There’s a Millionaire Born Every Minute

March 7, 2012

 

Barnum had his own midget decades before having your own midget was cool

 

While planning for a long trip to Costa Rica this winter, your humble blogger needed a way to entertain himself in a land where the nearest bar showing NFL games is a dirt road and a ferry ride away. Fortunately there exists the Kindle Store, where you can not only buy the Greatest Personal Finance Book Ever Written for next to nothing, you can get dozens and dozens of classics free. Almost anything that’s out of copyright, Amazon makes available. Within minutes the complete works of Mark Twain, Middlemarch, The Wealth of Nations, Ulysses, The Man Who Would Be King, The Iliad, War & Peace, The Count of Monte Cristo and dozens of others found their way onto the Kindle, so many books that they left barely 96% of its storage available.

The last book downloaded was an afterthought, and like many an afterthought, has inspired something of substance. That book is Art of Money Getting or, Golden Rules for Making Money by Phineas Taylor Barnum.

Here’s everything we knew about Barnum before buying the book:

  • founded a circus that, via a couple of mergers, still exists a century and a half later
  • introduced Tom Thumb to the world
  • said “There’s a sucker born every minute.” It turns out that Barnum never actually said that, which doesn’t matter because his verifiable quotes are far more profound.

Barnum wrote Art of Money Getting at 70, which was only 9 years after he founded his circus. Barnum spent the first 2/3 of his adult life building theaters and producing shows.

Art of Money Getting is short at 128 pages (if pages are still the measurement you use for book length. It’s 504 Kindle locations long.) But its ideas resonate way out of proportion to its length. Right out of the gate, in fact. The opening line:

In the United States, where we have more land than people, it is not at all difficult for persons in good health to make money. 

Barnum wrote this in 1880. The nation had 50 million people spread over 39 states. The first electric streetlight was installed that year. Ohio congressman James Garfield won the presidential election by 1,898 votes, catching a bullet for his troubles a few months later. Helen Keller checked in, as did the University of Southern California.

The road to wealth…consists simply in expending less than we earn; that seems to be a very simple problem. 

(Bolding and italicizing ours.)

Barnum quotes Charles Dickens’s Mr. Micawber, who said that if you make £20 a year and spend £19/6, you’ll be “the happiest of mortals”. Spend £20/6, and you’ll be “the most miserable of men.”

One look at the Occupy Wall Street protestors, United States senators and congressmen who spend your money, indebted graduate students, degenerate lottery players*, underwater adjustable-rate mortgage holders walking away from their homes instead of honoring their obligations and clueless personal finance bloggers who carry 5-digit credit card balances yet can’t wait to plan their honeymoons might lead you to believe that you can indeed spend more than you earn and still be happy. Barnum knew that that kind of “happiness” is riddled with more holes than a Lindsay Lohan alibi.

More cases of failure arise from mistakes on this point than almost any other…many people think they understand economy when they really do not.

One says, “I have an income of so much, and here is my neighbor who has the same; yet every year he gets something ahead and I fall short; why is it?”

Barnum’s question was rhetorical, and even back then the concept of living within your means struck many people as somehow boring or square. Other people never reached beyond a pedant’s understanding of economizing:

There are men who think that economy consists in saving cheese-parings and candle-ends, in cutting off 2d. from the laundress’ bill and doing all sorts of little, mean, dirty things. 

Does this sound like anyone familiar? Seriously, does it? Anybody?

This class of persons let their economy apply in only one direction. They fancy they are so wonderfully economical in saving a half-penny where they ought to spend twopence. 

Barnum illustrates this with a tale of a woman who rents out her house to overnight guests. When one complains that it’s hard to read late at night, she explains how she can only afford extra candles for special occasions. The money she’d make by spending a few bucks and having happy repeat customers

would, of course, far outweigh a ton of candles.

Her parsimony then reveals its true colors. It’s not about being cheap because of poverty, it’s about being cheap because:

Feeling that she is so economical in tallow candles, she thinks she can afford to go frequently to the village and spend $20 or $30 for ribbons and furbelows. 

If that’s not an admonishment to “buy assets/sell liabilities”, we don’t know what is.

(A furbelow, by the way, is not a Mediterranean woman. [Sorry. That was truly, truly horrible.] It’s a ruffle on a dress.)

Quoting Ben Franklin, Barnum writes:

“They are like the man who bought a 1¢ herring for his family’s dinner and then hired a coach-and-four to take it home.” I never knew a man to succeed by practicing this  

Contemporizing things, you can buy a 1¢ herring at Ross Dress for Less. You can buy a coach-and-four at your local university’s graduate school.

Barnum adds that if you want to build wealth, don’t make it hard on yourself.

Unless a man enters upon the vocation intended for him by nature, and best suited to his peculiar genius, he cannot succeed. 

