Author: A.T.

Steve Berman: “You quote towards the bottom of your column that 9% is the average annual return for US stocks including dividends but before inflation. I thought the IBBOTSON data for large U.S. stocks was much closer to 11% a year — going back at least to 1925 or so — and even higher for small stocks. What gives?”

☞ I was looking at the traditional number before this amazing 18-year run-up. Only when you add that in does the 9% or so jump to 11% (and perhaps even a bit more when you include small stocks). So the question is — is 11% or so the new “mean” we can expect going forward, or is 9% or so the traditional mean to which the market, with time, will revert?

I obviously don’t know for sure, but my hunch is that 11%, pre-tax, pre-inflation, will not be the new standard. (And note that even if it is, that would be a lot lower than we have come to expect, lo these last boffo 18 years.)

I hope I’m wrong!

Dean Cardno: “You slightly misrepresented ‘Reversion to the Mean’ in today’s column. As applied to tossing coins, it does not mean that an observed string of heads will be followed by slightly more tails. Even after an improbable streak of heads, the forward-looking expectation remains 50/50 heads/tails. The results will ‘revert to the mean’ only when an infinite number of trials are averaged in with all the past results (necessarily a finite number).

☞ You’re right. I used a bad example. But I came close!

Sergei Slobodov: “If you flip a coin 100 times, you are likely to find the number of heads (and tails) deviate from the mean by about 10 or so, in one direction or another. If you flip the coin another 300 times (total of 400), the deviation would be about 20, or square root of 400. This is known as ‘random walk.’ After a million flips, you are likely to ‘walk’ about 1000 away from the mean. And since the coin does not remember the past, there is no reason to believe that you get more tails (or heads) in the next million flips to ‘compensate’ for the past history. Thus, no reversion to the mean.”

☞ You’re right. I used a bad example. But I came close!

Jonathan Levy: “Assuming a fair (balanced) coin, the expected distribution of future coin flips is 50/50 regardless of past history. Coins do not have memories. Neither do dice.”

☞ You’re right. I used a bad example. But I came close!

If a bright child flipped 7 heads out of 10 the first time he tried it, he might conclude that there’s something about the coin that tends to make it heads-heavy, and to expect 70% heads in the future. As he kept flipping, of course, the overall result would inexorably revert back to 50% — but not, as you say, because a run of heads can be expected to be followed by a run of tails.

I feel as if the last 18 years in the market, because of falling interest rates and rising price/earnings ratios — which have magnified the earnings gains — have been atypical. Rates will not fall forever, p/e’s will not expand forever, and thus earnings gains will not be magnified and translate into outsize stock-price gains forever.

So a lot of bright young investors who’ve come to expect 70% heads just because it’s “always” been that way in their 18-year experience might be expecting too much going forward.

A “string of tails” would result if price/earnings ratios — or earnings growth — fell for a while. That may not happen for a long time, or might conceivably never happen. But though I’m an optimist, I’m not that much of an optimist.

I expect great things for our planet, our country, and the stock market. But I doubt the stock market will do nearly as well these coming 18 years as it has over the past 18.

Sorry about yesterday. Make back-ups! Make back-ups! Make back-ups! Happily, all I actually lost was 28 hours, but no data. And all that caused it was a brief power outage.

Tomorrow, “Reversion to the Mean Coin Flippers.” But today, a first look at Dick Cheney.

My own advice, as some of you know, was that the Republicans should go with a proven strategy: Bush / Quayle. Instead, Bush reached out to Dick Cheney.

Cheney is, by all accounts, a nice guy. But here are some things that struck me about his record – and that may portend the kind of Supreme Court nominees that Bush will send over to Trent Lott for confirmation if he wins. I apologize if you’ve already read the essence of this six times – I’m sure versions of it will make their way around:

In 1983, Cheney voted against the Equal Rights Amendment – the one that banned discrimination against women. This isn’t to say he doesn’t believe women should be treated fairly, just that he voted against that landmark legislation.

