One More Time: Temporary Setback = Opportunity.

August 8, 2012

It’s a knight! In shining armor! Get it? Do we have to explain everything to you?

Last week we wrote about the meteor that landed on Knight Capital. If you can’t be bothered to read that post, the New York Stock Exchange’s biggest market maker endured a computer glitch that resulted in the company losing $440 million. Knight fell victim to a singular event (at least one wag actually used the term “black swan”), shrank to a third of its size overnight, and looked like it might not survive the week.

Here we have a company that

  • Provides a valuable service.
  • Is the market leader, more or less.
  • Has a solid reputation.
  • Suffered a temporary, non-lethal, inadvertent misfortune, as opposed to doing something villainous.

Knight’s stock (KCG) opened trading at $10.33 last Wednesday. The software flaw showed up immediately and was contained within 45 minutes. KCG closed the day at $6.93, opened the next morning at $3.48, reached a nadir of $2.43 late in the afternoon, and closed at $2.59.

This is what’s called a buying opportunity. KCG opened the following Friday at $3.11, closed at $4.05, and on Sunday received the $400 million cash infusion it needed to stay alive.

Who loaned them the money?

  • TD Ameritrade, one of Knight’s biggest clients.
  • Stifel Nicolas, a brokerage that sounds faintly Swiss but is actually based out of St. Louis.
  • Blackstone Group, a private equity firm.
  • General Atlantic, another private equity firm and owner of Getco (Global Electronic Trading Company), another market maker, one of 6 firms designated as such by the NYSE.
  • 2 unnamed investors, probably selfish capitalists like that job-killing tax cheat Mitt Romney.

The money comes with strings attached, of course. The lenders received something called “convertible securities”, which are bonds that will turn into stock at a certain undisclosed price. The 4 disclosed lifeguards and Mystery Firms E and F don’t make it a habit of lending money without it offering the likelihood of decent return, especially when forced to make a decision with only 2 days’ notice.

While we don’t know many more details of the deal, including the strike price of those convertible securities, the consensus belief is that it’s less than the $4.05 Knight stock ended the week at.

Here’s the type of reasoned response that makes the consistently under-water easy to distinguish from the enterprising few. From the LA Times story on Knight:

Not that internet comments are ever going to be a source of any usable knowledge, but it’s probably fair to say that COOLTUB and Highpressure’s opinions are not out of the mainstream.

The easy, effortless, simplistic, reactionary and false way to look at the Knight capital infusion is as fat cats covering for each other. The first commenter seems to think either that federal taxpayers are cutting a check to Knight, or that there isn’t a difference between that and private capital.

We don’t want to assume anything, but we’re guessing that when Magic Johnson and a handful of rich white financiers recently did the exact same thing for the Los Angeles Dodgers, COOLTUB and Highpressure were ecstatic about it.

Don’t be an idiot. How can you compare the two? The Dodgers as a team are a community icon, not just a bunch of rich guys shuffling paper.

No, they’re a bunch of rich guys swinging bats and fielding balls. The Dodgers pay an average of $3,171,452 to their top 25 employees. We don’t have a similar figure for Knight, but it’s almost certainly less.

We’re getting off track here, and we swear we didn’t start this post intending for it to turn into a sports analogy. But it’s important to remember that when a legitimate business that provides a benefit to society (in the form of liquidity) gets smacked in the mouth, it’s a chance for a sharp investor to make some money. If Knight had been charged with fraud, that’d be something vastly different, and inapplicable here.

Maybe you’re tentative, and still don’t think KCG is a good buy. Or you’re not familiar enough with the company’s stock in trade to take a position. Fine. Look around you and you’ll see opportunities daily. Seriously, daily. The local business that needs cash to expand and is looking for a silent partner. The overextended homeowner, or car owner, desperate to sell. The stock of the company that recently underwent an even less traumatic event than Knight did. (Read WSJ.com and Yahoo! Finance, just for a few minutes a day at the start. Think of it as unmarked course work for your future career in self-determination.)

You can get past the initial reluctance, the thought of “The markets? Not for me. Nothing more demanding than a conservative mutual fund in my company-directed 401(k), thanks very much.” Really, you can.

Or you can just assume that your job and its annual cost-of-living raises will help you build wealth as convincingly as seizing opportunities will. Whatever.

Filed Under: Capitalism, Estate Planning, Finance, Investments Tagged With: ,

You, CFA

August 1, 2012

If you don’t handle your retirement, he might do it for you. IS THAT WHAT YOU WANT?

You can do this.

