The Death Of Buy And Hold....Only Idiots, Salesmen, and/or Idiot Salesmen Need Apply

I read a very good post on My Money Blog the other day regarding the death of the buy and hold strategy. You can see the article complete with spreadsheets and graphs here. This is a must read for beginning investors.

A regular reader Don sent me a post entitled Long Term Buy And Hold Is Still Bad Advice. Okay, fine, everyone and their mom has been telling me this recently. But I read it, and it was such a bad analysis that I had to rebut it here. I think Mish writes a lot of useful and thought-provoking stuff on his popular blog, but he really missed a big error here.

The sky is falling! Oh wait, there’s a little fine print.

TC is ignoring dividends

Let’s bold that. The analysis and data above completely ignores the dividend return of the S&P 500. This is like buying an investment property and ignoring the rent payments coming in. What? There are checks coming in every month from the tenants? Nah, let’s not cash those.

The post goes into a lot more depth and explanation but the example above is one that you will likely hear again in one form or another. I have been hearing that the buy and hold strategy is a poor strategy a lot lately as well. I think it is an idiotic argument at best, especially for the everyday average Joe investor. Even if our traditional view of the market has changed or is now ‘wrong’, taxes and the fees associated with the markets have not changed. If you consistently buy and sell, fees and taxes will eat you alive. Unless you either have the skill (questionable at best) or through blind statistical luck end up being a rock star fund manager/investor it is nearly impossible to overcome taxes and fees over time let alone beat a low cost index fund. If you want to take those odds be my guest, just send a copy of your W-2 to me as to remind me what not to do while your at it. The way I see it, I have no choice but to be a buy and hold investor. I have accepted that I cannot time the market, I cant predict the future and I don’t have increased skill or access to information. The only logical thing for me to do is to control what I can control, like how much I invest and into what asset allocation I put that money into, and to keep on trucking. Anybody who tells you differently is either selling you something, is dumb, or unfortunately is both selling you something and dumb.

High Frequency Traders

Interesting article on high frequency traders.

It is now generally understood that high frequency traders (HFTs) are dominating the equity market, generating as much as 70% of the volume.

HFTs are computerized trading programs that make money two ways, in general. They offer bids in such a way so as to make tiny amounts of money from per share liquidity rebates provided by the exchanges. Or they make tiny per share long or short profits. While this might sound like small change, HFTs collectively execute millions of trades a day, making it an extremely profitable business.

I have had a theory that part of the reason we have so much volatility in the markets these days is the increased use of electronic trading programs. Hedge funds electronically buy and sell once the market hits their set point. I haven’t been following the market all that long and to be honest I don’t even watch it that closely but it does seem like every other day the market is drastically shifting up or down. I think it might be because many of these HFT’s aren’t really acting with any logical thought behind them, they are merely just milestones that are being met that trigger a predetermined action. Couple the high frequency traders with the market information overload that is shoved down every investor's throat everyday and I am amazed the market isn't more volatile! Some of the points in this article are scary to say the least.

There’s a lot to worry about:

1. HFTs provide low-quality liquidity

In the old days, when NYSE specialists or NASDAQ market makers added liquidity, they were required to maintain a fair and orderly market, and to post a quote that was part of the National Best Bid and Offer a minimum percentage of time. HFTs have no such requirements. They have no minimum shares to provide nor do they have a minimum quote time. And they could turn off their liquidity at any time. When an HFT computer spots a real order, the HFT is not likely to go against it and take the other side. The institution is then faced with a very tough stock to trade.

2. HFT volume can generate false trading signals

This can cause other investors to buy at a higher price, or sell at a lower price, than they would otherwise. A spike in HFT volume can cause an institutional algorithm order based on a percentage of volume to be too aggressive. A spike can attract momentum investors, further exaggerating price moves. Seeing such a spike, options traders can start to build positions, which, in turn, can attract risk arbitrage traders who believe there’s potential news that could affect the stock.

3. HFT computer servers are faster than other trading systems

Because most HFT servers are co-located at exchanges, they can beat out institutional or retail orders, causing them to pay more or sell for less than they should have for a stock.

Then there are the “what if” problems that could be created by HFTs:

1. What if a regulation like the uptick rule were enacted?

Volumes could implode and stocks that appeared highly liquid could become extremely difficult to trade with wide spreads and no depth in the quote.

