I usually pre-write my posts Sunday morning. Thus, in a completely unplanned companion post to Canadian Capitalist’s comments on this article about the investment industry not being empathic to a retired investor, I look at whether financial advisors are truly the enemy or whether we have seen the enemy and it is us.  Canadian Capitalist looks at this situation from the perspective of poor asset allocation. I address the larger point of whether we are pushovers to our financial advisors.

Most readers know that I use to be a lawyer (cue the jokes now…). If there is one professional that is more disrespected and despised right now than the lawyers, it is the financial/investment advisor (IA)- although its a close race. Good, bad or indifferent, the IA is being blamed for many of the ills of people’s portfolios. But, ultimately, having answered a lot of questions from friends on how to deal with their lawyers, your professional is yours to instruct. Even if you give crazy instructions (assume your instructions are for a legal act), the professional either has to carry it out or resign due to a fundamental disagreement with your strategy.

In other words, professionals work for you and not the other way around. The tail should not be wagging the dog. But some of us let our professionals, especially IA’s, get away with so much, holding their use of jargon and fast-talking circle-speak as signs of expertise.

Then we complain when we do poorly and blame it on the IA. But who’s really at fault? The person carrying out the instructions or the instruction giver?

Are we, in fact, pushovers with our IA’s?

Here are 5 signs that you may be a pushover:

1. You let the IA act without instructions. “You do what you think is best” gives your IA carte blanche to do anything they want which may include putting you in unsuitable products. Alternatively, the IA trades on your account without seeking instructions- a huge no-no- but you don’t say anything (whether you made money or not on an unauthorized trade is not the point; it would be like praising your 10 year old son for taking the car and driving it down the street without hitting anyone).
2. You never meet with your IA regularly. Yes, we are all busy but out of sight is out of mind and out of mind means they are inattentive to your account so they do not call you when the market or your life circumstances dictates some correction in your financial strategy.  Make yourself heard so you know you should be treated as an important client no matter how big or small your account is.
3. You never question their rationale for their advice. Little kids would make wonderful clients- they ask “why”, “what else is there to look at” and “why” (again and again) a lot. They make you justify their decision. If an IA says buy “ABC” don’t automatically assume that is the best product. Ask them how it fits into an overall strategy, whether there is an XYZ equivalent to ABC, how much they are making off the sale etc. Make them walk through their thought process so you know how they arrived at product (product is product; its the strategy that is important).
4. You do not want to be seen as pushy. Polite but poor is a better alternative. I use to chuckle when clients referred to me as “Mr.” especially when I knew they were much more successful in life than me. You are paying for your IA’s time, directly or indirectly, be assertive (but not abusive) if you must to get a point across.
5. You don’t call them on the fact they made a mistake. My IA has on occasion missed something which he catches or I catch (looking at your statements monthly in detail helps as a safeguard against unauthorized transactions or signs that your IA is indifferent to your account). It is usually something minor like he didn’t put my contribution into a money market fund when I asked him to. In every occasion, he corrects the error even if he pays out of it out of his own pocket (he gives me the interest lost). My IA and I have a good friend in common so there is more than just a professional relationship for him to keep. But the point remains, I do see the error and ask him to correct it. If you don’t, you are implicitly telling your IA that he/she can get away with larger errors (the whole slippery slope argument which lawyers are so famous for…).

There are good IA’s and bad IA’s (or really salespeople). But even the good ones can treat you poorly if you don’t stick up for yourself. The barrier to entry to become an IA is relatively low so don’t hold a large degree of deference to them (or any professional) and don’t let the size of your portfolio determine your importance to your IA. You are only negotiating against yourself if you think that way. Be proactive with your finances. It is your money after all.

Passive investing and the ease in which people can now find unbiased financial information has, in the eyes of some, made the investment advisor/investment planner unnecessary. This school of thought, of which Canadian Capitalist and Michael James are large supporters, argues that most people are better off planning their own portfolio by buying exchange-traded funds which track broad based indexes and ignoring the chattering of the financial industry. On a rational level, there is considerable merit in this belief. On an emotional level, I always believe that this school of thought is driven by a back-lash against the worse excesses of the financial industry. But I always make this observation- every financially successful person I know has a lot of advisors around them (financial, legal, accounting) so perhaps going it alone isn’t the best thing to do.