Fund managers have to be conservative, by definition. Even the smallest fund has tens of millions of OPM (Other people’s money. What are you, 80?) under its control. A fund manager has far less margin for error than does a private investor, at least professionally. If you maintain your own portfolio, and it loses 40% of its value in a given year, that’ll affect you and a handful of others. Do so as a fund manager, and your career will be dead on impact. (Actually, that’s not true. You’d be fired way before you lost 40%.) Imagine the looks of horror and sotto voce comments at the Wharton class of ’07 reunion. (And yes, plenty of fund managers are indeed that young.) You wouldn’t dare show your face. “Is that Spencer? Wasn’t he on the fast track at Vanguard? I heard he’s working in the suburbs now. Had to cut his cocaine use back to weekends only. Poor bastard.”

Fund management, for the most part, is regression to the mean. The same funds hold the same damn stocks, over and over again. Some funds are required to hold the stocks of companies that have reached a certain size. Make the Wilshire 5000, and that automatically qualifies you to be in somebody’s fund. Join the Dow (and someone soon will, to replace recently departed Kraft), and the same thing happens.

This is perverse. The tail is wagging the dog, for lack of a more original phrase. A fund doesn’t take on a new component because the fund manager sees something he likes and discreetly buys a position before someone else can. Funds take on new components because they have to. Or because everyone else is doing it.

Furthermore, fund managers aren’t just sheep. By and large, they’re hypocrites and liars. (Yes, we know. Welcome to the human species.)

Joe Light recently wrote in The Wall Street Journal that Facebook didn’t just seduce ordinary investors suffering from Streisand Syndrome. The professionals got sucked in, too. Big names. Fidelity. JPMorgan. The most successful website since Google (by number of users, anyway) went public, and did so in at least a couple of senses of the phrase. Everyone was talking about it and familiar with the story of its origin (thanks to a timely and critically acclaimed big-budget movie), and few institutional investors had the fortitude to say “no”. Or even say, “Can we take a look at the company’s financials?”

160 mutual funds bought Facebook. These included Fidelity’s Dividend Growth Fund.

Read that last sentence again. Facebook doesn’t pay a dividend.

The JPMorgan Intrepid Value Fund presumably invests in value stocks. An unproven IPO (that ended up losing 1/3 of its market cap out of the gate) doesn’t fit anyone’s definition of a “value” stock.

The managers of these funds didn’t answer the allegations of impropriety. Neither did any company spokespeople. And for the sake of consistency, we’ll end this paragraph in italics, too.

So why the hell were these funds, with their objectives included in their titles, buying a stock that had nothing to do with those objectives?

Again, defense. Say Facebook did what its devotees wanted, and exploded out of the gate. The punishment, professional and otherwise, for being the manager who could’ve bought Facebook but didn’t is overwhelming.

You can complain about how the financiers are screwing the little guy, Wall Street over Main Street, etc. if it makes you feel good. Or you can go David and aim for their heads.

Being small and nimble, i.e. an individual investor, gives you advantages that no fund manager can ever enjoy. Why?

  • You don’t have to answer to anyone.
  • You can take calculated, intelligent risks. Ones where you’ve weighed the potential downside and have decided you can live with it. Professional fund managers can do that too, to some extent, but when they do it it’s no bold move. It’s a piddling activity whose downside is mitigated by there being so many components to their funds. Hundreds of funds owned General Motors stock when it got delisted and the company eventually went bankrupt. No manager who bought GM lost his job, at least not for buying GM.
  • Your objectives are clearer. You’re there to make money. To maximize return by finding value and exploiting it.
    Is a fund manager there to make money? Yes, but not as unambiguously as you are. A fund manager makes a cut, yes, and also makes a salary. Thanks to that salary, the fund manager is operating under the same directive that most people do – I must preserve my job at all costs. The higher the salary, the more tightly someone will hold onto that job and the less they’ll to do risk getting fired. Playing not to lose isn’t just acceptable, from a fund manager’s perspective, it’s good business sense. At least as far as longevity is concerned.

Yes, selecting investments (it’s not “picking stocks”, thank you very much) is hard. It’s not an intellectual exercise along the lines of solving one of Hilbert’s Problems, but it’s hard in that it requires discipline. The same intestinal fortitude that gets your heart in shape or your lungs tobacco-free, can get you rich. Here’s how to start.

Filed Under: Estate Planning, Finance, Healthy Living, Investments, Making Smart Choices Tagged With: , , , ,

How To Stay Poor In However Many Easy Steps

June 15, 2012

My mom's doing tequila shots at Coyote Ugly right now. Thank God I can spell.

Take a vacation. You earned it!

You need to get away. You also need to spend less than you earn and invest the difference, but Carnival Cruise Lines doesn’t stop at the Port of Personal Responsibility. Nor are there daiquiris.