In 1985 (and on eight other separate occasions), he voted against economic sanctions on South Africa. This is certainly not to suggest he favored Apartheid – surely he did not – but the net effect of his votes was to make him one of the Apartheid government’s best allies in Congress.

In 1986, he voted against a resolution expressing the sense of the House that President Reagan should urge the South African government to, among other things, grant immediate and unconditional release to Nelson Mandela and other political prisoners. This is not to say he favored keeping Mandela in prison – obviously not. But many others did favor the resolution.

In 1988 he was one of 13 only House members to vote against the AIDS Federal Policy Act, which was the first major bill to provide funding for HIV/AIDS counseling and testing. Cheney also supported an effort to reduce funding for HIV/AIDS research.

Also in 1988, he was one of only 29 House members to oppose collecting statistics on hate crimes, let alone try to do anything about them. The conservative position is that all crime is hateful, regardless of motive, and that while distinctions should be made based on intent – first degree murder, second degree murder, manslaughter, and so on – dragging a randomly selected black man on a chain behind a pickup truck until he is dismembered, just because he was black (or for blacks to do the same to a white guy, just because he was white), does not fall into a category of crimes that threaten our diverse society more than others.

So he’s a nice guy – and I mean that without sarcasm – but his conservatism could seriously erode Pat Buchanan’s base.

Friday: Silver

Computer crash: back online tonight or tomorrow.

You might think that $1.70 is worth about $1.70, or that a rose by any other name smells as sweet — but already I am confused. As sweet as what? (Why did that man never just come out and say what he meant?)

So let us review:

1. When tiny little Calton Homes (CN) had what appeared to be about $1.70 in cash and no liabilities or expenses or operations, no one wanted it at $1. Who wants to pay a buck a share for $1.70 in cash, the market’s reasoning seemed to go, when at the very same time you could buy some dot-com with no appreciable cash for 2000 times earnings?

Well, I wanted it — for two reasons. First, I liked the odds. Sure, the owner could screw it up and lose that $1.70 in cash, but he had more than 11 million reasons not to. His own shares. Second, I liked the simplicity. In a complicated world I surely do not pretend to understand very well, a company with essentially no expenses or operations or liabilities and just a big pot of cash is the kind of company I feel marginally able to form an opinion about.

And what could account for a thing that appeared too good to be true? Three things. First, CN, despite its American Stock Exchange listing, is just so small and trivial that no self-respecting player, let alone institution, could possibly be interested. Second, the frenzy for New Economy stocks may have made an asset play like this even less interesting than usual. Third, everyone knows that if it seems too good to be true, it probably is — presumably, there was a catch.

And there still may be — cockiness is rarely a winning analytical tool — but let’s continue with the review.

2. Calton put a few hundred thousand dollars of its cash horde into an e-business that it renamed eCalton. Well, now, that’s different! eCaltion! eXcitement! eGads! And the $1.70 in cash that most people wouldn’t pay $1 for was fairly quickly bid up to a high of $6 and change. The message boards had discovered this hot new eCommerce stock — a smart 62-year-old home builder from New Jersey who had entered the dot-com fray — and, well, what dot-com incubator wasn’t worth a billion or two?

By the time CN did reach $6 and change, I had sold most of mine and had recommended you do likewise. My February 11 column was titled, “The Lunatics Take Over – Yippee!”

3. Not long afterward, the stock collapsed, along with the other wing-and-a-prayer eStocks. Today, we’re back to its selling for about 85 cents (well, actually $4.25 after a one-for-five reverse split, but let’s stick with the old numbers for now), and, after a variety of transactions, it still has something like $1.50 a share in cash. Except now it also has stakes in a few Internet businesses as well. And still the homebuilder guy from New Jersey has 11+ million reasons not to screw it up. (Well, 2+ million post-split).

So I’ve been buying again. How bad can it be to buy $1.50 in cash for 85 cents?

