Watch that basket

March 19, 2010

Nzedele ignored his 401(k). This is what happened.

A great way to drive yourself crazy is to constantly track your investments. A great way to lose control of your financial future is to never track them.

You probably have a 401(k), and you’ve probably given it zero thought since the day you enrolled. If you’re the kind of person who memorizes his login and routinely checks his 401(k)s per-share value, congratulations. Now step back and check it less often. Once a quarter should do it. If you see any glaring omissions or mistakes – e.g. a 401(k) whose managers foolishly loaded up on Sallie Mae or Capital Bancorp stock, only then should you panic if your 401(k) loses money. Otherwise, relax and realize that it takes years if not decades to see significant changes.

If iit looks like the terms are synonymous, they aren’t. A 401(k) is a retirement savings plan, authorized by the federal government in the early 1980s. The government doesn’t have anything to do with the plan, it simply set the law that said you don’t have to pay taxes on the money you and/or your employer put into the 401(k) until you retire and start taking money out of it. (The term “401[k]” refers to the relevant section of the IRS code.)

Review your 401(k) accounts quarterly to determine that they’re allocated the right way, and that they’re performing. How much do you invest in each fund, stock, or plan available? How much risk are you willing to assume, and how do long you have to invest? (A delicate way of asking how close to death you are.)

Here’s how your 401(k) should be allocated, in general. Err on the side of equity, where you have the greatest opportunity for long-term returns.

Most 401(k)s consist of mutual funds. They’re easy for the 401(k) manager to operate, and they achieve the presumably laudable goal of keeping your eggs in several baskets. Mutual funds themselves are supposed to differ in their objectives – some are for aggressive investors who love to take risks while exposing themselves to huge downside, others are for conservative investors who play not to lose. Still others are for those who want to invest in companies whose stock prices are unduly low, or those who want consistent income in the form of regular dividends paid out to shareholders of the underlying companies.

A mutual fund is a bunch of publicly-traded stocks, bought en masse by a financial services company, which then sells uniformly proportioned chunks of the bunch to whomever wants in. This is a wild oversimplification, but say a firm buys $1 billion in Adobe stock, $2 billion in Boeing stock, and $3 billion in Chevron stock. The firm then creates a mutual fund with the stock, and offers it to the public. If you were to buy a $1000 share of the mutual fund, it’d consist of $166.67 worth of Adobe, $333.33 worth of Boeing and $500 worth of Chevron. The next day, when Adobe’s stock price falls 2.7% while Boeing’s rises 1.1% and Chevron’s rises .8%, the relative proportions of your holdings (and everyone else’s) change correspondingly.

Let’s start with an ordinary fund, the Allianz NFJ Dividend Value Fund. (Mutual funds try to be candid by putting the fund’s objective in the title. It’d be as if Crocs changed the name of their product to “Celibacy Shoes”.) Allianz is a financial services company (the 2nd biggest insurer in the world) based out of Munich. They hold this mutual fund, then get a reseller (in this case Morgan Stanley Smith Barney, but it could be one of many) to offer it to the public (that’s called underwriting.) MSSB then gets one of their new hires, probably a 20-something chick who’s all proud of the MBA she just earned, to do the grunt work of knocking on doors, selling 401(k)s consisting of mutual fund shares to human resources directors. Your company’s HR person schedules a meeting for all the employees, you attend it, the MBA chick passes out a bunch of indecipherable forms, makes a vague promise about a lifetime of financial security, and you sign up.

First, what does that acronym stand for? No-load Fund/Japan? National Fiscal/Joint Account?

It’s named after the guys who founded the fund, then sold it to the Krauts: Najork, Fischer and Johnson. The Allianz NFJ Dividend Value Fund trades on NASDAQ and has a ticker symbol (PNEAX), just like ordinary stocks do. Enter the symbol on Yahoo! or Google Finance, and it’ll tell you irrelevant information (the managers’ names, the R2 coefficient of determination) and some relevant information (a few of the stocks that comprise the fund.) It’s listed near the bottom, as “top 10 holdings”. Those holdings comprise 32.89% of the fund’s total, which is about average for a fund’s 10 biggest components. Does that help?

