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After looking over the responses to yesterday's post, my new working theory is that the subprime mess can be boiled down to a widespread failure to follow the most basic rule of investing: diversify.

That's true whether we are talking about the widow, or the pension funds, or the banks, or any other corporate entities that held these exotic mortgage backed securities. If they got in trouble, it is only because they put too many eggs in one basket.

Apparently lots of people bet their corporate and/or corporeal lives on these unfathomable investments. You might be making the same sort of mistake right now, but in a different way.

I know people who use financial advisors to help them spread their money across many different financial investments. This feels like diversification, but it isn't. If the financial advisor is a crook, or incompetent, you put all of your eggs in one rotten basket. In the case of the widow who was convinced by her financial advisor to put a lot of money in these exotic securities, the problem was the advisor more than the securities.

When I first started making serious Dilbert money, I let experts manage half of it, and I managed the rest, as a hedge against both the experts and myself. The experts invested in Enron, Worldcom, and a number of other companies that promptly exploded. The experts reduced their portion of my money by about a third over five years. (The experts work for one of the most respected financial institutions on Earth, by the way.) My own investments did better, precisely because they were more diversified. So now I handle my own investments, probably incompetently.

I didn't own much in the way of stocks for the past several years, thanks to not using professional advisors. A big chunk of my money has been in California Municipal bonds of various types, and all are insured. When I asked my bond advisor what good it would be to have insurance if the entire state of California goes to hell, they advised me emphatically, and obviously incorrectly, that these big insurance companies are ready to take any hit.

In order to diversify more, I started migrating money over to the stock market during this recent plunge. The market could go a lot lower still, but this is either the beginning of the end of the United States as we know it, in which case it doesn't matter how I invested, or it is a once-in-a-lifetime stock buying opportunity. It was an easy decision.

Are you diversified?
 
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+1 Rank Up Rank Down
Oct 17, 2008
Hi Scott,

not to dishearten you but recent news suggest even caifornia's finances are in a mess.
At a time when the entire worlds economy is in a mess - paper money is of little us. It will be a good idea to add some gold bullion to your portfolio -say 10 to 15 %.

We in India have been doing this for generations -indians brought about 800 tons of gold jewllery last year .


reason???
Well the real reason to own gold is because the U.S. government and other governments around the
world have been and will continue to try to remedy all known and perceived economic and financial
market ills with their printing presses.
My guess is that somehow they'll be successful - at least for a while.
And just in case they're not, stocking up on gold and bullets isn't a bad idea.


What to do you think???

Cheers,

Alok
 
 
Oct 16, 2008
Many of the financial companies that went out of business thought they were diversified. Take AIG - credit default swaps were just one of a bunch of businesses they were in. They thought they were covered for the worst situation, but the current situation was a lot worse than they imagined.

A lot of the problem was that there was so much borrowing going on that when one thing went bad, it had a chain reaction - people calling their loans in and refusing to lend more. Mortgages were just the trigger, there were plenty of other problems that could have had the same effect.
 
 
Oct 16, 2008
This isn't a once in a lifetime opportunity - major bear markets happen maybe 4 times in a person's life.
This level of value isn't particularly compelling yet - stocks appear cheap because of the recent past of the 1990s and 2000s, but we are just barely reaching the cheap level - plenty of bear markets went to lower P/PE (price to peak earnings, more reliable than price to earnings) levels like the 1973 and 1980 bear markets.

I am starting to move into the stock market a bit, but I am going slow - this has been a very short bear market - they usually last longer than this.
 
 
Oct 16, 2008
I think you're right. Either the turnip becomes the new global currency denomination - in which case I might as well plough all the money I have left into stocks, as it's about to become worthless anyway - or as you say the stock market will eventually bounce dramatically and I'll become rich. Thanks for the advice - I was about to blow everything on hookers and drugs.
 