Now let’s switch to the post-split numbers. Because of the 1-for-5 reverse split, the price is now $4.25, not 85 cents. And the $33 million or so in cash (based on the last public report I saw) is divided over about 4.3 million shares, not 20+ million, which works out to about $7 each.

And maybe the owner will still find a way to fritter away all that cash and, ultimately, make his, and our, shares worthless. Believe me — it’s been done before.

Having said all this, “if it seems to good to be true, it probably IS,” so please do not invest in this even a nickel that you could not be philosophical about losing. I live in dread of ever hurting you financially.

And please don’t “bid up for it.” As tax-selling season approaches in earnest, I like to think that many of the folks who paid $25 and $30 a share — and that one guy, at the top, whoever he is, who paid $33.75 — will be selling their shares in disgust, for the tax loss, driving the price down even further. That would be good news for us buyers. Yes, CN may be “worth” about $7, because of its cash. But please don’t pay anywhere near that much. What’s the incentive to pay $7 in liquid cash for $7 of cash you can’t actually get your hands on? Especially when, run wrong, CN could blow through that cash in no time?

But who knows: with enormous good luck, maybe one of the little dot-com investments CN’s been making could be a winner. It’s a long shot. That’s what makes it fun.

Yesterday, Allan asked me to tell him — “in a couple of paragraphs” — why I thought stock market returns would be a lot lower these next 18 years than they’ve been the last 18 . . . and what to do about it.

My plan was to do all this in two curt paragraphs. Here was the first:

1. “Why [do you expect] lower returns?”

–Because price/earnings ratios have been expanding for 18 years and interest rates generally falling. This cannot go on forever, and even if it just stopped, let alone reversed, the rates of return would be lower.

I was all set to move on to the second part of the question, and the second curt paragraph, when I decided that . . . hmmm . . . some of you might appreciate a little elaboration.

Before I knew it, millions of perfectly good electrons had been sacrificed to this end. So lengthy was my elaboration that it broke the server (apologies if you got a stale Q-Page delivery or saw an endless unformatted version) and, once it was finally fixed, put a large percentage of you to sleep and caused at least one of you to be late for work and lose her job. For this I am profoundly sorry.

So today — briefly — Allan’s second question:

2. “What should we do about this, particularly those of us who are planning to retire soon (‘don’t’ may be good advice but it is so depressing!)”

–Don’t.

Oh, OK, go ahead and retire if you’ve really thought it through. But there are strong arguments for working a bit longer — or transitioning to semi-retirement, enjoyably supplementing your income as a consultant or part-timer or running a bed and breakfast as you rock on the porch.

Argument one is that retirement kills. Staying busy, needed and involved (although not necessarily drawing a paycheck) keeps you healthy.

Argument two is that we have a shot at living a lot longer than most people used to, so prudence suggests that we should earn some more, while we can, to provide for those extra years.

In playing with retirement “calculators,” it all comes down to the rate of return you guess you may earn on your money. If you assume 15%, you can retire by Tuesday and live comfortably off your investments for another 100 years. But I would urge you to assume something much more modest, like 5% (to net out the effect of inflation), or even less when you need to plug in an “after-tax” return. Perhaps this will prove too conservative. Wonderful! I’d much rather you be annoyed with me because you have too much money supplementing your Social Security 20 or 30 years from now, rather than too little.

Beyond that, here is some very general, brief advice. Obviously, one size does not really fit all. But . . .

1. Especially as you grow older, a portion of your assets should be someplace relatively safe. That’s one reason I like Series I Savings bonds — they are backed by Uncle Sam, they protect you from inflation, and they grow tax-deferred. Visit savingsbonds.gov.