Having been a legal advisor for many years, and sat on both sides of the table as advisor and advisee, I am not sure the solution is to forgo an advisor but to find the right one and I believe that under-performance is not so much a result of the wrong product but the wrong advisor. I will try to give some insight having sat on the other side of the table as an advisor.

1. Find the advisor by framing the referral in its context. This is the process of how I found my advisor; I asked a close friend who I trusted and who is good with money who he used. Got an introduction. Found out whether his life goals were consistent with mine (he is a saver, takes care of his parents, is a good community guy). Hired him. Here’s the kicker- I do not think if I met him in another context, my advisor and I would be chums. Friends certainly. But I did not hire him for his company. But the key was that the referral source was from an existing client who is good with money (i.e. it wasn’t just a “call my buddy Gus” throw-away referral) and I hired him more on competence and his financial goals aligning with mine than pure compatibility (I am not dating the guy so it is not Investment Advisor eHarmony at work). My best clients were mostly people with similar life goals and not so much people I got along with best.
2. Don’t abdicate your authority to your advisor. I believe this is the root cause of most unhappiness with advisors. I had clients who would come in to see me and say “I have XYZ problem, please fix it!” with no accompanying instruction on what the client wanted as an ideal outcome. To a good advisor, this is an exercise in frustration. We have no idea what the client wants. To a bad advisor, this is an invitation to juice up their commissions with high-commission products. The best instructions for advisors are typically- here is what I want as an end goal, please map out how we get there and let me approve before we proceed knowing what the costs will be. What you want doesn’t have to be extremely specific; it can be as diverse as: I want good performance but don’t want to watch my portfolio every single day (passive investing) to I love playing the market (active investing) to I am nearing retirement and want to protect my savings (conservative). A good advisor can take those emotional responses and translate them to desired outcomes and put nuts and bolts to how you get there.
3. Remember why an advisor is there: to give you another perspective and to act as a stupidity brake. I often scratched my head when my clients would get mad at me for not agreeing with them. An advisor’s job is to give differing opinions so that the client can make a fully informed decision; a good advisor is not a yes man. A bad advisor will want to do things their way no matter what (see point #2 on abdicating your authority). An advisor also acts as your stupidity brake- she will talk you out of your flights of fancy or other strange ideas that do not align with your goals. I often find there is an unrealistic expectation that the advisor has some magic solution to all your life’s problems if you retain them. No one does. Avoid the one’s that sell you that. Hire an advisor for differing opinions and as your source of sober second thought.

I have an obvious and acknowledged bias that I believe everyone needs an advisor. The key is not to hire any old advisor but to hire  a good one and use them properly once you hired them. I have mentioned before my advisor gets a memo from me every year setting out my expectations (my long term goals are on the top and then my short-term goals on how we get there are on the bottom) and we work from there. The “what” are my thoughts. The “how” is his to figure out. It is certainly how I wanted to be treated when I gave advice.

As a completely unsolicited endorsement, Preet’s from Where Does All My Money Go  would be a good example of a solid advisor; he’s very passionate about what he does and he’s not pushing product in your face but ideas and thoughts to consider and, given our exchanges on the markets, he knows not one size fits all for everyone.

I am realistic enough to understand that not everyone needs an advisor. However, even if you are a ragging DIY investor, it may be helpful to hire an advisor on an annual basis and pay them an hourly fee to review your goals and portfolio.

As a programming note, tomorrow begins my mini entrepreneurship and personal finance series. 

Statistics show that the over-whelming majority of mutual funds under-perform the general stock market index; a study found 78% of actively managed mutual funds lagged the Vanguard 500 Index fund (which tracks 500 large cap stock in the U.S.). Why? The explanation usually given is that mutual funds, even high-flying ones, eventually “revert to the mean” and perform just like the rest of the mutual fund sector. However, “reversion to mean” glosses over the structural issue that the mutual fund industry faces in matching or exceeding the general stock market indexes and gives further credence to the growing chorus of experts advising you and I to simply buy an exchange traded fund which tracks a broad based stock index(es).