If I showed you one-third of a new car, and kept the remaining two-thirds under a tarp, would you be interested in buying it?

You need to do a few seconds worth of excavating on the fund’s site. Google the name of your fund. This will likely take you to a page with the same semi-helpful information; the fund’s biggest components. Look for a link that says “complete portfolio holdings” or something similar. Here’s what you’ll learn:

-your fund probably has 80-90 components
-the ratios that made up the fund the day it went live bear no resemblance to the fund’s current makeup.

Take a fund that consisted of equal parts of 80 companies, then 40 of those companies went south during the ensuing years. By definition, they now comprise less of the fund, because they’re worth less. The components that gained value – and any group of 80 companies has to include some winners – will thus make up a higher percentage of the whole. Which would appear to make the fund’s managers look good, except it can’t help but make them look good. Say your mutual fund bought Wal-Mart stock 20 years ago, when it traded at $7. It now trades around $54. All things being equal*, the fund’s percentage of Wal-Mart stock held has gone up almost 8-fold. That’s not prescient, that’s inevitable. The point isn’t to find a fund that consists of nothing but rockets; such a fund doesn’t exist. Instead, you want to preserve value, be aware if you aren’t, and at least understand where your money’s going. “Set it and forget it” doesn’t work when Controlling Your Cash.

*Which they never are, but that’s unavoidable.

Filed Under: Investments Tagged With: , , , ,

Think your lek can kick my colón? Get riyal.

January 18, 2010

Strong dollar, weak dollar, what does it mean?

I haven't seen this many Indochinese dong since Sunee Plaza. Hi-oh!

It means the price of the dollar, as quoted in foreign currencies. (It doesn’t make a lot of sense to quote the dollar in terms of domestic currency. It’s always going to be worth $1.) There are 182 national currencies in circulation across the planet, but for this post we don’t need to concern ourselves with sparsely traded ones like the Botswanan pula or the Kyrgyz som (no offense to our readers in Gaborone or Bishkek. Control Your Cash is huge in Bishkek.)

Most of the world’s large cross-currency financial transactions are undertaken in just a handful of currencies: among them the euro, the pound sterling, the Japanese yen, the Canadian dollar, the Australian dollar, the New Zealand dollar… and the U.S. dollar. In the world financial markets, the U.S. dollar’s value is expressed relative to the prices of these other currencies. And around the world, that can be vital. One Control Your Cash author had the perspective of growing up in Canada, where the value of the Canadian dollar (quoted in U.S. cents) is at least as prominent a financial indicator as the Dow is in the U.S. Given that the U.S. dollar has historically been the most widely held stable (and most stable widely held) currency in the world, it makes sense that it’d be the one that other countries would choose to quote their currency in terms of. In many parts of the world not referred to above, three particular (foreign) currencies carry equal importance when measuring their relative strengths. In South Africa, for instance, the U.S. dollar, pound, and euro are quoted in terms of each other, making for 3 daily rate quotes (6 if you count each quoted in terms of South Africa’s own rand.)

We do this – quoting euros in dollars, or dollars in pounds, or pounds in euros – because there’s no pure, objective measure of wealth: no commodity whose value always stays the same with respect to everything else. There can’t be, as the economy is dynamic and accelerating. Millennia ago, it might have made sense to count, say, a suckling pig as a unit of currency. My hog is worth 4 of your sucklings. My horse is worth 20. My cow, maybe 8. Oh, wait, it’s a bull? Fine, you can have it for 3. When consumer electronics and decorative tiles and golf clubs don’t yet exist and therefore can’t be quoted in terms of suckling pigs, no problem. But the moment an economy advances even a little, you need something uniform and readily transferable to conduct business in. Even cigarettes work better than piglets, but that implies that your economy has already advanced to the point where cigarettes can be manufactured. Gold works to some extent, as we discussed here, but there are myriad reasons – mostly nationalism and conspicuity – why each nation insists on printing its own money.

