Invest With Less Risk

A friend of mine sent me a link to this video clip.

Wow.  After watching this what does that leave you feeling comfortable investing with?  Gold, silver?  If the entire system is hanging by a thread where can you turn for safety?

Even the venerable Ben Stein says there was no way to predict and protect our portfolios against this kind of economic meltdown:

Because the past 15 months have been by far the most upsetting time period of many investors’ lives — including mine — I am continuing to examine the lessons learned from this crisis.

First, we have learned that even the most rigorous back testing of portfolios did not work during this period. The reason was simple — no back test allowed for as much stress as markets were under from late 2007 to fall 2008. There simply was no postwar historic precedent for markets to be as volatile on the downside as they were in 2007-08. Thus, back testing (very similar to stress testing) that called for maximum falls of, say, 33 percent simply did not work when markets fell as far and fast as they did in 2007-08.

To be sure, there have been other times when the markets fell as far — the early and mid-1970s are an example. But the daily volatility and unprecedented decline after the failure of the Treasury to rescue Lehman Brothers were simply not on most radar screens.

We Weren’t Prepared

That meant investors were not prepared, in terms of volatility, for what happened.
Nor were we prepared in terms of modern investment theory for a time when almost all categories of investment collapsed simultaneously: US large cap, US small cap, US value, US growth, foreign developed, foreign emerging, foreign growth, foreign value — all collapsed. At the same time, corporate and municipal bonds fell sharply, as did nearly every commodity.

Real estate, both commercial and residential, also fell dramatically. No amount of diversification worked to preserve capital, other than having short- and medium-term Treasuries and insured cash.

This was not supposed to happen.

Any thoughts?  I am at a loss.

Beating the Bank

In April of 2007 I finally got on the peer to peer lending wagon.  I had seen articles and blog posts about how you can beat other investment sectors by lending to folks that would rather pay you interest than the bank.  You as the lender could evaluate each potential borrower to determine if they met the risk levels you were comfortable with or if you just wanted to “invest” in the latest mobile hot dog vendor on the southern California boardwalk.

What’s not to like; I am able to get upwards of 20% interest on my money and they get their 3 year loan to do whatever with.  As I got a bit more finicky I began only loaning to the more trustworthy folks, meaning those with a higher credit score, who have free cash in their income statements to easily make the payments.  See my initial post on Prosper.com.

The Economics

Fast forward two years, the economy is a wreck, press releases announcing 50,000 layoffs in one day are in the news, the banks take billions in bailout money to pay the exec’s Christmas bonus and the stock market is in tatters.

Given everything else and that the P2P loans are unsecured is it any wonder that delinquent borrowers are popping up like fruit flies?

The Results

Granted my financial investment of $1000 in P2P loans is minor compared to others but of my 15 active loans 5 are currently late, in collections or have been charged off as bad debt.  Another PF blogger that got me started on Prosper has 53% of his 202 loans late or defaulted.  He had over $11,000 invested according to LendingStats…ouch!

These defaults and delinquencies are being reported on the borrower’s credit bureau and in theory they will be forever banned from the site.  If the top rated borrowers are shirking their obligations to me why would I want to put more at risk?  Does this economic climate spell the end of peer to peer lending?

I know with Prosper in regulatory, class-action hell and my rate of return dropping like a rock all I want is my cash out.  I suspect that others are thinking the same.

A while back I wrote a post about Douglas Andrew’s Missed Fortune book series. As you can tell from the name of the site I am looking for ways to maximize my investment returns while minimizing my risk. I’m sure you can all appreciate that in these market conditions not only is return on capital important but return of capital is even more so.

With that in mind, I contacted the folks at Missed Fortune to see what kind of plan they would work up for me. I filled out their online form and a few days later one of their reps got back with me. We had a couple of phone interviews, a plan was created and then they presented it to me via the web & telephone.

What they came up with basically transferred all the money that I am already putting towards my 401(k) to get my employer match and the equivalent of my full Roth IRA contribution towards a fully funded cash value, minimum death benefit universal life insurance policy over a 10 year period. The illustrated plan also included dumping the full cash balances of my bank accounts, not including my emergency fund, into the Bucket (their name for the insurance contract plan).