The first structural issue is, quite simply, very relatable to anyone who works in a large organization. Large mutual funds work by committee and committees tend to make the safest decision and not the best one. When a mutual fund is small, the fund manager can still wrap their mind around what to invest in, when and for how much- the fund manager has a pulse on the industry. However, small mutual funds which do well become big mutual funds and, suddenly, the fund manager cannot look after the day-to-day operation of the mutual fund.

Investment committees have to be formed and, in my experience, most committees take middle of the road decisions rather than the correct one no matter how technically gifted the committee members are (the over-riding principle to such decision-making being CYA- cover your as*). Thus, big mutual funds become closet index funds- because that is the safe choice to make (and why pay the MER to have a closet index fund?)

The second structural issue is qualitative in nature. In the finance lingo, mutual funds don’t buy stocks, they take positions. When a small mutual fund takes a position, its position, in real dollars, is relative small (a small mutual fund may have under $1 billion of assets under management- remember we are talking about things being relative here; the largest mutual fund in the U.S., American Funds’ Growth Fund of America, has over $162 billion under management as of 2007). It can buy and sell without affecting the price of the stock being bought or sold greatly.

Now consider the plight of a large mutual fund (now we are talking about mutual funds with over $10 billion of assets under management) which we will call Acme Mutual Fund. Acme Mutual Fund has $10 billion assets under management (which would not even make into the 50^th largest mutual fund in the U.S.- not even close) and wants to invest a mere 2% of the fund, or $200 million dollars, to buy stock in ABC Co.

What effect do you think Acme Mutual Fund would have if it bought $200 million worth of stock at one time? Of course, the stock price would go up. To mitigate that effect, it tries to buy over time but you still have $200 million going into one stock over the short to medium term which tends to push the price up (or an enterprising investor finds that Acme Mutual Fund is taking a position and starts buying as well). In effect, the mutual fund is bidding against itself and buying positions for more than it should. Consider the Buffet effect- what happens when Buffet takes a position in a stock? It immediately goes up, making it harder for Buffet to add to his position at the same price.

Consider the other side of the equation, when Acme Mutual Fund needs to sell a stock/position. Now you have the opposite effect, you can’t dump $200 million worth of stock on the market without creating a drop in the stock price. Thus, you do the same thing again- you try to sell in dribs and drabs to ensure the stock price doesn’t fall completely. But, you have the same effect occurring. The market sees that there is a lot of selling going on and that supply exceeds demand in a stock meaning a drop in the stock price.

In effect, Acme Mutual Fund is getting in its own way; when it buys, the price goes up and when it sells, the price falls. It is getting the short-end of the stick both ways because it is a giant with clay feet.

Think about that the next time, an investment advisor recommends you invest in a large mutual fund because large mutual funds are safe. The Titanic was a big boat too.

One school of stock investing has always been invest in trends you see around you. Recently, I started noticing how many of my friends were having kids (I am told that women have physical urges to have kids once they reach a certain age which is around my age- umm… “urges” eh? My face loses all color as I write…). If you read various other financial blogs, there also seem to be a disproportionate amount of bloggers having kids, discussing child care credits, cloth diapers vs. regular diapers etc. etc. The contrarian in me thinks that maybe stock investing on demographics should not focus on the obvious investment in stocks based on an aging population but, perhaps, a mini baby boom.

This seems to be supported by the demographics. In 2006, the United States had the highest birth rate since 1971. Even more importantly, the U.S. fertility rate hit 2.1 children in 2006 which means, if this birth rate can be sustained over a period of time, there will be enough births to replace deaths. For policy purposes, this means there will be enough members of the next generation to support the retirement of the thirty-somethings like me. Keep in mind, however, that the 2006 birth rates have to continue over a long period of time for this to occur (come on urges! I don’t intend to work forever).

I dug a little deeper though to determine why someone may want to invest in the “baby industry” (for lack of a better term) based on the statistics. The 2000 U.S. Census revealed a spike in birth rates from 1991-1993; persons who are now entering College and/or University. If you are active in your University alumni club or live in a University town you know that this mini-surge in birth rates has lead to the construction of new dorms, student recreation centers etc.