 
Oct 16, 2008
After a couple of times of watching our retirement investments go down in amounts which would have totally paid off our home and all our vehicles, the tractor, bought the 20 acres next door, AND paid the taxes on withdrawing the money early, I've about decided that our retirement fund is about as real as monopoly money.
Yes, I know. The 15% of money paid in each year was real, all right, but the increase in that money was not made by the sweat off our backs. So did the fact that we agonized over each decision as to where to place it make those increases any more ours? Nope, not real work, and it seems the economy is determined to teach us that.

I sorta like the way taught in a certain religion, which says that no matter how specialized your work may be, you must also have a basic, hands-on work capability. So a software engineer is also required to be competent at installing plumbing, for instance.

So, like a lot of other folks, I also intend to diversify. Into hard assets. What do I need to live? Where do I need to be?

The problem is that our monetary system is built on an unsound foundation. Like building your house on cardboard. Our money system is built on the value of debt. Average citizens are just starting to wake up to
that fact. And what we don't know seems to be the biggest reality now. We just don't know. Did you know that real money was leveraged into 'credit default swaps' to the extent that the real money was watered down to very little value? I didn't. So unless you KNOW all the in's and out's of exactly how a corporation is invested, how can you
make any rational decision on whether to invest in it? Is it sponge worthy? Better do a background check, first.
And really dig.
 
 
+1 Rank Up Rank Down
Oct 16, 2008
I'm delighted to hear this news, Scott, as I just got back into the stock market last week after an absence of a couple of years. And since I get all my financial planning advice from you, via "Dilbert and the Way of the Weasel," I'm glad that we reached the same conclusion.

Parenthetically, I wonder if this is at least part of the reason that your political poll of economists didn't generate more interest - I wonder if most people can make the distrinction between economists and financial (or bond) advisors? Hell, I'm not sure if there is a distinction between them. Add some tarring of the economists' reputation by those that create "sophisticated financial instruments" and you may have a pretty good explanation of why people don't care what economists think about national policy.
 
 
+1 Rank Up Rank Down
Oct 16, 2008
Nothing to do with the ongoing discussion, but pertinent all the same. Does the economist Scott Adams still believe that McCain will be the future US president?
 
 
Oct 16, 2008
Diversified; have you ever been diversified?

Well... I have

(apologies to Jimi: http://www.youtube.com/watch?v=SaZJFWOEzrc )
 
 
+1 Rank Up Rank Down
Oct 16, 2008
Right you are! This is a good time to buy some stock. That's what I'm going to do.
Just don't pick the wrong ones ...

Don't be fooled by that Graph of the Dow Jones index, it's on a logarithmic scale.
 
 
Oct 16, 2008
Few fund managers will outperform an individual managing his own investments. This is because of what is commonly known as the tyranny of compounding fees.

Assume that the market goes up 12% per year.
Assume a management fee of 4% per year.
100 dollars compounding at 12% per annum will leave you with 2996 dollars after 30 years.
100 dollars compounding at 8% per annum (12 minus 4) will leave you with 1006 dollars after 30 years.

In short, you have not paid 1/3rd of your gains as fees, but almost 2/3rd.
Guess who's laughing all the way to the bank!
 
 
Oct 16, 2008
Somebody said,
"If you aren't diversified enough, you aren't aggressive enough.
You never know where the next bull run is going to be. "
 
 
Oct 16, 2008
j l larson

Nice reassuring graph - but surely the scale is a bit whacked out? Or are all stock market graphs logarithmic or somesuch?
 
 
0 Rank Up Rank Down
Oct 16, 2008
Remember what Bob Dylan once said......"When you ain't got nothing ....you ain't got Nothing to loose"





 
 
+1 Rank Up Rank Down
Oct 16, 2008
offtopic Solar:

If you happen to be tomorrow at the Solarpower, you can come to talk a bit solar. Ask for Christian at the SANYO booth, you can fire all your questions and get honest answers. You can whisper your questions if you wish ;-) do not strain your recent recovery!

If you did not plan come down to the conferences, too bad, they are very interesting!
Seeya,
 
 
Oct 15, 2008
Twenty years ago when I was first getting into the stock market as a private investor/speculator I visited my stock broker who worked for a large brokerage house. He was churning my account and I asked to speak to his supervisor. After some hem hawing around I finally got in to see him.

