Tax Update

Posted on June 19, 2010 by Carl from Chicago

When Dan and I were first invited to join Chicago Boyz Jonathan mentioned my high quality posts on energy and taxation.  Recently I have not been writing too often about taxation because the news from the US perspective has been almost universally negative.

Two core principles of taxation are:
1) the tax should be effective, meaning that if it intends to raise a certain amount of revenue that it should be designed to achieve that end
2) the tax should minimize negative impacts on overall economic behavior

Japan Considers Lowering Its Corporate Tax Rate

There was an old joke that Arkansas’ motto was “thank god for Mississippi” because else Arkansas would have been #50 in the rankings by state on various metrics.  In that same vein, when ever I talk corporate taxes and about how the United States is the least competitive corporate tax environment in the world, they would say that in fact, Japan was worse.

Now even Japan has woken up to the fact that high corporate tax rates push investment overseas (since companies can choose where to invest in new plants, subsidiaries and businesses) and are a relatively poor way to raise incremental tax revenues.  According to this Wall Street Journal article titled “Kan Seeks Cuts in Japan’s 40% Corporate Tax Rate” the newly installed Japanese government is considering reducing this punitive rate, which would take away our “Mississippi” per the analogy above.
Continue reading →

Posted in Taxes | Leave a comment

Word Press 3.0

Posted on June 17, 2010 by Carl from Chicago

This site recently upgraded to Word Press 3.0.  I initially did not understand all of the enhancements present in the new version.  I went to the Word Press.org site and saw a brief video and boy, oh boy are there lots of new features to learn about.

While any half-way decent programmer could always customize a Word Press site, I don’t qualify as a half-way decent programmer.  I focus on content and am only marginally interested in spending hours tweaking code.  In fact if I get 30 minutes to focus on anything that is an eternity.

To me the most immediate benefits were due to the fact that a new Word Press THEME comes with 3.0.  The original Word Press theme is called “Kubrick” and it is VERY old.  You have probably seen it all over the web and this theme screams “I am all about content” and don’t care about presentation.

This new theme finally makes it easy to customize the header and the sidebar and widgets and a million other features.  You’ll notice the picture on the top – it is one of my own and while it may or may not have much to do with investing it is a nice start.

I will be spending some time with Word Press 3.0 and will put in some more advanced features on the site over time.  Since Dan and I run a few sites any knowledge gained can easily be applied across all these sites with a bit of work.

I would like to thank Word Press for putting out such a great product and all of the volunteers who do all the work.  And I especially want to thank them for updating the default theme because this will allow me to learn a lot without having to navigate through myriad themes on the site which all have different features, capabilities and bugs.  These default themes are really for people like me because skilled programmers just tweak them anyways, so thanks again for thinking of us poor people who just want to focus on content.

Posted in Announcements | 1 Comment

Impact of Currency Moves On An ADR

Posted on June 17, 2010 by Carl from Chicago

One of the stocks recommended in prior years’ and currently held in Portfolio 2 is Diageo, the UK spirits company.  Since the portfolios that I run for my nephews and nieces only purchase and hold stocks on US exchanges (for simplicity reasons), in order to get international exposure to companies like Diageo they are purchased as an ADR, or “American Depository Receipt”.    Here is a decent definition of an ADR, from wikipedia:

An American Depositary Receipt (abbreviated ADR) represents ownership in the shares of a non-U.S. company that trades in U.S. financial markets. The stock of many non-US companies trade on US stock exchanges through the use of ADRs. ADRs enable U.S. investors to buy shares in foreign companies without the hazards or inconveniences of cross-border & cross-currency transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.

Each ADR is issued by a U.S. depositary bank and can represent a fraction of a share, a single share, or multiple shares of the foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR often tracks the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

Thus for practical purposes the ADR is issued in US markets which enable US investors to easily hold and trade the stock and receive dividends.

Our shares of Diageo (the ADR is on the NYSE,  while the “main” stock is issued on the London Stock Exchanges or LSE) were purchased in late September, 2007 at a price of $88.75.  The current price of the ADR as of mid June 2010 is $66.42, calculated as (88.75-66.42/88.75) a LOSS of 25% of its value, as traded on the NYSE as an ADR.

The “main” stock on the LSE, however, traded for about 1074p in September, 2007 and is now worth 1,115p as of mid June 2010, for a (1115-1074/1074) GAIN of 4%.

Leaving aside the issue of tracking error on in the US ADR which is not likely to be significant, the gap in performance of 29% between our loss and their gain is measured by the performance of the US dollar vs. the British Pound.  In September, 2007 the British Pound was trading for roughly $2 against the dollar.  It is currently trading at approximately $1.46 against the dollar, for a  (2 – 1.46/2) LOSS OF  27%.