What Barnum’s saying is simple. Don’t go to college out of obligation and then get an English degree because it’s the easiest one to obtain once you’re there. If you love sea kayaking that much, stop kidding yourself and become a tour guide. After a while, for less than the price of that college education, you can lease a storefront, buy a business license; advertising; and enough paddles, kayaks, helmets, life vests and tiedowns to keep your clients happy and yourself profitable and self-actualized.

Or you could just spend money on junk. And it doesn’t matter whether that junk is toys you have to finance, or an education that the marketplace offers no sufficient reward for:

There is scarcely anything that drags a person down like debt…
Debt robs a man of his self-respect, and makes him almost despise himself.

Barnum didn’t understand wasting money, but he did understand leverage:

I do not speak of merchants…who buy on credit in order to turn the purchase to a profit.

There’s another exception, too:

(quoting an underidentified “Mr. Beecher”) “Get in debt to a small amount in the purchase of land…safe to a limited extent, but getting in debt for what you eat and drink and wear is to be avoided.”

Barnum couldn’t stress it enough. If you’re dumb enough to have gotten into debt in the first place, live like a stowaway on a freighter bound for Cape Town before you incur any more debt. Sorry, but you get to neither eat your cake nor have it. That’s for people in the black.

Money…is a very excellent servant but a terrible master…It works night and day, and in wet or dry weather.
Do not let it work against you; if you do there is no chance for success in life

Also, don’t be an idiot. We don’t make it a habit of quoting Mohammed on this site, but Barnum references him, too. Camping in the desert, one of his tired followers said, “Screw this. I’m going to loosen my camel, and trust in God.” (Paraphrasing.) Mohammed came back with, “No, tie your camel and trust in God.”

Barnum explains how most quitting is done early. Perseverance isn’t easy, but it’s a lot easier than failure. And perseverance engenders momentum. Take the case of John Jacob Astor, whose fortune in constant dollars dwarfed what Bill Gates and Warren Buffett are worth today:

It was more difficult for him to accumulate his first thousand dollars than all the succeeding millions

Donald Trump’s first apartment building, Ted Turner’s first acre of ranchland, Timbaland’s first hit song…none of them were especially noteworthy at the time, but they each represented a milestone. Because going from 1 quantifiable accomplishment to 2 means merely doubling your success. Going from 0 to 1 means increasing your success infinitely. The first step really is the hardest, which is why most people never take it.

Which might be a singularly American concept. Upon visiting the United Kingdom, Barnum was shocked at the concept and understanding of class, and couldn’t wait to get back home:

In this Republican country, the man makes the business. No matter whether he is a blacksmith, a shoemaker, a farmer, banker or lawyer…he may be a gentleman. 

By “gentleman” Barnum doesn’t necessarily mean a guy who holds doors open for women and puts his hand to his mouth when yawning. He means a man of affluence, or at least comfort. In the U.K., comfort didn’t come without a pedigree.

We leave you with this, as apt a comparison of richness and poverty as any:

The poor spendthrift vagabond says to a rich man: 

“I have discovered there is enough money in the world for all of us, if it was equally divided; this must be done, and we shall all be happy together.” 
“But,” was the response, “if everybody was like you, it would be spent in two months, and what would you do then?”
“Oh! divide again; keep dividing, of course.”

*”I don’t really ‘play’ the lottery, I just buy tickets once in a while. Besides, it’s just fun!”

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We Put the “Fun” in “Bond Funds”

February 15, 2012

 

Wake me up when they stop talking about bond funds

 

Why would you invest in a bond fund? It sounds like the most conservative of investments.

It isn’t. Bond funds, like the bonds they’re comprised of, offer yields that most stocks and mutual funds don’t. Bond funds can be volatile.

We examined the composition of the Wells Fargo Advantage Total Return Bond Fund (ticker symbol MNTRX), one of the biggest (if not the biggest) bond funds in existence. Here’s what it’s invested in:

That lists the fund’s 10 largest components, leaving 80% of the fund unaccounted for. So what’s missing?

Scroll to the bottom and in a tiny font it says “Click here for more complete holdings.” The hyperlinked part of the copy (“Click here”) isn’t even recognizable as a hyperlink.

How many bonds does MNTRX has a piece of? One Control Your Cash author guessed 50.

It holds 569. That’s not every bond in existence, but it’s plenty. We can’t fit the entire list on one page, nor would you want to read it, but here’s as much as we could cram into one screen cap.

 

 

If you can’t be bothered to look through all 569 components, this summary breaks them down by sector and grade.

 

 

The bonds typically pay interest quarterly, so there’s always money going in and coming out, thus the fund has to have cash reserves, therefore MNTRX’s primary component is a money market fund with readily accessible cash. (The rare “so/thus/therefore” hat trick.) Understandably, that money market fund is a Wells Fargo security too.