But here’s what really interests me about the census. Take a look at the age of Mothers. The number of Mothers between the ages of 30-34 and 35-39 increases over the 1990’s with a corresponding drop in younger Mothers (20-29). The increase of Mothers between 35-39 is quite dramatic. Assuming that older Mothers are financially better off than their younger counterparts, it stands to reason that older Mothers may spend more on baby products. Even if the sheer number of kids does not increase, the amount of money spent could still be substantial as there are more older Mothers with the economic means to buy those $1200 strollers, $120 GAP kids snow-suits, $100 booties etc.

How does an investor benefit from these trends? I have often mused openly about starting a business aimed at the baby industry- the margins are impressive and no expense is spared (nor should it be) by the potential clients. From a stock investing perspective, take a look at Middle Class Millionaire’s list of stocks which will benefit from the aging population. Remove the financial companies and the same companies which sell to seniors also sell to the baby industry. What comes around goes around one supposes. The Johnson and Johnson and PG’s of the world capitalize from both ends of the demographic spectrum (it is also interesting to note the recovery of McDonalds after a rough late 1990’s coincides with the aging of the 1991-1993 baby boomlet).

At the very least, interesting food for fodder next time you change the diapers. As usual, please do your own due diligence before you decide to invest in the baby industry.

This is my last post of 2007. I am taking an early holiday to rest up (I have had a cold all week), enjoy the family, retain water and watch a lot of meaningless college football bowl games. Before I write on 2008 predications, I wanted to thank everyone for reading and commenting this year and wish everyone a safe and relaxing holiday.

Last week, I received a 100 page report from the research department of a investment firm on 2008 predications. Because it clearly has a “do not distribute” sign on it,  I am going to have to keep the issuer of the report on a no-names basis lest the lawyers come a calling but I found some very interesting insights in the report which I will highlight. Please note that the outlook from investment firms are always short to medium term and, as usual, do your due diligence.

1. Stay in cash for 2008

The report indicated that an ideal portfolio for 2008 was 55% equities, 25% bonds and 20% cash. 20% is an unusual high proportion but reflects the fact that no one knows what is happening in the market these these days. Yesterday, I had the following conversation with my investment advisor:

Thicken: “any reason why Power Financial dropped $1.00 today? I don’t see any new press releases?”

Advisor: “No one knows what is happening now. Random stocks are rising and falling.”

Yikes.

2. A tough year for CIBC

This report came out before CIBC announced yesterday that it may take another large charge on subprime loans but it had dropped CIBC from its best picks list. I don’t know if CIBC has a sugar daddy to bail it out like UBS or Citigroup did. There is one rumor making the rounds that if CIBC gets into real trouble, another Canadian bank may buy it with the government’s consent (only a rumor at this point; a lot of things would have to happen for this to occur and to splash cold water on this rumor, CIBC’s financial ratios appear to be healthy even if it had to take some substantial losses). On a similar note, I had lunch with the family on Saturday and a friend of my Dad’s came by and he started complaining about how poor the service was CIBC; so much so, he changed banks to Scotiabank. When you hear things like this happening on the street-level, it should make the suits in CIBC sweat a little. It is one thing to lose a lot of money on bad institutional bets on subprime mortgages or bad commercial paper but when people on main street are leaving, it has to be very worrisome. Banks have a lot of different ways to make money but still rely on taking deposits as bread and butter business.

3. Load up Sin Stocks and Insurance

People drink and smoke in good times and bad- more so in bad times. So there is beginning to be a shift towards sin stocks. I asked my advisor about Rothman’s and he said that a lot of his clients are moving into tobacco. People also invest in financials- usually for high-dividend yield and stability. With the banks near future in uncertainity, the shift in this industry has been to insurance.  This report notes that investor may want to load up on sin stocks and insurance stocks.

That’s it for 2007! Don’t forget to make a donation to a charity this season; it will do your soul good and its tax deductible!