If everything has a value – and if anything should, money should – it stands to reason that currencies can be traded for each other. And what makes a currency worth buying? Well, considering money isn’t edible, what makes it valuable is its potential for growth. It’s an investment, like anything else people trade in the financial markets.

If I buy ExxonMobil stock, I’m betting that the stock will increase in value – or in other words, that each dollar I’m buying the stock with will one day be worth less stock.

Yes! Breakthrough.

But currencies are different. If I buy pounds, doesn’t that mean I’m betting that my dollars will one day be worth fewer pounds?

Yes.

Does that make me a traitor to my country?

No, it makes you an investor. Indeed, currency transactions differ from most transactions in that when you deal in currency, you’re exchanging two abstract quantities whose only practical purpose – whose primary purpose – is ultimately to buy other things with. But if the currency you do business in (and if you’re American, that’s largely going to be U.S. dollars) is in danger of losing value relative to other currencies, there’s no point in waiting for it to happen while watching your dollars get weaker.

A “weak” dollar only means weak relative to other currencies. A currency can also lose value relative to itself over time (and almost always will), but that’s a different phenomenon – inflation, which can occur without respect to what’s happening in the rest of the world.

There are plenty of reasons why currencies fluctuate in value, a big one being interest rates. Let’s use the U.S. dollar and the pound as examples. The United Kingdom’s central bank*, the Bank of England, recently set its bank rate (the rate at which commercial and investment banks can borrow money from it) at ½%.  Every few months the Federal Reserve sets the American equivalent, the federal funds rate. Instead of a number, it’s a range, which is currently 0–¼%. (The more a bank borrows, the lower the rate it pays.) The effective federal funds rate, which is a weighted average of the money borrowed by banks, is .11%.

The U.K. rate is unequivocally higher, and not by a little. Which means that ever since those rates were set, the pound has promised higher returns than the dollar. Which makes the pound more desirable than the dollar, which is why the pound is worth more dollars now than it was a few months ago.

(The Bank of Japan’s rate is .1%. The European Central Bank’s is ¼%**, as is the Bank of Canada’s.) We’re not recommending currency investing, nor discouraging it. We’re just trying to explain how it works, which is better than you understanding it retroactively.

In the last 10 months, the pound has gained 20% on the dollar. Does that mean the entire American economy is weak relative to the Brits’? No. If your U.S.-based business buys a lot of British materials (labor, capital, whatever), it’s gotten more expensive to operate, because your business is taking in money in dollars and paying it out in pounds. If your U.S.-based business exports a lot to the U.K., then life is magical. You might not have noticed a thing regarding the price of what your company sells, or what it costs to make it, but from the perspective of a British consumer, your products got cheaper (in pounds.) Which is a big advantage over any British competitors of yours.

There are other criteria that determine currencies’ relative strengths, of course. A country with a lot of debt relative to its size (e.g. Venezuela) might have a crazy person in charge (which it does.) That crazy person (Hugo Chavez) can keep printing currency to settle the country’s debts, making the currency worthless and vaporizing the wealth of all the Venezuelans who earn and save money in that currency. But a country with a vibrant economy, little debt, and lots of imports relative to its size (e.g. Singapore) will usually have a stable currency. Singapore has to buy goods from other countries in order to survive, which means Singapore has a vested interest in keeping its currency worth something. It doesn’t have a lot of financial obligations, so there’s no incentive to weaken its currency by inflation.

Where do we fit on this scale? The United States has a tremendously vibrant economy, at least relative to the rest of the world, regardless of what’s been happening the last 18 months. The U.S. also has a lot of debt. However, we import a lot in absolute terms (although in relative terms, it’s nothing compared to Singapore. Plus we export a lot, too.) And while our chief executive isn’t crazy, it’s not a stretch to call him an opportunist who’d think nothing of ordering the Federal Reserve to help accomplish certain political goals that might not be economically sound.

