Unintended Consequence

LIMRA recently surveyed 2,000 Americans to gauge their knowledge of basic financial and retirement topics.  Not surprisingly, the respondents didn’t do very well.

However, the study did disclose that those who work with a financial professional were more likely to have a higher level of financial literacy. More specifically, consumers who use advisors are more likely to save for retirement (78 percent versus 43 percent), are likely to save at a higher rate (61 percent versus 38 percent) and feel more confident that their savings will last throughout their retirement years (71 percent versus 43 percent).  Even so, 8 out of 10 respondents say they only would pay $100 or less for financial advice.

Examined Rationality

As illustrated (left), you are faced with three urns, each containing 2000 balls. A has 2 reds and the rest black; B has 20 blues and the rest black; C contains 1 red, 10 blues and the rest black. You may reach into the urn of your choice and remove a ball at random. If you draw red, you get $1000; if you draw blue, you get $100; if you draw black, you get nothing. 

Which urn do you pick and why?

Source: The Big Questions (from a paper by Armen Alchian, with the exercise attributed to Harry Markowitz) 

What’s Your Baseline?

I spoke at an excellent conference recently and was on a panel there with two big-time economists.  While I was sitting on the dias listening to my “colleagues,” I couldn’t help thinking about this old gem from Sesame Street.

And I was the “thing” that didn’t belong. 

That said, I was a bit surprised that we had so many areas of substantial agreement because our starting points were pretty different.  Economists look at the investment world somewhat differently from the rest of us.  They come at things from a different place.  Plus, neither of them was American, making our outlooks even less inherently consistent.

The End of the Bond Limbo Party (“How low can you go?”)

We should always be skeptical when someone claims that “this time is different” in the markets.  New paradigms come around, of course, but not nearly as often as claimed. You’re much safer betting on ”old always” rather than on a “new normal” unless and until the new, new thing has proven out over time and is demonstrable based upon actual evidence and data. 

With that carefully rendered predicate out in the open, it’s worthwhile — and perhaps significant — to note that we will eventually see something truly new in the markets.  We’d all do well to be prepared for when the bond limbo party finally ends.

Forecasting Folly

John Hussman is a really smart guy as well as an interesting and often insightful analyst. But forecasting is exceedingly difficult even for the best of us.  Notice what he wrote on March 5, 2012: 

“The present menu of investment opportunities continues to be among the worst in history.”

It was thus an “awful time to invest.”  Since that piece was written, the S&P 500 is up 20.91 percent.  Oops.

Good Day

Mind the Gap

The question is a common one for many institutions – For the real estate allocation, should we use publicly traded REITs or private real estate?  The usual answer is to mix them.  Yet recent research highlighted by Institutional Investor magazine notes that public “REITs have beaten private funds by almost 5 percent a year over the past three decades.”  For the 30 years ended December 31, 2011, listed REITs returned 11.95 percent annually while private funds returned 6.97 percent. 

That’s a huge performance gap.

FOBOR or FUBAR?

In a no-yield world, many perceive themselves as ”forced buyers of risk” (FOBOR). By way of example, the Financial Times reported the following note from BofA Merrill Lynch:

In a world of zero rates, where $19.4 trillion of government bonds (that’s 48% of the total market) is trading below 1%, it’s little wonder the “lust for yield” is as strong as it is. Last week Rwanda offered 6.875% 10-year bonds to borrow $400mn, an amount equivalent to 5.5% of its 2012 GDP. The offer was 9-10X oversubscribed. And Panama successfully issued a $750mn 40-year bond with a 4.3% coupon (note that in the past 50 years the US 30-year Treasury bond has traded below 4.3% for just 10% of the period).

In what universe does it make sense for people to fight to loan Rwanda money at 6 7/8 percent?

Think Like a Scientist

Yesterday I recommended that investors employ the scientific method even though investing is the last liberal art.  That may sound like a contradiction, but it isn’t.

The Oxford English Dictionary defines the scientific method as “a method or procedure that has characterized natural science since the 17th century, consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses.”  What it means is that we observe and investigate the world and build our knowledge base based upon what we learn and discover, but we check our work at every point and keep checking our work.  It is inherently experimental.  In order to be scientific, then, our inquiries and conclusions need to be based upon empirical, measurable evidence. 

Thus the scientific method can and should be applied to traditional science as well as to all types of inquiry and study — including investing. The great scientist Richard Feynman even applied such experimentation to hitting on women. To his surprise, he learned that he (at least) was more successful by being aloof than by being polite or by buying a woman he found attractive a drink.

Signposts: A Daily (Baker’s) Dozen for Investors

Being human, we want investing to be easy.  We want formulas to plug-in, systems to follow and outcomes to be assured.  Instead, successful investing requires hard work, mental acuity and the willingness to adapt when things (inevitably) don’t go as planned. 

But how should we go about it? 

Here’s my (very tentative) listing of lessons and guideposts, a baker’s dozen in total, that we would all do well to abide by and internalize as we try to navigate the investment process.