Here’s my statistic of the week: Bloomberg reports that that Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman Brothers and Bear Stearns will earn a combined $28 billion this year down 8.3 percent from last year. Merrill Lynch and Bear Stearns reported some substantial write-downs from subprime mortgage/asset backed commercial paper. So, despite all of that, financial institutions continue to make money. But 2008 may be an equally rough year right? Bloomberg estimates these same firms will reach $32 billion in profit in 2008.

Financial institutions generally don’t lose money. Did they do some utterly crazy things such as lending out subprime mortgages? Of course. But, large, diversified financial institutions also have other sources of revenue- M&A, wholesale lending, wealth-management, foreign exchange, credit cards, wealth management, traditional banking, trading activities etc. etc. They just shift their resources elsewhere and they are doing it with our deposits. A financial institution is other people’s money to the extreme.

Stocks in this industry are taking a beating but it is compared to expectations. We have had an approximately 5 year run on banks and expectations got too high. RBC reports a 14% earnings increase two quarters ago and the market punishes their stock. Things are little out of whack when that happens but remember that the expectation is “how much money are you making” and not “are you going to make money?”

In an industry like tech, when the industry is in a slump, companies are going bankrupt. In an industry like financial institutions, when the industry is in a slump, companies are making good, but not obscene, money. Every once in a while, a player goes down but the industry keeps going onward and upward.

I am not going to guess if we have hit rock bottom but, if I was 25 again, I would sign up for a share subscription plan with a large bank with a lot of different revenue streams and just keep buying. In 10 years, I suspect one would be very happy. Instead, I spent my 20’s buying bad mutual funds.

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Of all the scary things that personal finance can throw at you, I am finding talking to my parents about their impending retirement to be a 16 on a scary scale of 1 to 10. For your entire life, your parents teach you about money- either through conversations or observation- and then suddenly one day, your parents turn to you at dinner and ask you about how to plan for their retirement. Should they buy an annuity or Manulife Income Plus?  How much do they need to retire? Should they apply for CPP a year early?

The shoe goes on the other shoe quite quickly- suddenly, you are expected to have an intelligent conversation with your parents about money but considering (a) they have 30 years more of dealing with money on me and (b) I have never retired before, its really uncharted territory for all and such a change of roles. You also end up trying to have non-morbid conversations with your parents that may contain the phrase “…and when you die…” and trying to sound normal about it.

I readily admit my chest tightens up when we start talking retirement- there’s more baggage than an airport on this topic- and I really need a guide but here are the three things we are trying to do:

1. Ignore the media. This one is hard to do since my entire family are news junkies and read everything. There’s so much mis-information about retirement; the most infamous one being you need 80% of your pre-retirement income to retire comfortably (I don’t believe this one at all- my parents grew up in a time when society wasn’t obsessed with consumption. They won’t blow their life savings). Its hard not to get sucked into the fear-driven advertising of the financial industry. We try not to have conversations that begin with “I read a study…”
2. Get the accountant involved. This one is hard since you are asking an outsider to talk about a very personal matter. But retirement is a numbers driven exercise and the accountant needs to help.
3. Focus on the numbers and not the emotion.  We are trying on this one too.  Its weird for everyone to talk about this issue so we are trying to remove the awkwardness factor by breaking out the spread-sheets and working on budgets.

Anyone else have any tips?

The funny thing about starting and running your own small business is that you have to become a magician. There’s a lot of smoke and mirrors involved in making sure you look bigger than you do and you are not merely a one man shop. In a previous life, I started a small business approximately 4 years ago with basically a lot of guts (or insanity- take your pick), lots of smoke and mirrors and not that much starting capital. My office was a sublet in the sub-basement of an office, I actually did a lot of my own deliveries at lunch to save money on courier fees and my computer was the one I used in grad school with a bunch of new parts put on by my brother. In other words, the business was being run on financial smoke and mirrors- allocate money where you need it and no where else and prey nothing bad happens (I never did tell my landlord I had no tenant’s insurance even though I was supposed to)! I once had a heart attack when my $800 printer broke after 3 weeks of use before I realized that it was still on warranty- the first thought that came to mind was I could either replace the printer or cut my own pay that month.