Where to find currency rates? Yahoo! Finance is our favorite all-purpose financial site: it’s clean, comprehensive and easy to navigate. Scroll down to “Currency Investing” on the left column and have at it.

*You do a blog post, and then you realize halfway through that you might introduce an unfamiliar term. A country’s central bank – most every country of decent size has one – isn’t a bank in the sense that it has branches you walk into and make deposits in. A central bank exists to lend a country’s government its currency. The central bank actually creates the money the government borrows, which is why the dollar bills in your pocket carry the phrase “Federal Reserve Note”.

**You can choose between decimals and vulgar fractions on your own blog. We’re using both.

**This post is featured at Compounding Life**

Filed Under: Economy, Investments Tagged With: , , , ,

3 Investments for the next decade

December 11, 2009

Received honorable mention. Put on own socks. Enjoys lists.

Disclaimer:

Posting in list form is for the lazy and the epistolarily challenged. However, in an attempt to get more readers than the tens of thousands who already stop at Control Your Cash regularly, we’re following the edicts laid down by the people at ProBlogger. They recommend a different daily exercise for a month. Today is Day 3, and the exercise is…a post in list form. It’s embarrassing to even reference this contrived method of indirectly canvassing new readers, but in a couple of lines we’ll move from self-flagellation back to financial advice. Let the form of this week’s post be a lesson in the virtue of seeing a commitment through, no matter how dumb parts of it seem.

So here’s our list. Of investments it’ll be OK to make for the foreseeable future:

1. Commodities.

These are the protoplasm of the market, the most fundamental securities of all.

What are most institutional investments, really? A bank account sounds simple, but on its surface it’s somewhat intangible – it’s really a bet you’re making on the credibility of the bank and its officers. In a sense, you’re wagering that the bank’s lending and borrowing policies are conservative enough that the bank will pay you back with interest.
Say you advance to a slightly more sophisticated investment – 100 shares of Ford Motor Company. Ford, somewhat unsurprisingly, makes cars. They also make parts and lend money, but their primary business is the creation of Mustangs and F-150s. When you become a shareholder, your investment doesn’t directly correspond to a particular car, or part of a car. What you’re really buying is another intangibility – the future prospects of the company. You’re hoping that Ford management is adept enough at its primary business and its ancillary businesses that the $1013 you invest today will appreciate.

But commodities are as tangible as it gets. You buy a commodity, you’re actually buying cotton, hay, milk, heating oil, light sweet crude, gold, whatever. Take the unassuming soybean, available for about $1000 per metric ton. Soybeans fill bellies, thus taking care of the most basic human requirement. Soybeans trade in a more sophisticated manner on today’s Chicago Board of Trade than they did in the Sumerian marketplace of 6000 BC, but the principle is the same.

Remember the hierarchy of human endeavor. With apologies to Abraham Maslow, mankind’s highest occupations are, in descending order:

1. agriculture
2. engineering
3. medicine.

First, we need to eat. Second, we need devices that free our labor for other uses. Third, this all loses meaning if we get sick and die. The farmers, engineers, doctors and their related professions do all the productive work on this planet, while the rest of us just emit carbon dioxide. There’s nothing wrong with this, as we all benefit from the symbiotic relationship among the 3 categories above. The engineers create the axial-flow combine and develop superphosphated fertilizers, making the farmers more productive, which makes food cheaper, which frees the remaining 98% of us up to become investment bankers and bloggers.

2. Single-family homes.

Good Lord, there’s never been a better time to buy a house.

Even if you’re as unobservant as a TSA official, you might have noticed that home prices have dropped in the last couple of years. A desultory look online can show you graphs that demonstrate how 2009 median home prices are essentially what they were in 2001. You can find other graphs that seem to state that the recent bust has lowered home prices to levels not seen in 100 years.