Now for some of my basic financial background…I have no debt other than a rental property mortgage. I have no car payment, paid off credit cards, no student loans and live in a small apartment within sight of where I work. If I really work at it I can get by on half my take home pay.

I am also a fan of Dave Ramsey. Amazingly he is the only financial guy that my mother likes; she won’t investing in anything risker than CDs and big surprise Dave is a very conservative financial guru. His Baby Steps method of prosperity helped get me where I am now. That said he is not a fan of cash value life insurance.

One driving argument that Douglas’ Bucket plan has is that your money will grow tax free and can be withdrawn tax free in retirement. Another is that the plan can be tied to a stock index like the S&P 500, gaining in up times and having a guaranteed rate in down years. If you need it for your family, there is also a life insurance benefit component.

Sooo after all this rambling I decided that I just could not give the go-ahead to start it up. Doing the math, if I followed the maximum 10-year funding schedule they laid out ~30% of my take home pay would be going into this plan. If another 50% goes to pay my bare bones routine bills that doesn’t leave much for a car payment when my newest decade old vehicle kicks the bucket or to make a house payment should I get sick of apartment living. I would also be missing my 75% company match in my 401(k) at current levels.

I commend the Missed Fortune group for not charging me for the plan workup like they advertised on their webinars. I was curious as to what they would come up with for me. I enjoy reading/listening to Douglas, Emron and Aaron Andrew’s materials but I just don’t want to kill my cash positions right now given the current economic environment.

That said I do not want present their plan of action in a totally negative light. With the housing market as it is I do find myself agreeing with the plan to pull equity out of your property and place it into a Bucket. I saw this week that mortgage rates are available at 4.5%. You would be silly not to refinance out the equity and put it some place safe. In that respect I lean towards Robert Kiyosaki…let cashflowing properties using leveraged money make you wealthy.

Generating and preserving wealth is an ongoing process. The same tool may not be the best one for every job. Keep learning new methods so you can know when and how to apply them.

The Investor Back Story

As I mentioned on another post (Rule #1 by Phil Town) that I am a nerd and don’t like to consume a lot of time on repetitive tasks when a machine can do it much quicker. Phil Town says to look up what you know for potential stock investments but don’t bother figuring the Sticker Price until the growth numbers meet the minimum qualifications of 10%.

Being lazy I didn’t want to play hit or miss forever with random companies so I used the same sites he mentions in his book and wrote an application that grabs a lot of the information to narrow the field down. This way I can sweep the entire stock market (NYSE, NASDAQ & AMEX) in less than an hour. I’ve added a couple more fields like book value, dividend/yield and insider ownership for my own gratification.

The Results

That said here are the results of a run I performed on the major markets and the S&P500 this evening. The ticker symbols listed passed the minimum 10% growth rate for Equity, Sales & EPS growth. If you open the corresponding google doc you will see the rough output of my application with the other numbers figured. The last trading price along with anything starting with Y! came from Yahoo’s web pages; everything else was pulled from or calculated with MSN MoneyCentral data.

As always do your own due diligence…don’t let a blind program be your only screening process.

NYSE: AOB ARG AZZ BBL BHP CHD CHL CVS CW EDU FCN FDS FSC GIL GKK GNK GPN HOC JEC KEX KWK MBT MTW NE OII PCP PCZ PHX RAH RBA RMD SII SSL SYK VAR WW
http://docs.google.com/Doc?id=dm6×7d5_5hkv9vsc5

NASDAQ: AIRM ANSS BCPC CEDC CTSH CTXS EGLE FOSL GMCR GRMN HANS HSIC ICLR IIVI IPAR JST NEOG NVDA ORCL QSII SCHN TISI TROW UEIC URBN WRLD
http://docs.google.com/Doc?id=dm6×7d5_4dsmnhtdv

Amex: none passed
http://docs.google.com/Doc?id=dm6×7d5_3pbxg6fgq

S&P 500: CTSH CTXS CVS JEC MTW NE NVDA ORCL PCP SYK TROW VAR
http://docs.google.com/Doc?id=dm6×7d5_6d6fkcncd

In the interest of full disclosure from the above lists I have purchased, owned and/or sold GKK, KWK, MTW, EGLE and GRMN. Note to potential investors, EGLE just suspended their $2 dividend last Friday. They changed “the story” I had written for the stock so I sold my entire position at ~$6.80.