Thus the difference in performance between the two stocks was 29% and the fall in the British Pound vs. the US dollar was about 27%, so you can see that this delta is almost totally caused by the change in currency value during this time.

For years this currency effect has worked in FAVOR of US investors putting money in overseas stocks because the dollar was declining against other major currencies (the pound, the Euro).  However, now the US Dollar is strengthening against foreign currencies so the impact is reversed, and if you have significant overseas exposures in most currencies you are now seeing losses when they are translated into US Dollar terms.

Since I track a lot of items on the custom spreadsheets that I make for each portfolio I will start tracking the currency impact on ADR’s as distinguishable from the performance on the underlying exchange.  This will highlight the DIRECT portion due to changes in currency costs.

A couple of minor items:

- for my portfolios where I don’t usually owe taxes one minor annoyance is that taxes are withheld for overseas dividends.  If you pay foreign taxes you can net them against your US obligations (at a simplistic level) but since my portfolios don’t generally pay taxes due to their low level of gains and losses I don’t get this back.  Here is a company site explaining how a Finnish company withholds taxes on dividends which is useful.  For my purposes in the portfolio I only show the “net” proceeds; on my yield calculation I may start to show it “net” of withholding since I don’t get it back

- of course currency issues are far more complicated than this in that the company may earn in USD or in British Pounds; for example Diageo earns a lot of its income on US sales so it may book gains or losses anyways on currency but these are already “embedded” in the income statement.  The ADR price between the LSE and NYSE is due to the  “currency change” impact, but changes in currency rates may also impact the price of Diageo on the LSE itself

Posted in Stocks | 1 Comment

Don’t Forget Sin Companies

Posted on June 17, 2010 by Dan from Madison

This is an interesting story from Bloomberg.

A Scotch whisky matured for more than six decades sold for 25,200 pounds ($37,245) at an Edinburgh auction today as collectors vied for rare malts.

The bottle is one of 61 produced by the Glenfiddich distillery and the whisky has matured for 64 years, host Bonhams said in its catalog. It was bought by an unidentified purchaser over the telephone. Bidding started at 10,000 pounds.

Many of the uber-rich are making what are called “alternative” investments and buying things like aged scotch, paintings, diamonds, expensive cars, and other worldly goods and storing them away for fear that their paper investments will cascade down in value.  It is an interesting concept.

Of more relevance here on this blog (joe blow retail investor) is the whole concept of Sin Companies, as I call them.  Some people try to let their consciences get in the way of their investing, but I have never looked at it that way.  People are always going to smoke, drink and do other things to try to escape their realities.  It isn’t my problem.  My problem is to find ways to maximize yield for my investments.

I have always been a huge fan of MO and I own a sizable chunk in my portfolio – and I always will.  The cigarette business is almost a purely cash business, as is liquor.  Hardly any accounts receivable.  I wish my business ran that way!  Right now, the yield on MO is a staggering 7% ($1.40, at $19.86/share as of this writing).

I don’t see an end in sight for MO as many, many young people smoke and in the key area of the Far East, EVERYONE smokes like chimneys all day long.  Phillip Morris International is also a nice choice.

If you like booze companies, try to pick one with large international exposure.  As people in China and India get more money, they will be buying more, and better quality booze.  I have some exposure to Indian technical people and in off the cuff conversations, it seems that they are crazy for Jack Daniels of all things.  Brown-Forman might be for you, although over the past year that stock has had a huge run-up.

I guess in the end, I am the type of person that doesn’t really care about what others do with their bodies and always look to the Sin Companies to round out parts of my portfolio.  Others don’t share this same philosophy and I can respect that as well.

Posted in Stocks | 1 Comment

Illinois = Fail, But Not All Munis Suck

Posted on June 16, 2010 by Dan from Madison

How about this:

While most eyes are on the highly leveraged European countries, especially Spain over the past week, back here in the US, Illinois today is close to passing California as the most troubled municipal credit in the country as measured solely by their 5 yr CDS. Illinois 5 yr CDS is up 4 bps today to 295 bps, a record high and up 70 bps in just the past two weeks. California is trading at 299 bps, higher by 2 bps on the day and up about 50 bps in the past two weeks. It does though remain well off its record high of 460 bps back in Dec ‘08. Both municipalities are closing in on Bulgaria at 320 bps, Croatia at 300 bps, Hungary at 318 bps, and Lebanon and Portugal both at 310 bps.

Man, that is some brutal stuff.  If you invest in anything Illinois, you better be getting a great risk premium.  I don’t have those kinds of stones.

But I do have decent sized position in SWFRX.  It is a Municipal Bond fund run by Wells Fargo.   The position has increased in value steadily and I recently doubled down on it.  I started my orginal position in May of ’09.  So what is it?

