The Personal Financier

Why Enough is Never Enough

noreply@blogger.com (Dorian Wales) — Sat, 12 Dec 2009 09:34:00 +0000

A short tale on leg space, social status and the irony of human nature

Pressing up against the window trying to create some space between himself and the man sitting next to him, Joe Aspiring kept wondering how great it would be getting around by taxi. The redundant meeting he had just left only served to increase his frustration. Never ending travels by bus were one of his less desired pastimes. One more year of internship and my status will change, he kept encouraging himself.

The luxury of taxis on the company’s expense did cheer him up, for a while. It was a refreshing change sitting back on black leather, enjoying the leg space. Looking at the windows of the adjacent bus he took some pleasure in the fact he had moved up in life.

The never-ending meetings frustrated him. I wish I could have worked on the international client, he had pondered. I could use a change of scenery. How did those guys get on the international team at the first place? Probably strings were pulled on their behalf. Spending every other week abroad must be fantastic.

The taxi that drove him to the airport was taken for granted. “Could you please turn down that music?” he angrily turned to the driver. These drivers are a menace, he thought. Next time I’ll insist on a proper ride. His senior team leader, traveling with him, had told him they’d probably only meet only at the baggage area at Heathrow since he was flying business.

The check in was a nightmare, as always. Endless lines and tiresome airport security personnel took their toll on him. Stepping slowly down the aisle he lovingly caressed the wide spaced sofas of business class. Perhaps one day, he thought. Inching further he had hoped and prayed. It took an eternity to get to his seat, waiting behind what seemed like a horde of people insisting on bending the laws of physiques by squeezing huge trolleys to tiny overhead spaces. Slowly raising his eyes he exhaled deeply, 42J was right between a 10 year old and an elderly woman. He cramped himself between his fellow passengers, legs, again, tightly squeezed against the seat in front of him. Someone should look into the relationship between leg space and social status, he thought. There must be a deeper reason than economy. Perhaps a constant reminder of your worth, he had bitterly thought.

He could stand the flights no longer. His surprising upgrade to business class was nice but left a bitter taste. He felt awkward among veteran business class travelers. An accidental upgrade is just that, he thought. Look at all these people; they must be wealthy and successful, groomed by their companies. When I’ve earned the privilege of routine business class I’ll know I’ve made it in life.

When his assistant handed him his e-ticket for his upcoming conference in Rome he was disappointed to see his miles weren’t enough for a first class upgrade. Those young executives with their constant laptop tapping and blackberry staring are impossible to travel with. Sitting in the lounge he eyed the door to first class’ part of the lounge. I wonder what kind of food they serve their. It has to be better than this bagel, and the wine is terrible, what happened to the service here?

First class was his dream coming true. Such comfort, such service, I could get used to this, but who are all these Nuevo rich surrounding me?

How Japanese manage personal finance, 2009 page turners and the lure of store credit cards @ the RoundUp

noreply@blogger.com (Dorian Wales) — Sat, 12 Dec 2009 08:55:00 +0000

As always I try to bring in my roundup the more interesting articles and posts I've encountered over the past week or two.

From leading magazines:

The Lure of Store Credit Cards, and the Hook @ NY Times - A fitting article for the holiday season.
Page-turners @ The Economist – The best books of 2009

Carnival of Personal Finance #234 – Weirdest Toy Crazes Edition was hosted by Suburban Dollar. My post on The Dangers of Excess Frugality – Budgeting and Balanced Living was chosen as Editor's Pick! Recognition always gives me a warm fuzzy feeling. Here are some of my favorite posts from the carnival:

4 Japanese Personal Finance Gripes @ Foreigner's Finances – My first acquaintance with this blog and it’s a good one. The blog broadens our financial horizons, a very stimulating concept.
5 Little-Known Websites That Will Save You Time and Money When Booking Airfare Online @ Get Rich Slowly – One of those focused niche posts that bring real added value if you're looking to save on airfare. Highly Recommended.