This experience probably influences me on why I am so pro emergency fund. Financial Blogger wrote on the flip side of this argument on why there is no need for an emergency fund. I don’t believe the argument is fundamentally wrong. It really comes down to what life experiences you have that influence your thinking on emergency funds or personal finance in general. When I was a kid I couldn’t understand why my Dad, who also ran his own business, kept a lot of money around in his business- why not pay yourself more or spend it? When you end up being self-employed, the word “emergency” means a lot more than disability, emergency car repairs etc.- it means the printer breaking, an ex-employee stealing your entire hard-drive and having to pay to recreate your records (happened to a friend of a friend), spending hundreds of dollars for printing costs for a last minute pitch you have to make, your client not paying you for 45 days- stuff just comes up (do you want to know why employers freak out about stolen stationary? Stationary bills are staggering once you have to pay for it yourself!).

When the stuff comes up you are either drawn down on your line of credit and you don’t want to draw down anymore (or can’t) or you need to have cash around; I now understand my Dad’s strategy about keeping cash in the business. These are the types of experience I have which influence my thinking. I have friends who have secure pensioned jobs who also psychologically need to know they have an emergency fund around. Debt just makes them (and me) uncomfortable given our experience, upbringing and environment.

Moving away from the psychological side of things, if you do not have extended disability or critical illness coverage, not having an emergency fund also means you are relying on the fact you have a line of credit which you have not drawn down on substantially, interest rates stay low and you can return to income producing activities in a short period of time to pay off the line. A lot of things have to go right in order for that to occur. In many ways, we have so little control over our investments (stocks go down due to events far away, pipes burst in your investment property, bonds cannot be cashed because of no institution will accept them for now) being in cash is one of the few things I can control. Yes, its very old-fashioned  but many old-fashioned people have become millionaires by buying IBM 30 years ago and never selling.

An opportunity cost argument is also made about not keeping emergency funds- why keep one around if you could invest those funds?  I started building up an emergency fund about 2 years ago once the business’ cash flow smoothed out a little and the one thing I noticed is that it also disciplined me to save more money for non-emergency reasons- I knew a part of it was tied up for the emergency fund so I needed to save more money so I could invest it.  I may now contradict myself a little here but the thing about an emergency fund is that if you are over-funded there is nothing stopping you from using a part of that to acquire assets when they are cheap (come on market correction!). But over-funding an emergency fund keeping in mind this fact helps you put money aside rather than spend it. The opportunity cost argument only works if you have the discipline to actually utilize funds in income producing activities. If you do then more power to you.

I don’t believe there is a right or wrong to whether you should have an emergency fund or not. It comes down to risk tolerance, life-experience and comfort level.

Are people building emergency funds or are people using their LOC as a buffer? Let me know your thoughts.

I was looking at my financial account statements on Friday to see what my asset allocation is and I started tracking back to much older statements. I went back to the 90’s and things looked quite ugly. Hindsight being 20/20, I must have made almost every investing mistake you could make. Thankfully, I made them while I was still young and with modest amounts of money and to paraphrase a business quote- make your mistakes young, fast and cheap (the actual quote is “fail often, fast and cheap” by Jim Estill but I want to avoid failing often). This applies as well to personal finance (which is really the business of “Me Inc.”). If you are a younger reader or simply like to read some carnage, I would rank these as my top 5 investing mistakes (in no particular order):

