Just last week, I was speaking with a friend who came from nothing and has become a veteran financial journalist. He is dumbfounded and sickened with what has become the “new normal” and how the little guy, the normal investor, is always left holding the bag.
“Tony,” he exclaimed, “I’m most concerned that the mechanics of the market have changed so dramatically that we’ll never go back to the world we once knew — when what was going on beneath the surface in individual businesses and the economy mattered. Today it’s all macro and algorithm-driven, tied to the latest headline.”
Over the past three decades I’ve had the privilege of working with millions of people across the globe in business and personal development as well as personal finance. Helping people take the right steps towards financial freedom has always been a focus of my mission but the reality is, we are living in a “new normal.” The dangers and potential opportunities that lay ahead have forced me to put the topics of investing and personal finance on center stage. Thankfully, I have the privilege of having access to some of the top financial traders in the country, 24 billionaire business moguls and other successful entrepreneurs / investors. My goal has been to extract their global views, determine their course of action, and ultimately find real solutions or my friends, family and clients.
Like most Americans, never before have I been so concerned with two things:
- Our country’s national debt and out-of-control spending, which will ultimately impact your quality of life through inflation and rising taxes.
- The financial services industry, which is addicted to volatile investments and allowing the investors to shoulder all the risk (while they are compensated regardless).
Consider the “new normal” in which we are living:
- “Buy and hope” no longer works. Only 4% of stock mutual funds have beat the S&P 500 in the last 10 years (USA Today, December 2011) which means they are adding no value whatsoever. David Swensen, manager of Yales endowment writes, “Overwhelmingly, mutual funds extract enormous funds from investors in exchange for providing a shocking disservice.” This is not to say that ALL mutual funds are bad, but the vast majority are charging hefty fees for no additional return (when compared to the broad market).
- Nearly 55% of trading volume today is done by algorithms in search of profit. Wired Magazine reports: “In 2007 the SEC instituted an ambitious new rule, the national market system, that opened the door to dozens of new venues for stock trading, but now that transaction times are measured in microseconds and prices are carried out to six decimal places, those opportunities have arguably gone past a point of diminishing returns.”
- Just this week The Wall Street Journal released an article called “Why stocks are riskier than you think.” Volatility is through roof, yet like an addicted gambler, investors keep going back to the tables and forgetting the risks of another possible 2008. The author writes, “Even though they experienced the hazards of stock ownership firsthand in 2008, investors are venturing back into equities again. They’ve been advised that there’s no other way to make up the losses they suffered—or meet their looming retirement requirements—and, not to worry, the risk of stocks diminishes the longer you hold them.” The author goes on to say that “Despite the assurances of the financial industry, stocks are always a risky investment, and the longer you hold them, the better your chances of getting blindsided by a downturn.”
Do As I Say, Not As I Do
The allure of market returns aren’t there for the insider, they are there for us. It’s challenging to filter the noise. We are continually sold and influenced by those who “don’t eat their own cooking.” Many in the financial world have transformed themselves from adding value to extracting value from customers. And somehow, everyone has become OK with it. It’s the herd mentality at its worst.
The financial entertainers of the world are touting the same old buy-and-hope strategy. One of these talking heads consistently discusses the mythical growth mutual fund, which she says should average 12% over the long haul. Show me one mutual fund that has averaged 12% over a 20-year segment. To top it off, when explaining how most of her $32 million net worth is invested in zero-coupon bonds, this particular financial entertainer told the New York Times: “I have a million dollars in the stock market, because if I lose a million, I personally don’t care.”
In searching for a top-performing fund manager, we often look to rating websites or glossy brochures to discover the fund’s performance numbers. But John Bogle, founder of Vanguard, cautions us, “Surprise, the returns reported by mutual funds aren’t actually earned by the investors.” Come again? That’s right, we don’t actually get to see the true net returns to the investor after you subtract the expense ratio, the transaction costs, the tax drag and the other undisclosed costs. Is this a modern day version of the emperor with no clothes?
In a sobering 2009 study released by Morningstar, in tracking over 4,300 mutual funds, it was found that 51% of the managers owned no shares in the fund they manage. That’s right. The chef doesn’t eat his own cooking. Of the remaining 49% or 2,126 managers, most own a token amount of their funds when compared to their compensation/net worth:
- 2,126 own no shares
- 159 managers had invested between $1 and $10,000 in their own fund
- 393 managers invested between $10,001 and $50,000
- 285 managers invested between $50,001 and $100,000
- 679 managers invested between $100,001 and $500,000
- 197 managers invested between $500,001 and $999,999
- 413 managers invested more than $1 Million
In March of 2008, just months before the market landslide, The Economist wrote the following: “Imagine a business in which other people hand you their money to look after and pay you handsomely to do so. Even better, your fees go up every year, even if you are hopeless at your job. It sounds perfect. That business exists. Its called fund management.”
Ben Bernanke, chairman of the Federal Reserve and the man more familiar with risk than anyone, doesn’t seem to like to gamble with his own money. According to a 2009 financial disclosure, his two biggest assets were annuities. No individuals stocks are corporate bonds in his portfolio. (source USA Today). And if you work for the Federal Reserve, your retirement assets were far more protected that the average American who has 77% exposure to stocks in their 401(k) (source: investment company institute fact book).
As of the first quarter of 2009, employees of the Federal Reserve overwhelmingly chose safety and guaranteed for their retirement savings. Over 75% of their plan assets were invested in the “Interest Income Fund.” 87% of this fund is comprised of fixed guaranteed annuities with major life insurers (source: Federal Reserve).
The quality of your life will often reflect the quality of questions you ask yourself. The following are challenging but necessary questions:
- How much more money am I willing to lose? Or is there a better way?
- Is it REALLY true that in order to have the quality of life I desire that I must gamble a large percentage of my net worth in the stock market?
- What portion of my assets are guaranteed to not decrease in value, and more importantly, are guaranteed to provide an income that I can’t outlive?
In PART TWO of this blog series I will begin to layout a few concrete strategies that I have sought out in order to help my family, friends answer these questions. The first strategy I will present is one that offers following benefits if structured properly:
1) 100% principal protection – You don’t have to accept the belief that losing money is just part of the game.
2) Participate in the market upside without the downside – yes you heard that right. You can link your returns to the upside when the market/index performs, but you don’t have to ride it down when the market turns against you.
3) Protection from inflation and taxes – you can grow your monies without tax (deferred until withdrawal) as well as choose non-correlated options which have historically done well during period of inflation (i.e. energy, precious metals, commodities etc.)
4) Guaranteed income for life – Imagine knowing that for every dollar you invest, you will be guaranteed a certain annual income that you can never outlive, guaranteed. I call this the “Build Your Own Pension” concept.