What about the actual bond components of MNTRX? First, notice how many U.S. Treasurys are on there. Makes sense, seeing as those are the only investments “backed by the full faith and credit of the U.S. government,” to the extent that that phrase still means anything.

But that’s only a small part of the story. The top 22 bond components include:

  • 9 Fannie Mae
  • 6 U.S. Treasury
  • 3 Ginnie Mae
  • 2 Freddie Mac

Not long ago we explained as best we could how Fannie Mae and Freddie Mac are hundreds of times more rapacious than an entire investment bank full of Bernie Madoffs could ever be. Also, Fannie Mae and Freddie Mac investments come with no explicit governmental guarantee. So why would Wells Fargo, a profit-seeking company, invest in Fannie Mae and Freddie Mac bonds?

Because the ruse that they’re not backed by the government (and thus, you) is laughable. For all practical purposes, when the so-called “government-sponsored enterprises” run low on funds, the Department of the Treasury bankrolls them to whatever extent they can get away with.

Go to the second item in the list of components. The simple designation “FNMA” tells you little about the particular bond that the Wells Fargo fund is invested in. You have to look at the next column over, which contains a 9-character string called the CUSIP (Committee on Uniform Security Identification Procedures) number.

The first 6 digits of a CUSIP number tell you who the issuer is, the following 2 what type of security it is (debt or equity). The final digit is a check digit. There are a handful of online indices that let you search for a CUSIP, but they’re all either incomplete or they cost money. Your best bet is to just Google the CUSIP. Oh, is that too inconvenient for you? 20 years ago you’d have had to go to a broker’s office and look it up in a book. The second item on the list of components,  912828RM4, is listed as

U.S. Treasury Note, coupon rate of 1%, maturing October 31, 2016. 

We’ll do the next 8, too:

912828RF9
U.S. Treasury Note, coupon rate of 1%, maturing August 31, 2016. 

The only difference between the two is the maturity date. They each pay semiannually, and they’re each rated AAA.

912828RX0
U.S. Treasury Note, coupon rate of ⅞%, maturing December 31, 2016. 

31402CVV1
Fannie Mae bond with a 6% pass-through rate, maturing March 1, 2034.

“Pass-through” rate means what the bond pays after the issuing agency takes its cut.

01F032617
Fannie Mae bond, 30-year term, 3½% coupon, 30-year term. 

We can do this all day, but what does it mean?

In 2012, if you’re investing in a bond fund it’s because you want a higher return than you’d get from a certificate of deposit. You have to go all the way down to the 28th item on the list before finding a true corporate bond, that one being from Citibank’s Omni Master Trust series.

A whole bunch of federal government debt, interspersed with a handful of Extended Stay America and Bank of Montreal bonds. Does that mean that anyone with a list of bonds and a list of criteria could create a bond fund comparable to this one from Wells Fargo? Possibly.

Bond yields are extremely low right now. The yield on a 5-year Treasury Inflation-Protected Security is -.94%. Yes, negative. That’s more a function of the (steep) price it last traded at, than of how long it’ll take to mature. (10-year TIPS yield a slightly more rewarding .40%.) This is what happens when the Fed sets rates artificially low, essentially 0 for an extended period. You buy a bond with a negative yield when you’re anticipating that inflation will come, but hard. Keep in mind, we’re talking specifically about TIPS. Other treasurys don’t protect you against inflation. Nor do they protect you against deflation: should that happen, a TIPS will pay you the face value at maturity.

Oh yeah, the price. You can buy a share of MNTRX for $12.96 right now, which is almost the $13.10 it’s peaked at multiple times in the last couple of years. MNTRX debuted in 1997 at $12, and has never fallen below the $11.05 it sank to in 2000. A safer investment with less variance than a stock? Yes. A way to get rich? Probably not, unless the economy at large goes Greek. But a bond fund is a way to preserve your wealth while saving yourself from the risk of only having a couple of bonds in your portfolio and having them underperform. Unlike a bond itself, you can sell your position in a bond fund almost whenever you want.

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A Whole New Way To Diversify

February 3, 2012

You can't have corporate fraud without a corporation

 

Every company you can invest in has to be a corporation by definition, right? The corner barbershop that operates as a sole proprietorship can’t trade publicly, nor can any partnership.

Not quite. One of the least publicized securities available to you, the private investor, is the master limited partnership. People buy these when they want income, rather than capital gains. And despite their obscurity, MLPs are easy to buy.