What can I say, I’m a geek who likes ordered steps to arrive at a solution. Here are some author-generated lists mentioned in books and audio books I have consumed recently. I leave it up to you to read, research and ponder their context.

I was listening to the audio book version of Dolf De Roos’ Real Estate Riches the other day and he mentions his 8 Golden Rules of Property:

8 Golden Rules of Property

1. You make your money when you buy.
2. Always buy from a motivated seller.
3. Fall in love with the deal not the property.
4. Never be the first person to name a figure.
5. Be counter-cyclical.
6. Always try to buy with zero or little down.
7. Seldom sell.
8. The deal of the decade comes around about once a week.

Another couple of lists come from George S. Clason’s book The Richest Man in Babylon. This was first released in 1926 but I would encourage you to give it a read or listen.

The 5 Laws of Gold

1. 10% of what you make is yours to keep.
2. Put your money to work for you.
3. Use advisors to make informed decisions.
4. Invest in what you know.
5. Don’t get greedy.

The 7 Cures for a Lean Purse

1. Save at least 10% of what you make.
2. Budget your expenses.
3. Put you money to work for you.
4. Only invest in secure opportunities to safeguard your money.
5. Own your own home.
6. Invest for retirement.
7. Strive to better yourself.

My last list for the evening is from Mohnish Pabrai’s The Dhandho Investor: The Low-Risk Value Method to High Returns. I’ve read that people are saying he might be the next Warren Buffett. Here is his list for investment success:

9 Rules to Dhandho Investing

1. Focus on buying an existing business.
2. Buy simple businesses in industries with ultra-slow rates of change.
3. Buy distressed businesses in distressed industries.
4. Buy businesses with a durable competitive advantage - a moat.
5. Bet heavily when the odds are overwhelmingly in your favor.
6. Focus on arbitrage.
7. Buy businesses at big discounts to the underlying intrinsic value.
8. Look for low-risk, high-uncertainty businesses.
9. It is better to be a copycat that to be an innovator.

Over the last few days of being a slug at Borders I had the chance to read through The Last Chance Millionaire by Douglas Andrew.

The author’s contention throughout the book is that your money needs to be in tax advantage savings vehicles earning you money and/or reducing your taxes. Let’s get to it shall we.

Douglas has really two main points that he drags out through the whole book:

• Get your money out of your house, and
• put it to work, in this case buy investment-oriented life insurance

He uses the example of a glass of water and an empty pitcher. You view the water as your cash and the pitcher as your house equity. If you put your cash into the house then the money just sits there not earning any return but if you “pour” the money out of the house into into a side pot then you can maximize the interest deductions on your taxes and in addition will be able to invest your equity into another investment for a better return. On the asset sheet you would show your house value and your side pot of equity as well. This will effectively turn you into the bank by making use of arbitrage (borrowing at one rate and investing at a higher rate of return).

He believes that it is better to have an interest-only mortgage and invest the payment difference elsewhere. That said he also thinks that it is better to pay the tax man up front than when you are in retirement since most people think that taxes will be higher in the future. Do your Roths where you can and be sure to get your company retirement plan match.

His second point is more fiscally oriented towards the Boomers, or at least those with lots of home equity. When you take out your money by refinancing, it will be tax free since it is a loan and not earned income. If you invest it someplace normally you would have to pay taxes on the gains as well. His strategy is to put your money into a minimal death benefit, indexed universal life insurance policy.

He likes the indexed variety because this lets you participate in the growth of the stock market without being in the stock market. Your policy may have a guaranteed 2% growth rate and a index growth cap of 12-17% a year. This means if the market, the S&P500 let’s say, goes up 12% in year 1 you get 12%. If it goes down 9% in year 2 you get 2% & if it rebounds 7% in year 3 you get 7%. If you had $100k invested in the stock market you would have $109054.40 in 3 years along with some heartburn. In this policy you would have $122236.80 minus the insurance and administrative costs of the policy. See the year-by-year table below. Not too shabby I guess if you do the same thing for 15-20 years.