“Median” doesn’t mean “average”. “Median” means this: say you ranked all 110 million houses in America in order of price – starting with the $20 house in Detroit we mentioned a few weeks ago and ending with Susan Saperstein’s $125 million home in Beverly Hills. The median home would be the 55,000,000th on the list.

There’s no question that a median home in 2009 is more valuable than its 2001 (or 1890) counterpart. That 2001 house probably wasn’t wired with a flat-panel TV and a wireless router, or even an iPod dock. The 1890 house didn’t have a flushing toilet, let alone a fridge with a vegetable crisper.

Building materials have improved – everything from fiberglass insulation to your decorative cedar accents and maintenance-free exteriors. So…

-the quality of the median house has doubtless improved;
-the median house fulfills its function as well as ever. You can still live in it, and it’ll still protect you from the elements.
-yet the price has tumbled.

And houses are necessities. Economists talk about substitutes – if chicken gets too expensive, you’ll buy turkey. But there’s no substitute for shelter.

Now if builders are creating a product that’s superior to its predecessors, and the prices have shrunk in constant dollars, what does that mean?

It means there are too many houses and too few buyers. There are too few buyers because a lot of people either can’t get credit or can’t make enough money. Which means that if you can get credit (which you should, if you have a job and Control Your Cash), and if you make enough money (if you Control Your Cash), you should be making offers on whatever houses you can find. Not necessarily to live in, but to invest in. You’re supposed to buy at the bottom of the market. The market will never be (much) lower.

Don’t take our word for it. Listen to the clueless brass at the National Association of Realtors, while keeping in mind that that organization’s main agenda isn’t to increase home ownership, or to educate homebuyers, or to increase stakeholder value, or any of that nonsense. Their goal is to maximize the number of real estate transactions. If home prices stayed unchanged for the next century, realtors would still hope that people would want to move across the street to have the sun hit their windows from a different angle, and would gratefully take a 3% commission on every sale.

The NAR’s latest TV and radio campaign stridently reminds us “affordability has improved” (Corporatespeak for “houses have gotten cheaper”.)

Read between the lines. What they’re not talking about is how attractive an investment a house is. They’re (not) doing this for a couple of reasons. First, half the realtors’ clients are sellers, who don’t want to hear the inevitable truth that this is a horrible time to sell a house.

Second and more importantly, people are idiots and only assume an investment is worthwhile if it appreciated in the past, rather than the future. They see a graph of median home prices that points in a southeasterly direction, and they assume the pattern will hold – even though as we’ve shown above, that’s untenable. Prices can’t get much lower, or they’ll barely cover the labor and materials.

3. Your own judgment.

This isn’t any of that Jiminy Cricket personal motivation talk. We’re being practical here, as always.

Using your judgment means that when you’re confronted with an investment that sounds uncommonly good, look at what could possibly go wrong and ask the most challenging questions you can think of. Of all the people who’ve ever lost money investing, how many were merely the victims of haphazard market conditions, and how many refused to look at the economic reality that was staring them in the face rather than the heart?

The penny stock of a company that’s created a transcendent product, yet refuses to demonstrate the prototype. The cheap rural land that will soon sit adjacent to a burgeoning new development, except there are no roads and no water and no means of getting it there. The inert icon of American commerce that still trades on the New York Stock Exchange, even though it’s been losing market share to efficient foreign companies for decades and relies on government largesse to pay its suppliers. The clothing store that your friend is opening up, even though she has no experience handling a payroll nor a budget and only got the lease because the last tenant absconded and the landlord figures it’s better to set a few hundred dollars on fire every month than a few thousand.

Buy into any of those and you’re selling, metaphorically speaking, your judgment short. Think of the downside – even the surest things have a downside. If it’s as easy to visualize as the scenarios above, step back and let another pioneer take those arrows.

Wow, three items. That hardly counts as a “list”, but given that this week’s post is even longer than our average post (or our median post), it solidifies Control Your Cash’s position as the most comprehensive blog of its kind.

Filed Under: Investments Tagged With: , , ,
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