You already know what a partnership is – multiple people create a business; and for tax, credit and legal purposes, those people are the business. They have no protection against being sued for more than the business is worth, which is why most entrepreneurs will forgo a partnership to create a limited liability company or corporation. Long story short, the tax rate is more favorable. If you want the details, read Chapter X in “the best personal finance book ever written” (Len Penzo.)

The general form of a partnership is called, somewhat anticlimactically, a general partnership. In its variant, a limited partnership, some of the partners aren’t liable beyond what they’ve invested. For these limited partners, the partnership works like a corporation in this respect. The remaining partners, the general partners, are on the hook for everything. If you’re wondering what the advantage is to being a general partner, well, someone has to be. And the general partner(s) are the only ones who receive dividends. The limited partners enjoy a proportionate share of profits, or losses, but that’s it. As you can imagine, the general partners have enormous incentive for the company to do well. If it does, the general partners enjoy bigger dividends.

Master limited partnerships trade publicly. The limited partners again receive a share of the profits, while the general partner manages the MLP and gets paid contingent on how well it does. Managers form an MLP when they want to avoid the scourge of double taxation, which plagues standard corporations (a/k/a C corporations, as opposed to the S corporations that small businesses operate as.) Major corporations’ profits are taxed first when the corporations calculate their earnings. When the corporations pay dividends out to the shareholders, the shareholders also pay income tax on that.

There’s more to it, though. Not every limited partnership can qualify to be a master limited partnership. At least 90% of an MLP’s cash flow has to come from commodities, natural resources, or real estate. In practice, almost all MLPs are in the energy business.

MLPs offer “units” that pay out quarterly “distributions”, rather than “shares” that pay out quarterly “dividends”, a distinction largely without a difference as far as we’re concerned. Sell your units, regardless of how much the MLP appreciated while you owned it, and the IRS will charge you at standard income tax rates, rather than capital gains tax rates. Should the MLP depreciate while you own it, that’s what’s called a “passive loss”. If the MLP eventually appreciates, you can use the losses to offset the gains for tax purposes.

Enterprise Products Partners is the biggest MLP in existence. They transport natural gas and oil through 50,000 miles’ worth of pipelines. They also gather, process, ship and store it. The company is a giant, with $32 billion in revenue during its last fiscal year (comparable to Aetna) and shareholders’ (check that, unitholders’) equity totaling $11 billion, which is larger than that of M&T Bank. Enterprise Products Partners trades on the New York Stock Exchange, under the symbol EPD. Management owns 39% of the units, the remainder available to the public.

Let’s look at one of EPD’s biggest competitors, both to illustrate the similarities and to explain the subtle differences.  (And to show you how serious the general partners are about enriching themselves in concert with the company, rather than in spite of it.) Kinder Morgan Energy Partners (NYSE: KMP) also deals in stuff extracted from the earth, and clearly owes AC/DC a royalty whenever they produce something with the company logo on it:

To the casual observer, Kinder Morgan’s business is almost identical to Enterprise Products’. The former transports refined petroleum and natural gas, operates terminals, and also transports carbon dioxide. According to the company’s website, its namesake and CEO Richard Kinder draws a $1 salary and doesn’t receive stock options.

Ha! It seems they just wanted to see if we were paying attention. Of course he doesn’t receive stock options, there’s no stock. Only units. KMP also goes to the trouble of telling us that they don’t screw around with “unnecessary overhead…such as corporate aircraft, sponsorships, sports tickets…” And “we cap senior executives’ base salaries far below industry standards. (The executives’ bonuses) are tied directly to the performance of the company.”

Wow. Is it too late for Richard Kinder to run for president?

KMP’s equity stands at around $7 billion, its revenues $8 billion. And these two are just the tip of the industry. A disproportionate number of the players are situated in Texas, specifically Houston, for reasons that are hopefully obvious.

Like anything else that can be securitized, master limited partnerships can be packaged into mutual funds, too. One of the biggest is the ClearBridge Energy MLP Fund (NYSE: CEM). ClearBridge Advisors is a subsidiary of Legg Mason, one of the biggest mutual fund companies in existence. Another MLP Fund is SteelPath MLP Income Fund (NASDAQ: MLPDX), founded 2 years ago. CEM’s biggest component comprises less than 10% of the fund, MLPDX’s biggest barely 6%. MLP funds typically hold fewer components than do your standard mutual funds, largely because there are so few MLPs for the funds to be comprised of in the first place.

Master limited partnerships are attractive to many investors because the managers clearly have skin in the game. Managers are less inclined to jump ship, too: when you’re running a successful MLP, why would you want to leave? From our perspective, there’s plenty of reason to look at MLPs (and their funds) over more notorious securities. We don’t expect you to sit through consecutive posts about MLPs, so we’ll do something wildly different Friday and then hit this topic in detail a week from today. And, as always, look for value that most people can’t bother to find. ‘Til then, class dismissed.

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