2. What if a “rogue” algorithm entered the market?

Many HFTs are hedge funds that enter their orders into the market through a “sponsored access” arrangement with a broker. Many of these arrangements do not have any pre-trade risk controls since these clients demand the fastest speed. Due to the fully electronic nature of the equity markets today, one keypunch error could wreak havoc. Nothing would be able to stop a market destroying order once the button was pressed.

Gives new meaning to the term “mutually assured destruction”?

Paradox Post

I found this post on Andrew Sullivan's blog. The post is pretty funny but really telling of some of the craziness in our world. I will make an effort to post more paradox posts In the future but hopefully you enjoy this one.

CNN reports:
A Tennessee man is facing charges of aggravated sexual exploitation of a minor for what authorities say are three pictures...featur[ing] the faces of three young girls placed on the nude bodies of adult females... The third face appears to be Miley Cyrus, 16, star of Disney's popular television series "Hannah Montana".

A harmless pervert could go to prison for the crime of photoshopping, but Miley, at age 15, was allowed to date a 20-year-old in public for almost a year?

Investing Lesson - A Case Study

This article was featured on ESPN the other day, and although it is a sports article it teaches a valuable lesson about investing. The article talks about some current/former NHL players that are suing a developer for blowing their investment pool on lavish parties to entice higher profile and higher paid MLB players. Although the set up reeks of a classic Ponzi scheme, that's not why I chose to post this article. I chose to post this article not only because hockey is near and dear to my heart, but also to serve as an illustration of what happens when you violate one of the principle laws of investing basics.

A golf resort developer duped nearly two dozen NHL players out of $25 million, blowing the money on gratuitous parties that were attended by former Yankees players Roger Clemens and Reggie Jackson, according to a lawsuit filed Thursday.

The New York Post reported in Friday's edition that 19 former and current NHL players filed suit against Ken Jowdy, alleging they invested the money with the Las Vegas-based golf-course mogul to develop two luxury resorts in Mexico -- a project they say is seven years behind schedule.

One of Warren Buffett's favorite quotes is "Never invest in a business you cannot understand." I always try to remember that. I think that, in true Buffett fashion, his simplistic mantra is so insightful and all encompassing. In this scenario I would expand it to say don't invest in people you don't understand. If you aren't quite sure of someone's character or your gut is telling you don't invest, then don't. I am sure it is easier said than done and if it was me who made the mistake I'd be on BadskiBlog writing what I learned from the negative experience but simply put don't get blinded by the money or the prospect of making money.

Instead, according to the players, Jowdy squandered the money on "lavish parties" to impress the likes of Clemens, Jackson and banned hits king Pete Rose, among others, who Jowdy hoped would eventually buy real estate in the planned resorts.

The lawsuit seeks the return of the $25 million they invested and $15 million in damages.

Former New York Rangers and Islanders defensman Bryan Berard and one-time Islanders captain Michael Peca were hit the hardest, each losing $700,000 in the deal, according to the filing in Los Angeles County Superior Court.

"It's particularly uncomfortable for all," Berard told the Post. "He's taken our money without telling us, and it's supposedly all gone."

Other players involved in the alleged scam include: Chris Simon, who played for both the Rangers and Islanders; former Rangers Greg deVries, Steve Rucchin and Rem Murray; former New Jersey Devil Turner Stevenson; and Sergei Gonchar of the Stanley Cup champion Pittsburgh Penguins.

Sadly I don't think these guys will ever get a dime back. Everyone has the 'right' to enter into a poor agreement and it looks like that's what these guys did. The funny part is that if the $25M had been put in even a modestly aggressive asset allocation of low cost index and mutual funds they likely would have made, by all conventional definitions, a ton of money. When the majority of these guys were playing and in their money making primes was when the S&P was putting up a 10 year annualized return of roughly 19%. Instead of making money incredibly complicated they should have kept it simple and used the advantage they had, which was large amounts of money to invest with. A sad story but a great learning experience for the rest of us.

The Waiting Game: The Government and Youth of Iran

I came across this article on CNN today. The article does a good job showing how an Iranian government truly does business. I thought it was an odd play to call out President Obama who is not only extremely popular, but serves as the world's most famous figure as well. A famous figure that to this point has remained fairly restrained in his involvement in the Iran election crisis.

Also Thursday, Mahmoud Ahmadinejad, the declared winner in the disputed June 12 election, told President Obama to stop "interfering" in Iran's affairs, the semi-official Fars news agency reported.