The investment seeks total return that is exempt from federal and Wisconsin personal income taxes. The fund invests at least 80% of assets in municipal securities that pay interest exempt from federal income tax, including federal alternative minimum tax (AMT), and Wisconsin individual income tax. It invests up to 20% of assets in securities that pay interest subject to federal income tax, including federal AMT. The fund invests up to 10% of assets in below investment-grade municipal securities.

While we don’t have a crushing state income tax like other states, it is still there, and still significant here in Wisco.  This fund gives me exposure to munis without having to worry about one collapsing.  The yield isn’t spectacular (averages around 3%) but it is almost all tax free and is very low risk.  For my bond portfolio it is a great fit for me at this particular time.  The state of Wisconsin isn’t in as terrible shape as some of the others like IL and CA and AZ and MI, but we still have problems.  The good news is that we really didn’t have any manufacturing to speak of before the recession, so we weren’t hurt by that sector collapsing (that all left decades ago) - but the high tech and insurance/brokerage jobs have stayed for the most part in the state.  We don’t have a horrific foreclosure issue either.  I would recommend a fund like this if you live in a relatively strong state and need a place where you want some tax free yield along with very little risk.

Posted in Fixed Income, Taxes | 4 Comments

MGEE – A Stock That I Consider Fixed Income

Posted on June 16, 2010 by Dan from Madison

I just purchased a block of MGEE, my local utility.  In the big picture of utilities MGEE is a very tiny player.  Their daily volume is fairly low. 

Over the last 5 years MGEE has traded from a low of 28 (Mar 2009) to a high of 38 (June 05).  The 52 week low is 32.36.  I bought at 34.36 on June 7 and it has had a nice short term run up here to 36.35 as of yesterday.  But I am not overly concerned about the value of the stock in this case.  I treat this one as fixed income.  Even in the lowest of the low market back in March of ’09 the stock didn’t really tank.  That is a great indicator of a solid company that people really love (for whatever reason).  Yearly dividends are 1.47, making the yield about 4.05% as it stands right now.

I like this one as a safe long term play and treat it almost like a bond in my allocation.  I do think there is upside potential as this area wasn’t hit as bad as places like Michigan or Arizona in the recession, and there is always a chance that this tiny utility could get swallowed by one of the other giants.  One thing that is nice from a small retail investors perspective is that you can buy their stock directly if you choose, and you can sign up for this service at the MGEE website.  On the other hand, you will never get rich if you are waiting for a stock like this to rocket up.

Madison Gas and Electric has a sparkling reputation here in Madison, home of tons of hippies and enviro weenies.  If a company can do their business relatively uninterrupted in this environment, it really says something to me.  I will more than likely be plowing more into this one in the years to come, keeping track of it in my fixed income side even though it is a stock.

Posted in Fixed Income, Stocks | 5 Comments

Along For The Ride

Posted on June 16, 2010 by Dan from Madison

As retail investors, we are pretty much along for the ride as far as the stock market goes.  That purchase you make today of 500 shares of xyz company doens’t do squat to move the big numbers.  The institutional and commercial accounts who are moving millions of shares daily are the ones moving the needle.

At The Big Picture, Bill King puts up an interesting column today about how the end of this month might be “gamed” and could be good for a short term pickup in stocks.

Between now and the end of June, traders, wise guys and PMs will try to manipulate stocks higher to game Q2 performance – especially with May being the worst month for stocks in decades. 

This week is option and futures expiration. Normally there is a triple-digit DJIA rally for expiration week; and Bernanke pours liquidity into the system for expiration week.

If stocks would have declined last week, this week would have been a layup for a rally – as long as no new negative news surfaced. Ergo, the expiration rally this week might be more tepid than usual.

Another bullish factor for some stocks is the June 25 Russell rebalancing. So, barring ugly news or developments, the bias for the next few weeks should be to the upside for stocks.

Interesting stuff.  I recommend you read the whole thing.  Always remember that for investors on our level, we are along for the ride.

Posted in Stocks, The Big Picture | 2 Comments

Antoine Walker An Example of Net Worth vs. Earnings

Posted on June 14, 2010 by Carl from Chicago

One of the prime concepts behind this site is the difference between “net worth” and “earnings”.  Net worth is what you have, left over, after all of your liabilities (mortgage, car payment, student loans, and other debts) are paid off.  For most people, unfortunately, their net worth is very near zero.