The good thing about this insurance product is that if there is enough to pay the insurance portion you can withdraw money from the pool. Your initial invested money can be taken out tax free and you can take out loans against the appreciated earnings, thus withdrawing those tax free as well.

I say this book is slanted towards the Boomers or high-income earners more only because the younger you are the greater amount of insurance you will have to take out according to the author. This will eat into your “investment” dollars to cover the larger policy.

This shows Douglas Andrew explaining the Pitcher and Cup example of why you want to pull your home equity money out. Hope you find it enlightening.

Linked at http://www.youtube.com/watch?v=xvckL1VMGe8

One of the books that I have on my investing bookshelf is Rule #1 by Phil Town. I must confess that it has been a while since I’ve read it but I would highly encourage you to buy or peruse it at your leisure in your local bookstore or library.

Why you ask? The theme of this book expounds on the #1 Rule of Investing as spoken by Warren Buffet: Don’t Lose Money. This is quickly followed up by Rule #2: Don’t Forget Rule #1.

While there are may books out on the market that praise and crow about the value investing model and about how well the Oracle of Omaha can value/pick stocks but there are not that many books that take a step-by-step process to show you how to figure out the numbers yourself. This one does.

Phil Town was given his formula for successful investing as a reward by a well-off investor customer while he operated his own river rafting business. While he was skeptical at first his benefactor would not take no for an answer and after a few years Phil’s investments grew by leaps and bounds.

The formula, using conservative calculations, collects a handful of numbers relating to past performance and future estimates to determine what a stock has to be priced at to grow 15% per year over the next 10 years. The author knows we aren’t the hard-core business analyst types so we divide that Sticker Price in half to arrive at a Margin of Safety Price. If the stock passes the calculated growth filters and is below the MOS price then Mr. [Stock] Market is probably pricing the stock too low at the moment. This, as Warren Buffet says, lets us buy dollar bills on sale for $0.60.

The reason that I post this review now is last summer I decided that I was too lazy to randomly screen all the information myself so I wrote out an application that would crunch the numbers for me. This is the output of the S&P 500 stocks that met the filtering criteria and MOS price from July 16th of last year (2006). See GoogleDoc file.

Symbol —– 7-16 price —- 6-25-07 price —- Appreciation
COP ———- 67.08 ———– 78.04 ———– 16%
KBH ———- 41.67 ———– 40.68 ———– -2%
LOW ———- 27.96 ———– 31.22 ———– 11%
MRO ———- 86.90 ———- 124.20 (pre-split) 43%
MXIM ——— 28.90 ———– 32.71 ———– 13%
MUR ———- 55.54 ———– 58.24 ———– 10%
SYK ———- 42.93 ———– 63.16 ———– 47%
VLO ———- 64.51 ———– 75.94 ———– 17%

Total gain if you invested equal amounts into each one: ~19.375%

That said, here are the Sticker Price results I recently ran (6-18-07) for the Nasdaq 100 & the S&P 500. Remember if you are to follow Phil Town’s guidelines then you invest once the stock drops below the Margin of Safety Price and sell when it returns to the Sticker Price.

Just an FYI, these numbers were all calculated based on data available at moneycentral.msn.com.

More Than Enough by Dave Ramsey

More Than Enough in a straight forward sense does not address money or personal finance. It is slanted more towards the morals and virtues of being a good citizen which allows you to feel as if you have “More Than Enough”. It is more about contentment and doing the right thing. This book was described to me be the marketing fellow at the Dave Ramsey Live event as more of a book to read as you get close to being debt free and where to go from there. If that was the first book of Dave’s that I had read then I would have never picked up anything else of his. Skip this one if you are looking for direct knowledge and guidance.

Yes, You Can Get A Financial Life! by Ben Stein & Phil DeMuth

You Can Get A Financial Life is broken out by the progressive decades of your earning years. They cover the basics of child rearing and educating expenses to be expected as well as the single vs. married vs. divorced person’s earnings/savings expectations and the woman’s staying in the workplace vs. dropping out to have kids. They briefly cover asset allocation over the various times as well. The book almost had me thinking that they published a pile of fluff just to fulfill their book contract. I hope if they do another it has more meat to it. This is their third book I’ve reviewed recently. Please pick either of the other two to get your initial impression of their true value.