Yes, everyone needs to get away once in a while. Or spend on something beyond the basics. Money is meant to be enjoyed, at least some of it. But what a lot of people forget is that there’s still a window you have to operate in, contingent on your net worth and cash flow. This is not opinion. Concentrating on the result (your senses experiencing something pleasant) without paying attention to the effort rendered to achieve it (a commitment of your money) is insane. Rich people pay attention. It’s not why they’re rich, but it’s a leading indicator.

Rich people don’t want to commit a lot of their money, either – relative to what they have. No one in the top quintile of net worth is going to spend 3% of that net worth on an extravagance. People in the lower quintiles do it all the freaking time. That’s why they’re there, and the rich are where they are.

Here’s another way to cloud reality: justify an indefensible expense as being “for your kids”. For instance, “We’re taking our kids to Disneyland.” Congratulations, you painted yourself into a virtuous corner. Now, if you don’t take your kids to The Happiest Place On Earth, failing to do so would make you a parent who doesn’t love her (you’re probably a woman) child enough. Other people do it, why not you?

Number 1, screw other people. Number 2, what are you working for? If you have to choose between a smile on Junior’s face today and not having to move in with him 45 years from now, what are you going to pick? If you refuse to answer that question, or say “the smile”, you should find a less demanding blog. Here are four of them.

Here’s another handy phrase you can use to explain away your inability (REFUSAL) to build wealth:

“(Name of your indulgence) (present tense of positive verb) me.”

For instance, “My BMW 7-Series excites me. It makes me feel good.” The rest of my life sucks, my job is torture, but these 544 horses know how to snap me out of my funk.

Good for you. They’re probably also impoverishing you, if that’s the kind of thing that concerns you. Maybe it doesn’t, and if so then why are you reading this site?

Every time we say something heretical like that we have to spend undue time explaining it, because some readers aren’t that bright. Maybe reading the explanation will make them smarter. Here goes:

We’re not saying you shouldn’t buy a luxury car. Or a trip to Disneyland. Or whatever it is you want to buy. The only thing you should do is know your place. Michael Jordan gets to squander $300,000 in one night in the high-roller salon at Caesars Palace. You don’t. Why? Because he’s Michael freaking Jordan, that’s why. Alright, maybe that’s still not clear. Because he has a net worth somewhere in the 9-digit range. There, is that better? Gambling is still stupid, and indeed Jordan was dumb enough to lose half his fortune in what was simultaneously one of the most sadistic and masochistic divorce settlements in human history, but he can still withstand the losses. You can’t.

Your neighbor bought a boat, you say? Good for him! Did you see the bill of sale? How about the financing agreement?

Doesn’t matter. I want a boat I want a boat I want a boat.

Well, you’re also getting knowledge, whether you want it or not. You can pay $30,000 for a standard deck boat. Most people don’t have that kind of cash lying around. But if they do, and are also the kind of people who fancy themselves mariners, they’re probably not going to buy a $30,000 Tahoe. They’re going to buy a $140,000 boat and spend the next however many years paying interest on it.

“However many” doesn’t mean 3 or 4, either. It means 5, 8, 10, “or even 12 is not unusual.”

Not to focus on boats, that’s just one example. Swimming pools, jewelry, even (relatively inexpensive) expensive clothes. If you can find a merchant who’ll sell it to you on credit, and it’s not a necessity (and thus, by definition, a luxury), it’s not that you can’t afford it. You can’t, that’s not the point. The point is that you’re committing tens, hundreds, thousands, or tens of thousands of future dollars to whatever item it is you just can’t say no to, beyond its listed price. This is so simple that observing it hardly counts as conscious thought, but you know that credit card bill that you pay the minimum balance on every month? The one that’s going to take you 17 years to pay off at your current pace? It’s not just a uniform morass of cash. It’s that 99¢ iTunes download, now $1.78 with interest. It’s that $5 Quizno’s sub you didn’t think anything of at the time because, you know, $5. Even though it’s ultimately costing you $8.69. Some people justify the big purchases (see above), but no one even bothers to justify the everyday ones that make up the bulk of your total spending.

We’re not going to say that building wealth is the easiest thing in the world, but it’s far less complicated than many people make it out to be. If you can’t get ahead, look within first. Not to quote ourselves, but are you buying liabilities? Selling assets? Assuming that your opposite number in any transaction has your best interests at heart? Not putting the math you learned in the 4th grade to use?

If you’re struggling, you can get out. Easier and with less pain than you think. But you’ve got to want it. If you don’t, that’s fine, but you’re probably going to hate it here. In the meantime, buy our book and get started. Don’t say we never do anything for you.

Filed Under: Bad Examples, Consumer Debt, Credit Cards, Estate Planning, Finance Tagged With: , , , ,
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