Antoine Walker, the former Celtic who resides in Chicago, is a prime example of someone who earned a large amount of money during his lifetime and yet has a negative net worth.  He recently declared bankruptcy, as summarized in this article:

After a 13-year career and over $110 million in salary, Antoine Walker has filed for bankruptcy after being hit with a $2.3 million foreclosure lawsuit on a mansion that he bought for his mother in Tinley Park, a small city south of Chicago. Walker, of Wiggle (or Shimmy) fame, just has too much debt.  “Off the court, there were the cars, the jewelry, the houses, the suits, the gambling. He liked to move in an outsized entourage; his mother estimates that, during his playing days, he was supporting 70 friends and family members in one way or another. And speaking of his mother, he built her a mansion in the Chicago suburbs, complete with an indoor pool, 10 bathrooms, and a full-size basketball court.  And then this: “Walker turned the pavement surrounding his home into a virtual luxury car lot – two Bentleys, two Mercedes, a Range Rover, a Cadillac Escalade, a bright red Hummer. Often, the vehicles were tricked out with custom paint jobs, rims, and sound systems at considerable added expense. He also collected top-line watches – Rolexes and diamond-encrusted Cartiers.”

There you can see where the EARNINGS go – onto cars, watches, supporting non-working friends, and also clothes.

One part of the article I disagree with because it is poorly worded:

Mr. Walker owns four properties: a $2.34-million home in Miami; two South Side apartment buildings each worth $190,000, and the Tinley Park home, valued at $1.4 million, according to the bankruptcy filing.

Mr. Walker, as they refer to him, owns NOTHING.  He possesses some assets, but cannot make the payments to keep up with his liabilities, so net, he has no assets.

Mr. Walker, 33, lists liabilities of $12.74 million vs. assets of $4.28 million in the bankruptcy filing. Mr. Walker’s 2006 NBA championship ring, valued at $6,000, is listed among his assets, according to the Chapter 7 filing May 18 in U.S. Bankruptcy Court in Southern Florida.

This is a very sad story but one to learn from; no matter how high your earnings, if you keep spending enough money and taking on more debt, you will inevitably end up on the wrong side of the ledger.

Posted in The Big Picture | 1 Comment

Almost Time For Stock Picking Season

Posted on June 13, 2010 by Carl from Chicago

As a brief overview again of how my trust funds work:

  1. I set up individual trust funds for my nieces and nephews when they are around 11-12
  2. Every year I contribute $500 / each, they contribute $500 each, and then I match $500 more, for a total of $1500 / year
  3. I select 6 stocks a year and each niece or nephew selects 2 of them from that list (for about $750 / each)
  4. We make the stock purchase around September of each year; this gives them the summertime to earn enough money doing work or odd jobs to get the $500 for the additional match
  5. I watch the funds and if certain events occur and I think it is time to buy or sell a particular stock I will let them know and we can discuss and then I execute the trade.  When this money is reinvested then sometimes we purchase more than 2 stocks at a time or we increase the purchase amount of each above $750

From a portfolio perspective, once you get to 10 or so stocks (assuming that they aren’t in the same industry) you have a reasonably diversified portfolio.  Portfolio One (the longest term portfolio, at about 9 years) is at that state; the other portfolios may swing significantly in value based upon the performance of a single stock.

So it is now time for me to begin researching the stocks that I want to consider for my list of 6 stocks.  Dan, our newest contributor here, asked in semi-jest if I just threw a dart at the dartboard.  We are a little bit more sophisticated than that, although we realize that selecting individual stocks is a difficult business and not recommended fora large portion of your total portfolio.

Here is a mix of the principles that I use and what I look for in a stock:

  1. Value not Momentum – given that these are long term investments and I don’t want to terrify the kids with wide, gyrating swings I tend to look more at value type stocks and not chase faddish or momentum stocks
  2. Stocks I understand – I don’t expect them to fully understand everything (or I’d be forced to just let them pick from consumer products, which is a bad plan) but I want a stock that I understand.  Sometimes when I understand an industry (like the financial industry) it is strongly tied to me NOT recommending stocks from that industry.  I do try to explain every stock to them, what it does, and why it is on the list, because I want them to inspire to investing in this manner as they gain more experience over the years
  3. Seek international diversification – through ADR’s there are a large number of individual foreign stocks that can be purchased and I try to have half or so (all else being equal) of the stocks on the list as non US stocks
  4. Try to have a mix of large and smaller market cap stocks – there is nothing on the list that is typically less than $1B or so in market value but I want to have a mix of large and small stocks, especially since smaller stocks generally have more room to “run” than a behemoth
  5. Dividends are preferred – I don’t want a stock whose entire value is dependent upon a dividend stream but I think that paying some sort of reasonably large, regular dividend is associated with better management and dividends do make up a significant percentage of the return in the long term.  On the other hand, high dividend paying stocks are likely to be hit hard should the tax laws on dividends be significantly impacted

Since Dan has joined and he is a pretty sophisticated guy (and I have some other friends whom ultimately I will try to twist their arms to join, too) I will put up some of the stock ideas I have in an earlier, less-final manner and see what I get in terms of comments and suggested alternatives.