2. You might want to add to that a portfolio of fairly long-term high-grade municipal bonds, especially if you live in a high-tax state. If you buy “GOs” — general obligation bonds — you won’t have to worry about becoming an expert. They will be safe. And these days, municipals offer a good rate of return for people in high tax brackets. The only risks are, first, that interest rates will rise — leaving you wishing you had waited to get the higher return. And, second, that interest rates will fall — and your bonds will be called in early. So carefully check the “call” provisions of the bonds you buy. If you do buy municipal bonds, you can always sell them (at a loss, if rates have risen, at a profit if rates have fallen). But plan to hold them to maturity, because selling municipal bonds usually subjects you to a haircut. Your broker will likely offer you a fairly rotten price because he knows you have little convenient way of shopping them around to others. As for buying municipal bond funds, I would skip that. Why give up some of the income in annual expense fees? If you buy GOs, there’s no need to pay for diversification — they’re safe.

3. But even though you are retiring one day . . . and even though I doubt the next 18 years will offer nearly the same stock market returns as the last 18 . . . keep a good chunk of your dough in stocks — the simplest, best way for most people being though index funds (both US and international). And if you can, plan to keep adding the same $1,000 a month or $2,500 or whatever you’ve been adding all along. Because even if stocks don’t do spectacularly, there’s a good chance that, over the long run, they will do well, as they always have. And if you keep investing monthly, dips and crashes just help you buy shares cheaper.

4. Keep your riskiest investments outside your tax-sheltered retirement plans, and your relatively safe, high-dividend investments (like real estate investment trusts) inside. (And never put things that are already tax-deferred or tax-free inside a retirement plan. E.g., buying a municipal bond inside an IRA would serve to turn its tax-free interest into income you ultimately had to pay tax on at withdrawal. And buying an annuity, which is already tax-deferred, inside an IRA, is just wasting the tax-deferral of the IRA on something that’s already tax-deferred.)

5. Think twice and then three more times before buying annuities. (But if you have TIAA-CREF annuities, don’t be alarmed. They’re pretty good.) I’ve written about this several times before. Click here for one of my more succinct renditions and here for a wordier version.

There is surely more to say about this subject, but I don’t want anyone else losing his job.

Allan Sleeman: “EIGHTEEN LEAN YEARS? Just got around to reading the column where you allude to this. Did I miss something — Oh God, another Senior Moment! — or have you just joined the reversion-to-the-mean crowd (non-entities like Warren Buffet and John Bogle)? I would have thought, naive person that I am, that this would have been a major insight to share with us poor peons. But maybe you did do a piece on the expected long-term behavior of the market. If not, I at least would be extremely interested to learn why you are talking about much lower expected returns. Then, of course, I would like to know what sort of advice you would give about what to do about this, particularly to those of us who are planning to retire soon (‘don’t’ may be good advice but it is so depressing!). Naturally I am aware that a number of smart people have written whole books on the subject recently, but please boil it all down into a couple of paragraphs.”

1. “I would be interested to learn why you are talking about much lower expected returns”

Because price/earnings ratios have been expanding for 18 years and interest rates generally falling. This cannot go on forever, and even if it just stopped, let alone reversed, returns would be lower than they have been.

Right? If people are willing to pay $12, say, for each $1 of corporate earnings — 12 times earnings — and if those earnings are rising at 9% a year, stock prices will also rise at 9% a year. But if as the earnings are growing the multiple people are willing to pay is also grow, say to 30 times earnings, stock prices will have grown at a much faster than 9% rate. But now, say, the expansion in multiples stops and they stay steady at 30 times earnings. With 9% earnings growth, you are back to a world where stocks also grow at 9% a year. Unless the multiple people are willing to pay should actually begin sliding back down again. Then, even with 9% earnings growth, stock prices could actually fall for a while, or at least rise less quickly. And what if corporate earnings didn’t grow 9%, but only 5%? Or actually slip for a while?

I don’t know where earnings are going — up, I imagine, in most years. But I do doubt that the stock market multiple will rise much further, and would not be surprised to see it contract. So the big fun — 18 years of rising multiples — would seem to me to be over.

Obviously, there will be ups and downs in all of this. Obviously, “the market” is many markets combined into one. Lots of stocks have never come close to being richly valued, while others have been bid to crazy heights. Obviously, some of the adjustment to more moderate returns has already occurred. (The NASDAQ is down about 20% from its high, the Dow off nearly 10% . . . even as earnings have been growing . . . so some of the moderation in multiples has already occurred.)