"Do you think that this kind of behavior is going to solve any of your problems? It will only make people think you are someone like Bush," Fars reported Ahmadinejad as saying.

Obama is walking a diplomatic tightrope in finding the right response to the crisis. Since taking office, the U.S. leader has sought rapprochement with Iran, but this week he said he was "appalled and outraged" by the post-election violence.

I think that Ahmadinejad couldn’t be more wrong in his statement. I think this will bring more and more of the conservative Iranian population towards the middle. Ahmadinejad has continued his antagonistic behavior through two presidents that the majority of the world likely views as polar opposites. What is the common denominator in this situation?

My time in the Air Force has taught me a valuable lesson that I think is very applicable in this scenario. When a squadron is stuck with a horrible commander there is some pain and maybe even a few martyrs along the way. Yet on the outside it looks as though people are just mindlessly following orders and carrying on with business as usual. However the underlings have something on their side that the poor leader will never have, and that is time. The subordinates will basically wait out their time under the current regime and look forward to better days ahead. I see a very similar pattern emerging in Iran. I have watched numerous discussions on MSNBC and other outlets about whether or not Iran is ready for freedom, and the ever-present conservative population that supports Ahmadinejad. But that is not the point. The point is that the majority of Iran’s youth are not supportive of the Ayatollah and the current regime. As the youth continues to grow older and continues to be inundated with new information and connections with the world (unless the government continues to limit information rich technologies such as the internet) they will, in essence wait out their poor leader. Whether that time frame is a two year tour in the Air Force or the lifespan of a radical regime the concept is the same.

Stocks: The Lost Decade

The article from BusinessWeek below is very interesting. I have included the entire article below. I would love to hear some dialogue in the comments about what all you BadskiBlog readers think about this article.

There are still six months left in this decade, but it is not too soon to start drafting its obituary. Howard Silverblatt, senior index analyst at Standard & Poor’s, is already looking at the decade’s stock market legacy. It’s ugly. The S&P 500 is down 39.22% from Dec. 31, 1999 through Monday’s close.

“We need a 63.79% advance just to break-even for the decade,” Silverblatt says. That’s not going to happen by Dec. 31. “The last negative decade was the 1930s, -41.77%,” according to Silverblatt. Annualized, stocks lost 5.12% so far this decade; in the 1930s decade of the Great Depression they lost 5.26%.

When this decade started, the talk was about sure-thing tech stocks and worries that the Y2K software bug would set the world back to 1900. The computer clocks entered the new millennium. The tech stocks broke down within 90 days.

Some people said we should call this decade the oughts, for the two zeroes. The term didn’t catch on. Looking back, it is clear that the real oughts of the 2000s were that we ought not to have paid so much for internet stocks and that we ought not to have paid so much for big houses with granite counter-tops.

Now we know that it was a lot easier, and cheaper, to fix the Y2K bug before a calamity than to fix the stock, housing and credit markets after. To our regret, we were more skeptical of computer programs than the “efficient” markets we wanted to make us rich. Nerds win. Pigs lose.

When I read this article a part of me wants to cringe. I have done all of my investing during this decade, so to read the sobering statistics above is troubling to say the least. Hopefully you can tell from my posts that I am an optimist. Continuing with the optimist mentality, I have saved what I consider a significant amount in the second half of this decade considering my first two years of investing were during college and the last three have been starting out living on my own. Even with all those losses I still feel as though I have been successful in accumulating wealth. If you keep more than you spend and invest for the long term it doesn’t matter what your return is. Sure it sucks that stocks are down but it is only a matter of time until you reach your goals, even if you are taking a paper loss. Who knows the next decade could be a 10% annualized gain decade. You cannot time the market and you cannot control the return that the overall market bears. So control how much you save and let time value of money work its magic while you accumulate wealth.

Banks and Balance

Not sure I agree with everything in this article in Forbes, but there are some good points made. I think when it comes to banks it is a little trickier because people don’t act rationally when banks start failing. Banks are only required by law to maintain but a portion of the cash on hand that is managed within their institution. When people start pulling money out en masse banks don’t have the ability to get all the people their money. That reason alone makes it a little trickier to say that banks should be allowed to fail. However, I love how he illustrates the slippery slope of the 'too big to fail' mentality that I have blogged about numerous times.