I generally keep up to date on companies through the Wall Street Journal, Barrons (although I don’t subscribe to the paper version anymore because it got expensive), Investors’ Business Daily (which I periodically pick up, although their stock selections are usually too small and fast-moving for my purposes), Financial Times, and then the large general business magazines like Forbes, Fortune and Business Week.

Posted in Stocks, Trust Fund Details | 1 Comment

Bond Bubble?

Posted on June 12, 2010 by Carl from Chicago

A recent Wall Street Journal article titled “Bond Fund Managers See Signs of A Bubble” discusses the state of the bond market and large inflows into bond mutual funds by investors seeking returns and attempting the avoid the risk that they see in the stock market.

A key element to understanding this or any other analysis on bonds is the difference between holding an individual bond to maturity vs. buying a fund that invests in bonds. They behave very differently. If you buy an individual bond and hold it for its life, unless that company goes bankrupt or has some sort of liquidity event, you will receive back your principal at some point in the future and interest payments along the way. Unless you are unlucky and it goes into default, it is a predictable stream of payments. Bond funds, on the other hand, invest in a whole range of individual bonds and do not necessarily hold them to maturity. Bond funds are significantly impacted by interest rates; when interest rates RISE, the value of their bond holdings immediately falls and investors receive losses. If interest rates FALL, investors in bond mutual funds receive gains. Thus holding individual bonds, once purchased, is mostly about default risk for that particular issue, while investing in bond mutual funds is primarily about the direction of interest rates and also overall default risks across all issues.

This situation is summarized as such in the article:

Interest rates will likely rise in coming years from a base of almost zero today. But investors mostly only know what they have seen in the past 25 years, which for the most part has been period of steadily declining interest rates and rising bond prices.

There isn’t any “up side” to bond mutual funds right now, from an interest rate perspective, because rates are almost at zero. If rates are going to change they are going up. In addition, low interest rates means less pressure on entities that require debt financing, and rising interest rates will not only slam bond fund values but they will increase the default risk on bonds in the fund as those entities must pay a higher price to refinance future needs.

Compounding the problem is that many investors don’t remember when bond funds did lose money for a prolonged period.

The stagnant stock market over the last decade or so, as measured by the major indexes, along with terrifying swings in-between, are pushing individuals away from the stock market. I remember when I first (naively) started investing in the early 1990′s in my 401(k) and telling my peers that they were crazy not to be 100% in stocks, especially since it was a long way to retirement. While I am still in the stock market today, I would never give that sort of advice now and I believe that the guidance that you should be heavily invested in stocks when you are younger often goes too far when the % of stocks in portfolio climbs above 75% or so.

The same types of “herd” thinking are working in reverse for the bond funds. Since they have only MADE money over the last 20 or so years, they are viewed as low risk, when really a huge portion of that gain is due to our policies favoring low interest rates which results in gains for bond funds and also lowers default risk. As these forces turn around when interest rates go up, many individuals are likely to be surprised by the impact to their portfolio of remaining heavily invested in bond mutual funds.

While bonds may have issues, it doesn’t mean that you have to pile back into the stock market. Bond mutual funds are often used as a (sloppy) proxy for “safe” investing, which earns a return but doesn’t put much principal at risk. You can achieve that same goal with safer debt instruments such as certificates of deposit or short term treasuries. If you are in a bond mutual fund you should not view that money as “safe” – you should view it substantially at risk should interest rates go up or if default rates pick up significantly.

Cross posted at Chicago Boyz and LITGM

Posted in Fixed Income | Leave a comment

Greetings

Posted on May 10, 2010 by Dan from Madison

As you can see up above this blog is about running a trust fund for kids and general investing.  I will be mostly under the general investing end of things.  Thanks to Carl for letting me post here!

One funny story to open it up – I have several accounts that I assign to managers for diversity.  I have a manager for small cap, mid cap, value, etc. etc.  One guy bought a bunch of shares of C the other day and I promptly canned him.  I wonder just exactly what type of research that guy did before that purchase.  I mean, my time horizon is way under 50 years to actually use that money after all.

Posted in Humor, Stocks, The Big Picture | 3 Comments

Market Timing

Posted on April 26, 2010 by Carl from Chicago

In the past I, like many general investors, shied away from the concept of market timing. It was viewed as too difficult, and many investors left the markets when stocks went down and then missed the rally on the way up, essentially “buying high and selling low”. Instead, investors were advised to “stay the course” and keep investing, assuming that, over time, the rising markets would reward continuous faith with high returns.

An article in Sunday’s Chicago Tribune showed in a crystal clear fashion that, in fact, market timing is the ONLY issue for stocks, at least nowadays. This article shows stock performance for the top 50 stocks by market capitalization based in the Chicago region.