There are some fantastic forces that bode well for the future, and could argue against “reversion to the mean.” (Reversion to the mean is the notion that when things have been rising above average for a long time, they will eventually rise below average for a while until, overall, the traditional average is restored. It’s a law when it comes to flipping coins, but only a strong suspicion when it comes to the stock market. “Mean,” meanwhile, for those of you who were doodling that day, is the same as “average.” Median is the one that’s different. [If you have 10 people earning $20,000 a year and one earning $20 million, their median income will be $20,000 — the mid-point person’s pay — but their average/mean income will be $1.84 million.])

What are these fantastically positive forces?

• The peace dividend, which allows the world to spend less on nonproductive things (like hiring young people to leave assembly lines making things and employ them, instead, killing other young people or blowing up factories). The U.S. used to spend 6% of its GNP on defense, now closer to 2% — a huge swing. Russia used to spend 25% and must be spending less now. I don’t have global numbers, but they are a lot lower than in decades past.

• Freer trade and ever broader acceptance of free-market economics. Remember Ec 1 and the laws of comparative advantage? No? Well, free trade enriches all its participants over the long run — both Mexico and the US are better off because of NAFTA — even though it can cause short-term pain to specific people (if, say, it cost you your job) or companies (if, say, it put yours out of business). Same with free-market economics. Free market economies are more prosperous than controlled economies. (That said, enlightened regulation is absolutely necessary to make these things work. The anti-trust mechanism is indispensable to a successful marketplace, as are the Securities and Exchange Commission, the Federal Reserve, the Federal Trade Commission, and on and on. In trade, we need to be leaning on our trading partners, gently but persistently, to lift their workplace and environmental standards, as we have lifted our own.)

• Technology. It’s beyond magic, what’s going on these days, and should be reflected in greater productivity and prosperity.

These three argue for raising “the mean.” Maybe the average performance of the stock market — traditionally about 9% a year when you combined dividends a price appreciation (and before you adjusted downward for inflation) — should be permanently higher.

But I doubt it. Or at least not dramatically. Even a 1% increase, in the first place, is dramatic. A dollar growing at 9% becomes $5,529 after 100 years — but $13,780 growing at 10%. So it would be a huge thing, really, for “the mean” to have risen from 9% to 10%.

And maybe it has.

But it sure hasn’t risen to 15% or 30% or any of the crazy numbers some people have come to expect from the stock market.

And for all the power of peace, free trade and, especially, technology, there is a flip side. Can we be sure the world will always be so relatively peaceful? What would a little cyber-terrorism do to e-commerce and productivity and consumer confidence and corporate earnings? Not to mention potential military conflicts and arms races sometime in the future. And little issues like global warming — and inflation.

Technology is dazzling. But, as has been often noted, things like “electricity” were not trivial themselves. Radio and television were pretty big deals, too. Yet even with those astonishing economic shots in the arm, the stock market used to provide about a 9% annual return.

So, yes, I think large segments of the market have probably gotten ahead of themselves, and that even after the substantial correction earlier this year, which has helped to right the risk/reward ratio somewhat, people should be prepared for a less spectacular 18 years in the U.S. stock market going forward than the 18 we have just enjoyed.

2. “Then, of course, I would like to know what sort of advice you would give about what to do about this, particularly to those of us who are planning to retire soon . . . ”

My advice is: Come back tomorrow.

Jerry J.: “I’m looking for a place to put around 15K for a year or two when I’ll most likely be using some of it for a down payment on real estate. My question is which would you recommend, the Series I bonds you recently touted in your column or an index mutual fund such as Janus Fund(JANSX) or Vanguard Index Trust 500(VFINX). I’m leaning toward the mutual fund option at this point but I wonder how aggressive I should be considering that I’ll most likely want access to some of the money within a relatively short time period.”

