3.9 cents a minute for long distance anywhere within the 48 contiguous states. They used to have just one 1-888 number (this is a dial-around type plan), but have recently added two more 1-888 numbers to dial, together with local access numbers which, if you use, you are then charged only 3.6 cents per minute. They have just added a 75-cent a month fee, but that’s the only fee they charge. You have to pay in advance, online, using a credit card. I think it’s $10 increments. Phone call quality has been identical to any large company for me.”

Dan Beck: “A good site for phone rate comparisons among about every phone service extant is abelltolls.com.”

Have you seen Personal Fund lately? It’s now much more than the Mutual Fund Cost Calculator — and even that part has been improved in several ways, including access to 10-year performance ratings.

The beta you can now access is a work in progress. But WOW has Stefan Sharkansky, the genius behind all of this, ever been doing great work. Check it out. There’s a lot to it, and it will retain your portfolio information, so you can keep coming back to it.

The larger point here is that the world seems to be moving toward this idea of Personal Funds that several of us have been espousing. Click here to read Forbes‘s take, hot off the e-presses.

The question is: Should you do your investing through no-load, low-expense mutual funds, as so many of us have long been advising? Or, now that technology and dirt-cheap transaction costs have made it possible, should you build your own Personal Fund to minimize the costs even further and — more to the point — grab the tax advantages?

My own answer would be that, while everyone finds his own comfort level and goes at his own pace, Personal Funds are likely to become a Very Big Thing in the next few years. This is what Forbes seems to conclude, also.

In the meantime, the tools you’ll find at Personal Fund are free, and they may be useful both in analyzing your mutual funds and in getting a picture of all your holdings — mutual funds as well as individual stocks.

(For those of you new to the column, full disclosure: I am a part-owner of Personal Fund.)

Monday: No Guts; Phone Home

Corrections:
 
Tuesday, I showed how you’d do investing $2,000 in a Roth IRA from age 25 to 70. Idiot that I am, I entered “70” in my calculator as the number of years when I meant to enter 45 (70 minus 25). I’m usually more careful (and have gone back and corrected the column). But when it rains it pours . . .
 
Yesterday I was asked how the parties decide which one holds its convention first, and I said “It alternates. Next time, the Democrats go first.” Oops. As Bill Jones and others were quick to inform me: “By tradition, the party that does not hold the White House puts on their convention first.”

Charles made a sharp observation the other day. We were at a benefit concert that featured a sign language interpreter for the hearing impaired. As Boyz II Men were performing, I leaned over and asked Charles if he could make out the lyrics. Charles — who knows a lot of lyrics but not these — thought about it for a minute, pondered the irony, and replied, “Only the deaf people in the audience know what they’re singing.”

And that got me to thinking about signing and the ability to read lips.

And that got me thinking about politics. (These days, everything gets me thinking about politics.)

Click here.

Mike Cheymann: “Gore couldn’t or wouldn’t stand up and admit Clinton screwed up. That alone disqualifies him from any further sumstantive puplic position.”

☞ Well, that settles that!

Amit Basu: “How do the parties decide which one holds its convention first?”

☞ The party that holds the White House goes second.

Kurt Hemr: “Just a quick clarification to Jim Batterson’s comments: There is no backlog of criminal cases in the federal or state courts, nor could there be, because the Constitution guarantees a speedy trial. Nevertheless, J.B.’s correct that unfilled seats on the bench create a backlog — it’s a backlog in civil cases, which are moved to the back of the line to ensure that the criminal cases are tried in a timely manner.”

Jim Batterson: “Since you’ve posted my rant on slavery and other international issues I’ve been checking my facts and thought you might like some references and updates. As to slavery in Mauritania and Sudan, click here . . . I was wrong, or at least outdated, about the US position on children in combat. We refused to sign this treaty for six years but in January the pentagon relented and Clinton signed July 5th. Let us hope the Senate ratifies. . . . Click here for a fierce indictment of the (Republican) Senate Judiciary Committee holding up minority judgeship appointments . . . and here for a country-by-country synopsis that explains why the U.S. has not accepted the International Criminal Court. Finally, it was Trent Lott who blocked the vote on Hormel’s appointment to be ambassador to Luxemburg, not Jesse Helms, although Helms has blocked many on his own.”