EVERY SINGLE STOCK is showing positive performance over the last 12 months! What are the odds of that, assuming that the stock market has its ebbs and flows? Very remote. The ONLY issue in the market over the last few years has been timing; everyone lost in late 2008 when the market cratered, and everyone who bought in at the trough made a lot of money. Likely to see this same article in late 2008 virtually 100% of the top 50 firms would be in negative territory over the prior year.

While I can’t say for certain what is driving stock performance UP (now) or DOWN (2008), I can say that virtually the entire market is extremely correlated with this phenomenon, as indicated by the top 50 stocks all being in positive territory.

Recent articles I have seen point to returns as being closely tied to the P/E level; when you buy into a “cheap” P/E market, you do well; when you buy into an “expensive” P/E market, you do poorly. While no one can say for certain what cheap or expensive really means, that broad theory is one that might be crucial to stock investing post 2000. In modern history (the last 30 years) there hasn’t been a long period where stocks traded in such a narrow range (around the Dow 10,000 level); but we need to decide how to weight the last few decades against the entire history of the stock market.

While I am not a professional stock adviser, the fact that 50 out of 50 of the top Chicago stocks (by market capitalization) are all up has to be a signal of some sort.

Cross posted at Chicago Boyz and LITGM

Posted in Performance | Leave a comment

The Psychology of Gifting

Posted on March 30, 2010 by Carl from Chicago

Adult Giving

While I called out Gail Marks Jarvis of the Chicago Tribune for her article on our assumed rate of return, she provided what seems to be solid advice on the topic of giving in an article titled “Financial Cord Can Trip Up Adult Children“.

While this article is focused on parents giving money to adult children, the concepts still resonate with those setting up a trust fund for a minor (such as this site). She quotes from Brad Klontz, author of “Mind Over Money”.

Financial handouts are rarely helpful in the long run… money for nothing typically results in more of the same – nothing.

That is very well said, direct, and to the point. If you give someone something for no activity on their part, why should they try to help themselves?

While everyone has their own situation to consider, in my experience the “matching” concept has been very effective. Matching requires the recipient to take action in order to receive the gift, so you are rewarding action, not inactivity. Since the money came from their sweat and toil (it takes a lot of work to earn $500 when you are a kid, mowing lawns, working for minimum wage, or babysitting) they really take this process seriously, and feel that they have a stake in the outcome.

In order for matching to be successful, you have to be consistent in your expectations and give notice. The kids need to earn the money, and they need to know when it is due. For my nieces and nephews the end of summer is a good time because it is right before school starts and gives them a chance to earn money when they are on break. You also can’t reward when there isn’t any achievement on their side (we did put in an additional amount at our discretion upon graduating from school or college).

Handouts can also “lead to resentment on the part of the givers, who may feel that they are being taken advantage of”.

I learned from a good friend of mine who told their experience of giving when the recipient just wanted more, more and more and in the end they are hardly even on speaking terms. I listened to this advice in constructing my matching program.

Posted in The Big Picture | 2 Comments

Realism Required On Stock Returns

Posted on March 23, 2010 by Carl from Chicago

Gail Marks Jarvis is a columnist for the Chicago Tribune on financial matters. The Tribune recently combined their personal finance and real estate sections into one section, which seems to make sense.

Ms Marks Jarvis provides financial advice. In a column titled “Options About for IRA investors” she wrote the following:

Financial planners have not strayed from their usual advice for people in their 20s, 30s and 40s, despite the more than 50 percent decline in stocks and the subsequent 70 percent upturn.

If you have years to go before you retire, you are likely to make more money in stock funds than in CDs, said financial planner Gary Bowyer. On average, bonds gain 5.5 percent a year, while stocks return 9.4 percent. Although some years are awful, Bowyer said, gains close to the average are likely over 20 or 30 years.

The first and most crucial mis-characterization comes in the first paragraph; she mentions that stocks declined 50% with a subsequent 70% upturn. While this may technically be true, it will lead many people astray; it would SEEM that if you went down 50% and then up 70% you’d be “net” up 20% (70% – 50%) if you weren’t very good at math or didn’t pay attention to the subtleties of the market. However, it isn’t like that at all; if you have $100 and then it goes down 50% it goes to $50; a subsequent 70% rise means that now it is at $85, so you are still DOWN $15 (or 15% on your investment, ignoring the fact that you lost a year towards retirement that you can’t make up, which means that it is an even bigger loss than it appears).

I would agree that most “financial planners”, who make their living selling financial products, would tell you to keep on investing in stocks (mutual funds) and other types of products that earn them money; but it isn’t true that this is the advice that you will find out there at large nowadays (just keep putting money in stocks and it will be all right).