For the institutions supposedly lucky enough to be tapped by our federal minders as too big to fail, the much remarked upon "optimistic" scenario is one in which their cost of capital will drop for them being protected by Washington. This ensures that the many financial institutions not important enough to fit under the Fed's umbrella will be weakened for having to lend in an environment distorted by larger institutions profiting from their tight relationship with Uncle Sam.

I also like how he spoke about profit and loss being the real regulators. Legislation is flawed and people will always find the most profitable approach given new guidelines, and undoubtedly new problems will arise from new legislation. What remains unchanged though is the desire to make a profit and avoid a loss.

For banking institutions more broadly, the Obama plan involves raising their capital requirements while putting rules in place to make sure they're got more exposure to the loans they securitize and sell. What's forgotten here is that without investor capital there are no banks, so while it may be comforting to think that the federal government can rearrange the path to banking profits, if investors don't agree, they can surely take their money elsewhere.

Along those lines, the beauty of finance is that it is fungible. If the stringent capital requirements make it difficult for stateside banks to operate profitably, the dollars that fill their coffers will move offshore along with myriad financial jobs. Almost to a man politicians worship at the altar of "job creation," but if the new capital requirements prove problematic, the creation of financial jobs will occur in London, Frankfurt and Tokyo--not on Wall Street. "Systemic risk" will simply find a new address.

A truly free market economy does not and will never exist, so to state simply that total free market policy will be a cure all is a little unreasonable. However, I feel that when the choice is the free market or government legislation and intervention I believe we should always err on the side of the free market. People look to blame the free market and capitalism for the mess we are in today, but the free market was only free within the boundaries that were set by legislation. Lobbying and legislation have contributed as much as, if not more than, greed has to fueling the build up and eventual downturn we are facing today. I guess like most things in life it is about balance. What is the lesser of two evils? Letting banks fail unconditionally or going down the dangerous road of the too big to fail mantra?

New Blog Addition - Schaefer's Blog

I am adding a new blog to the list that I follow consistently. Disclaimer: I know this fellow blogger. I am adding Schaefer's Blog to the list. We both graduated the same year from Air Force Academy and I just recently began sampling his blog. He also writes for The Art of Manliness so he is the first to make my list twice. We didn't know each other all that well at school but I remember him being a good dude, and I have really been enjoying his posts lately. I hope you enjoy his blog. Here is a sampling of some of his work.

When I first created this blog, I was just coming out of a season of intense and enriching mentorship. I had recently graduated from the Air Force Academy where I had been surrounded by great teachers and officers, and through my local church I had made relationships with several quality individuals that poured their lives into me. So, it was only natural that most of my content would be focused on the various lessons I had learned throughout that time.

Since then, I’ve moved into a new season of my life. And though I’ve still maintained close contact with many mentors, my interests and passions have taken new, unexpected twists. That’s life. As many of you have noticed, I’ve posted very little content over the past several months. Though much of this has had to do with my crazy schedule as a C-17 pilot, the other has to do with a lack of passion for the subject matter I’d originally built my blog around.

Lessons in Skilled Living implies just that - each blog post imparting a life lesson. Well, for now I’m out of lessons, at least, I am not that interested in writing about them.

What am I interested in writing about? War, coffee, books, strategy, Christianity, technology, philosophy, the Middle East, John Boyd, education, movies, the outdoors, flying, Africa, being a dad/husband, music, wine, entrepreneurship, economics, foreign policy….just to name a few.

I Kissed A Girl And I Liked It....And It Was Metal!!

I found this over at Metal Injection, the best metal site ever. I don't know if Katy Perry would be proud but metalheads across the web are pretty happy. Classic!

Thank you to our hetero-lifemates over at MetalSucks for alerting us of this amazing power metal remix (not a cover if it uses the same vocal track kiddies) Katy Perry's smash hit "I Kissed A Girl". It's like a million times more epic. The remix was done by composer Andy Xiong who played all the backing instruments himself. Kudos to you, sir!

HEAR IT HERE!

Toyota Throughput

Although Toyota has not been immune to the global slowdown this article illustrates why they will continue to outperform GM. In my last post about GM I talked about how cost cutting can only get you so far. What happens to you when you are cutting costs as your strategy and global demand actually rises? Well that is exactly what just happened to Toyota, and I guarantee that they will be able to meet demand based on their strategy of increasing throughput and not just cutting costs and laying people off.

Toyota Motor Corp. got 180,000 orders for the new Prius hybrid in Japan in just a month, far surpassing its target of 10,000 vehicles in monthly sales, the automaker said Friday.