Told him my complaint and he came back at me saying he was not there to police his brokers but to motivate them, provide marketing incentives and methods to increase activity and commissions for the brokerage firm. Flat out, no apologies and the attitude of tough luck and don't you know this stupid? I have never look upon commissioned financial services people the same since. Most are !$%*!$ and go for the pocket book every time.
 
 
Oct 15, 2008
to put recent events in perspective. Here is a picture of the entire history of the dow jones industrial average, including the recent activity. http://www.flickr.com/photos/j_l_larson/2945176355/
 
 
+1 Rank Up Rank Down
Oct 15, 2008
Hey Beefmaster - I never said there was no risk involved in plunking down all of your chips on red. The point I was trying to make is that if you want to gain wealth from the capital markets, the ONLY sure way is to concentrate your investment not diversify as the investing salesmen want you to believe. Diversification eliminates risk and therefore limits return. Google "Modern Portfolio Theory" to learn more about the basics (I particularly like the site "Money Chimp") and then apply actual, real critical reasoning and you'll soon discover that all you have been told about investing is to protect the guy selling you crap mutual funds for a commission. Your best interest is not their best interest, which leads me to how we got into this "financial crisis" in the first place.

Try your best not to simply parrot what you heard someone say, do the work and research it yourself. Best of luck to you...
 
 
Oct 15, 2008
(This is unrelated to this blog entry...)

Scott,

Have you seen this Youtube video? Howard Stern, whom I do not listen to btw, sent out someone to Harlem and asked people if they would vote for Obama. The reporter would attribute McCain policies to Obama, like being pro-life or even saying that Sarah Palin was Obama's running mate, and the people still said they would vote for Obama. Scary. I'm afraid you may be right with regards to your views on elections and voting.
http://www.youtube.com/watch?v=NyvqhdllXgU

P.S. I'm sure that you could go to other places in America and find the opposite effect with McCain supporters.
 
 
Oct 15, 2008
Yes, I run into people who had 100% of their 401k invested in the companies stock , in the 401K plan and in their IRA's outside of the company. "I'm going to retire at 52 and live on a boat." Became, "I had 1.5 million dollars in company stock and now it's 75,000 dollars. I can never retire."

You know, it was only worth 1.5 million if you sold it. and put it in muni's or the money market. And if you withdraw it before age 59 1/2 it's worth a lot less, minus the 10% penalty and income taxes. The response is almost always, "I don't have to pay taxes on my 401K,." Well, not until you withdraw it. Unless it's a Roth IRA so I ask the question and the answer is "Well it must be a Roth IRA. My 401k is a Roth IRA." I tested this on a co-worker today, the words were not exact, but that's how it went down. If you think there is nothing wrong with the above, keep investing yourself.

Other people I know who manage their accounts complain constantly about missing this change or that change and how much they pay in fees and in taxes if they make money over the course of the year, the good news is that most people don't. Generall people who I know without wealth when they started working, made it by commissions (on insurance/investments), took a huge risk in business and borrowed like hell, or put 25% a year into investments. The people I know who hit me up for money work on commission and took a huge risk in business and borrowed like hell. Of those 3 things 1 works. I hear there is a 4th way that works for doctors and lawyers, but honestly I know they exist, but most people I know who are now wealthy doctors and lawyers came from wealth. A select few writing books, write software or something else. I heard some guy even did it with a comic strip.

The person who wrote the stock market preserves wealth for the wealthy is correct, and it's unlikely you'll get richplaying the market nothing. I agree.
I would also add that if you are building wealth by saving, it can help preserve it against inflation, unless the criminal who does your investing churns your account

 
 
+1 Rank Up Rank Down
Oct 15, 2008
The local consumer institute (here in NZ) has looked at managed investment funds a few times. Their conclusions:
1. The managed funds _occasionally_ do better than term deposits, but...
2. ...after fees are deducted, managed funds always [1] perform worse than term deposits.

[1] True for all the funds they examined, considering results over a recent ten-year period.
 
 
 
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