As far as stocks returning 9.4%, that is completely fanciful. Stocks have been DOWN for the last decade, and for it to return 9.4% you’d have to make up all that lost time plus the time value of money. Many planners are urging a much more conservative rate assumption than that. About the only people that use such high rates as assumptions are pension plans that are trying to avoid future cash infusions and yet pay out high payments to retirees.

There are many instances where the stocks aren’t regaining their past highs; look at the NASDAQ index which peaked at above 5,000 (5,132) but is now near 2400. The Japanese stock index (NIKKEI) peaked at 38,916 but is now near 10,800.

This is not to say that you shouldn’t invest in the stock market; but nowadays very few people would view it as sensible to assume such a high rate of return on stocks unless you discount the last decade or so plus the experiences of NASDAQ and the NIKKEI, among others. I also think that the 50% / 70% comparison is misleading to most investors.

Cross posted at LITGM

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Portfolios Four and Five Performance

Posted on March 16, 2010 by Carl from Chicago

Portfolios Four and Five began about 6 months ago. This isn’t enough time to gauge performance.

Portfolio Four has a value of $1524 and Portfolio Five has a value of $1443. Neither had sufficient dividend, interest or capital gains / losses for reporting for the 2009 tax year.

(Click to enlarge – Portfolio 4)

(Click to enlarge – Portfolio 5)

Posted in Portfolio Tracking | 4 Comments

Portfolio Three Performance

Posted on March 16, 2010 by Carl from Chicago

We set up Portfolio Three two and a half years ago. Unless you have been living under a rock somewhere you know that this was a hard time to start to invest in the stock market. We have been doing OK relative to the benchmarks, but as they always say, you can’t “eat” relative performance. Since this portfolio only contains 4 stocks, it is subject to significant moves based on the performance of even a single stock. Generally you can get decent diversification when you get to approximately 10 stocks.

The beneficiary invested $1500 and the trustee invested $3000, for a total of $4500. The portfolio is currently worth $3896, for a loss of ($603), or (13%) of value, at a rate of about (7%) / year since inception.

This year there was $9 of dividends, $5 of interest income, and no capital gains or losses from sales.

Portfolio Three as of March, 2010 in excel

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Portfolio Two Performance

Posted on March 16, 2010 by Carl from Chicago

We have been contributing to Portfolio Two for five and a half years. The beneficiary has contributed $3000, the trusted contributed $6000, and the fund is worth $9531, for a gain of $531, or 6%. This translates into an annual rate of approximately 1.6% over this time period.

For 2009 we had $92.57 in dividends, $4.53 in interest income, and a Long-Term capital loss of ($834) from a sale of Cemex during the height of the debt crisis.

This portfolio has 10 stocks, which makes it reasonably diversified. Until you get near 10 or so stocks your portfolio can move significantly based on the activities of just 1 or 2 stocks. This portfolio took a hit on Toyota (TM) with the recent problems with that company, although we are about break even on our investment in that stock net of dividends received.

Below is a link to an excel file with the detail for this portfolio.

Portfolio Two Performance through March 2010 in excel

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Portfolio One Performance

Posted on March 15, 2010 by Carl from Chicago

Portfolio One is my longest trust fund, which started about 8 and a half years ago. The beneficiary has contributed $4500, we contributed $9000, for a total of $13,500. The fund is worth $17,528, for a gain of $4,028, or an increase of 30% over the life of the fund. Using IRR this gives a return of 5.8% over the last 8 1/2 years, which does well against most benchmarks. You can’t use just the US benchmarks because I had some foreign stocks over that span.

For 2009 taxes, there are dividends of $296.65, interest income of $8.05, and a long term capital loss of ($1,235.63) for the sale of Cemex (CX) stocks in early 2009 when I didn’t know if the debt crisis might claim this company. We sold at $7 and it rose to $10, and it appears to have survived.

For tax purposes, you won’t get an interest income statement because the amount of interest income earned is so low; under $10 for 2009 given the super-low interest rates on balances today (your broker will only send a statement if you have enough of a balance). For dividends, being the detail oriented guy that I am, I realized that foreign stocks (ADR’s) in the accounts withhold taxes so the amount of dividends that you actually receive is less than what is paid out. Since it isn’t worth tracking down at this level of investment I won’t file to offset foreign taxes paid but it is kind of a pain since the numbers won’t tie exactly to the brokerage statement that goes to the IRS. This is something I will research a bit in the future; the ETF’s I have with international stocks don’t withhold in this manner it is only individual stocks.

Below you can find a link to the excel file if you want to see how performance is calculated. It takes a while to do all of the calculations each time; you need to update current values, track dividends, determine yields, and then even look at what stocks have done since you sold them (I probably just do this to punish myself).