The stock market is (always) a bad place for money you will need in a year, or even in three. Of course, the less you’d be disappointed if you couldn’t buy the real estate you’re saving up for, the more risk you can afford to take.

You lose 3 months’ interest if you cash in Series I bonds before 5 years, but especially if you live in a high-tax state, they could make sense anyway.

Dana: “Should one calculate one’s net worth as the amount one would have if one liquidated all of one’s assets (minus one’s liabilities of course)? In other words, after the tax bite. Or for calculations of net worth, should one treat stock ownership as the present balance on one’s brokerage account without adjustment? Please don’t use my last name if you use this. It’s a dopey question.”

There are two ways to do this and I’d do both.

The first and more common is to count everything, with no provision for capital gains taxes. It’s a bigger number and thus more fun. And if you were hit by a car, there’d be no capital gains taxes, as your heirs could write the basis up to the value at the time of your demise.

The second, and more realistic, number would exclude both the taxes you’d have to pay to cash in your chips, and also the items you really couldn’t easily part with, like your house and your car and your clothes.

This latter number gives you a sense of your readily realizable net worth (although some of it might not be so readily realizable, if you own, say, some nonmarketable securities or a minority share in some business).

Of course, should you ever need to liquidate your assets, it might well be because things were rotten in Denmark — meaning, in this case, the economy — in which case the realizable market values of your assets might be lower than they are today.

But leaving all that aside, it’s fun to have a sense of your net worth — and the first step in making it grow.

First, extravagance:

Thanks to Tsvi, who let me know about the Jewish couple that won the lottery. Perhaps you read this? They bought a magnificent mansion in East Hampton and filled it with the finest art and contemporary furnishings. Then they decided to hire a genuine English butler through one of those agencies. They even flew to London to interview the candidates before choosing one.

The day after the butler’s arrival in East Hampton, they instructed him to set up the dining room table for four — they were inviting the Cohens to brunch.

Then they went shopping.

When they returned, they found the table set for eight.

Why, they asked the butler, when they had specifically instructed him to set the table for four, had he set it for eight?

“The Cohens telephoned,” he explained, “and said they were bringing the Bagels and the Bialys.”

I thought you should know this.

Now, parsimony:

Click here to read about a guy who grabs used soft drink cups and pop corn containers off the movie theater floor, washes them out in the restroom, and then goes to the counter for “his” free refill. (Thanks to John Bakke for alerting me to this by Michelle Singletary in the July 2 Washington Post.)

You can never be too rich or too thin, but you apparently can be too cheap. (I had not known this.)

Pete C: “I am thinking about buying some I-Bonds and went to savingsbonds.gov. I used their Savings Bond Calculator to calculate the value of a $500 I-Bond issued in June and redeemed on 6 months later. The Calculator told me the bond would accrue $9.20 in interest. To my simple, (seemingly) straightforward math mind, that means the bond would have returned 1.84% of the principal in a six-month time period — an annualized return of 3.68%. However, isn’t the annualized return supposed to be 7.49%, the current posted rate for I-Bonds? Help please, I don’t understand.”

–Redeeming Savings Bonds before five years have elapsed, you forfeit three months’ interest.

Robert Pistey: “While searching for 20-30 year level premium term life insurance, I discovered John Hancock’s Marketplace website (jhancock.com). They appear to offer the most competitive rates, offering a 20% discount for ordering through the net as well as a 5% discount on the first year’s annual premium if paid by credit card. I’ve also found that calling the toll free number and mentioning the word ‘Internet’ will get you all the discounts without having to type in the information. The rep will take it over the phone.”

–Click here to get a quote. A 30-year-old nonsmoking male in good health might pay a flat $570 a year for 20 years for $1 million in coverage (until, say, the kids are largely grown).

Before you buy, do some comparison shopping over at Quicken‘s insurance page. (Interestingly, entering the same healthy 30-year-old male here and asking for the same $1 million with a flat premium for 20 years yielded a John Hancock quote of $1,000. Just goes to show the importance of “shopping” — even within the same company.)