1. Not buying in volume or enroll in a share subscription plan: I use to buy stock in small allotments which is extremely inefficient from a cost-perspective given you have to pay a sales commission each time you buy (this was in the mid-90’s when on-line trading was more expensive than now). This raised the break-even point on my stock; this was especially painful since I had a penny stock phase and your cost could be as much as 5-10% of your purchase price  in penny stocks. To paraphrase Buffet, buy in volume to minimize your cost of purchase or, if you cannot, enroll in a share subscription plan. A share subscription plan is not available for all stock but, where available, it allows you to purchase stock on a monthly payment plan for a small fee; most banks and insurance companies will offer share subscription plans. Most companies who offer a share subscription plan will state this on their website.
2. Not watching the cost of an investment. This is related to the first point. Like most people, I first started investing in mutual funds. Mutual funds can be good investments depending on the person but I never thought much about the fees on mutual funds back then. Remember fees are paid regardless of whether the fund makes money or not and there are more than enough funds available that a fund you are interested in probably has a competitor with cheaper fees.
3. Too much activity. I got caught up in the day-trading trend. I use to think I needed to do something, anything every so often. What I learned the hard way is to buy, hold and stop looking at the stock market ticker 6 times a day. I noticed something curious when I was on vacation; I was so busy moving and taking time off that I didn’t really watch the subprime meltdown that closely and I didn’t press the panic button and sell or buy anything.
4. Not buying on quantitative analysis. I use to buy the “cool” companies and avoid the old stodgy institutions. There’s a reason why they are old and stodgy- they make a lot of money and they don’t need to rely on the coolness facgtor. I learned to read financial statements and now I don’t buy anything without reading two years of annual statements- no matter how cool the ad campaign is (I do not own Apple, Research in Motion or Lululemon- too over-priced, not enough pricing power going forward and not recession proof respectively).
5. No plan/no focus= no profit. The point of investing is to make money but how? I just did thing willy-nilly without looking at the larger picture. The larger picture may change from time to time but I never asked myself how this investment fit into my larger plan (I am on the Derek Foster plan btw).

But here’s my saving grace- my parents taught me a lot of useful things in life and one of them was don’t get into debt (as a general observation, ever notice how anyone who lived in a country that was invaded during a war has a real good grasp of money management?). Pay cash or don’t buy it. As a result, despite my many investment failings, I am fortunate to report I never dug myself into a hole I couldn’t get out of. What I have noticed is that some blogs have readers who have just graduated from school or started making decent money and they ask the blogger what they should do now- my answer would be manage debt before you starting investing. Its a boring answer but boring does pay the bills and helps me sleep at night.

As a programming note, I have two guest bloggers this week writing on the pros and cons of being a real estate investor. The pro camp will be posted tomorrow. Thanks.

Investing in bank and/or financial institution stocks is like owing a casino. No matter how bad times get or how many times the gambler wins, the odds are stacked so the house always wins 51% in a worse case scenario (blackjack has the worse odds for the house- statistically speaking, the house only wins 51% of the time).  The subprime mortgage and credit bubble is a perfect example of this and why, despite the inequality and moral outrage of it all, the banks always wins and if you can’t beat them, invest in them.

I haven’t taken politics since undergrad and, seen in a certain political light, the subprime mortgage can be seen as the rich (the financial industry) lending to the poor. The rich then take all the money that the poor give to them, package it as commercial paper of questionable quality and sell it to the middle class (all the companies who bought bad commercial paper). Of course, many of the rich do not buy what they are selling the middle class (there is one interesting story of a bank advising their clients to buy questionable commercial paper but not owning any of it themselves- there’s a hardy endorsement of your product!). Along the way, the rich make money on the mortgages, packaging the commercial paper, selling it and trading it. When, lo and behold, the poor default on their loans and the house of cards comes down, what happens?  The rich asks the government to bail them out with short-term interest rate relief and central banks around the world have had to pump billions of dollars into the system. And, now there is a lobby to lower key lending rates.
This is obviously a very simplistic summary but isn’t there something fundamentally wrong with this? This is a gross generalization but the financial industry keeps asking for less government but, in times of trouble, who do they want to bail them out of their own mess? The government of course! This is after the industry has made billions in fees. Pretty unfair isn’t it?

Here’s the upside (if I haven’t depressed you)- if the rules are this stacked in one industries favor, why not invest in it?

The moral of this post was something that my Dad said to me as a teenager: “Always invest in a bank. Governments don’t let banks go under and if they do, we are all in big trouble.”  Now that my tongue is firmly out of my cheek, this may be a good time to keep an eye on the financial industry- watch for a second drop in the market as a buying opportunity. As my friend said, stock market crashes are like bodies falling off a building- it drops, bounces up and the drops again (a morbid but accurate analogy- the tech crash experienced two drops before it bottomed out). I am still waiting for the second drop.