Portfolio One Performance Through March, 2010 in Excel

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Trust Funds and Financial Aid

Posted on March 7, 2010 by Carl from Chicago

I started these trust funds over a decade ago. The financial opportunities and situation has changed over the years and we are open for doing things differently if needed.

There are many ways to save for college. From the perspective of this site, I am contributing as an external party to individuals that aren’t my dependents. Thus my situation is relatively unique compared to a parent contributing to accounts for their own children, for example, because they would have more tax deductions depending on the circumstances.

10 years ago, or 20 years ago, the amount of money needed to attend college including room and board was relatively modest. Now, however, costs have ballooned enormously, and many / most students leave college with substantial amounts of debt unless their parents are wealthy or they take action (scholarship, go to community college first then enroll, etc…) to mitigate the costs.

Thus pretty much everyone is filing for financial aid now. Recently an article was written in the Chicago Tribune titled “Savvy tactics can score more financial aid for college“. The article starts with a woman who has modest income ($32k / year) who received almost no aid after filling out the FAFSA form for her son, leaving him with heavy loans. From the article:

Many people think they will get aid if they need it. But it’s not that easy. To do better on FAFSA, know its ins and outs. Kalman Chany, a New York financial aid consultant, says he’s seen people with millions in assets get Pell grants (free government money for low-income people) while teachers such as you have struggled. It’s because financial aid is calculated based on a quirky formula that’s as complex as the tax code and little understood by pros.
Yet, much as clever accountants can legally slash taxes for rich people, parents who understand the FAFSA formula can increase their aid. That’s why parents should study Chany’s book, “Paying for College Without Going Broke” by the time their child finishes his sophomore year in high school. It suggests financial alterations that can greatly enhance aid.

I haven’t read that book by Chany but here is a link to it at Amazon.com – I think I am going to pay the $13 or so and see what he has to say.

Here’s another part of the article:

Also, if there is a trust, or maybe an account set up for your child under the Uniform Gifts to Minors Act, this will poison chances for financial aid.

I know that you need to disclose UGMA accounts for financial aid, but certainly the term “poison” doesn’t make me feel good.

I am going to get the book and look into other alternatives and write about them here, and see if it still makes sense to save, all in, in this manner. Note that there ARE advantages to this method – 1) we can choose any stock in the universe for the portfolio 2) we have transparency in fees and control costs 3) we can learn about finance in a more specific manner than in the abstract, which is a valuable lesson for later in life 4) it encourages thrift in the trustee because I match their contributions 5) I don’t mind, per se, that the amounts for the trustee are used for college. The point of a trust fund is to help them, and college certainly is valuable and can be an excellent investment.

More to come.

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Dividend Cuts and Interest Rates

Posted on February 19, 2010 by Carl from Chicago

Recently I wrote about how Interactive Brokers was offering to lend money at 1.25% in order to purchase stocks yielding 5% or more in dividends. I was struck by the low rate that they were able to offer as interest and the fact that there was a large universe of large companies offering such high dividend payouts (and not just companies that had a stock price decline with a dividend cut yet to follow so it was unusually high relative to the stock value).

To give Interactive Brokers some credit, the ad was kind of “tongue in cheek” in that it was made to look like it was written on a napkin like the classic business plan but there were enough elements there to get me thinking about what an odd state of affairs this represented.

Just recently this model started coming under siege. The Fed recently began tightening interest rates, increasing the discount rate to 0.75% from 0.5%. While the Fed has been denying that this is part of a long term policy shift, the markets have started to feel otherwise, as markets went down and yields increased on government debt. This won’t directly impact the 1.25% that they are able to borrow for on the “napkin” today, but it seems to be trending that way, even if this is just a first step.

On the other side, 2 large European firms just cut their high dividends. Daimler Benz (DAI), manufacturer of Mercedes autos, suffered a loss and canceled their dividend, leading to a drop of 4.6% in their stock price in one day. Socite Generale, a large French investment bank, cut their dividend from $1.2 Euros to $0.25 Euros (a drop of 79%) and their stock also fell 7.2% in a day.

The question is – how can companies pay out such high dividends in a sustainable manner when there isn’t much growth in the world economy and many of them are in mature industries? While 2 stocks don’t constitute a balanced statistical survey, they show that dividends are a function of profits and long-term profit view and to talk about them in an “historical” view is backwards.

The other side of this is that investing for yield in such a volatile area as stock prices shows that not only did the long term value of the income stream from dividends drop significantly (in the case of Daimler it dropped to zero, and for Socite it dropped by 79%) but then you can also see the impact on the underlying value of the shares, which dropped 4.6% and 7.9% in ONE DAY.

Cross posted at Chicago Boyz and LITGM

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