More from fellow personal financier bloggers:

How To Be A Skeptical Empiricist In One Easy Lesson @ Amateur Asset Allocator – Great post. I enjoy applied philosophy and have written quite about it myself (See philosophy under my categories for more).
How To Invest Online Using The Peter Lynch Strategy @ The Digerati Life – Looking into another investing philosophy.
What Is Your Financial Fear? @ Single Guy Money
What are your dividend investing goals? @ Dividend Growth Investor

The Dangers of Excess Frugality – Budgeting and Balanced Living

noreply@blogger.com (Dorian Wales) — Sat, 05 Dec 2009 15:25:00 +0000

"Virtue, then, is a state of character concerned with choice, lying in a mean… Now it is a mean between two vices, that which depends on excess and that which depends on defect; and again it is a mean because the vices respectively fall short of or exceed what is right in both passions and actions, while virtue both finds and chooses that which is intermediate." Aristotle, Nicomachean Ethics.

A Zen Garden

The dangers of excess frugality – The slippery slope of budgeting

The first steps in budgeting are usually a real eye opener. For the first time income and expanse are laid bare before our eyes more often than not resulting in surprise and disbelief as to the proportion of expense relative to income, the volume of different expenses and usually the inadequacy of income.

A little later on the potential hits. As with any new endeavor a significant portion of the benefit can be taken advantage on early on. Potential savings and sources of money leaks are easily identified and several quick and significant measures can be taken to materially improve the family's financials.

Newly discovered personal finance enthusiasm usually leads, then, to further interest and reading which in turn leads to discovering the power of finance and compound interest. The affects of saving early are empowering and goals are set to allocate a more significant portion of the budget to saving.

Frugality often follows. Each expenditure is carefully weighted and considered against the future alternative benefit which, when compounded over time, amounts to hefty sums. Considerations such as "This $1,000 vacation has an alternative cost of $1,800 in 10 years using a 6% interest rate" are not uncommon.

Retirement planning takes up more and more of one's time as a result. Thoughts of early retirement are fascinating with seemingly small sacrifices made on the way. Slowly but surely present time is replaced with imagery of retiring at 40.

Without noticing money becomes the object rather than the means. "I only need so and so much more and I'm settled". The present soon is sacrificed for the future.

Sacrificing the present for the future

The real danger of the slippery slope presented is sacrificing the present for the future. The American public as a whole is in no real danger of this happening and the future has already been sacrificing several times over on the altar of consumption. Still, many personal finance enthusiasts quickly find themselves torn apart when it comes to spending money.

Frugality, in its moderate form, is probably a good trait. However, any excess (or deficiency), as Aristotle had so eloquently put, lead us away from virtue. Virtue or sense, in this case as well as others, lies in the middle.

Excess frugality will usually results in forgetting our original goals altogether, abandoning them to the accumulation of wealth with no real purpose. The inheritance will surely benefit the next generation but our lives are ours to live, not to pass on (again, reasonably).

The problem with sacrificing the presence for the future is the unavoidable frustration. Any extreme behavior takes its toll on the person as well on the surroundings. Being happy in such circumstances isn't easy.

I should note I obviously do not suggest sacrificing the future for the present. I am only recommending a more balanced approach.

How to achieve Balance?

Balance will be represented, in this case, by the ratio of saving to consumption. In economics permanent income suggests a person wishes to average out his or her income over one's lifetime in such a way as to not consume to much in the present or, on the other hand, consume too little (by saving too much – There is such a thing).

The rule of thumb suggests middle class households should consume 75% of their income. The rest will serve as either an emergency fund for non-expected expanses and big planned expanses (which can be expected as I've elaborated on in Budgeting for unexpected expenses) or as long term savings (equally weighted).

If you're consuming less than 60% of your income or over 85% than an evaluation of income vs. expense is in order. Some circumstantial aspects obviously exist as dual income families with no kids would present higher levels of savings while others may present less available funds for savings.

Still, the rule of thumb serves as an indicator that something may be off. In higher income levels the ratio of saving out of income is obviously higher while in lower income levels saving money is something one can only dream of.

To some the idea of spending when you can save may sound careless. I argue the good mental health and happiness include the satisfaction of everyday needs. Stoic willpower may enable one to retire early but what of the years past? Usually the best years in life.

The illusion of having compounding interest working for you

There's a reason why the 30's are considered the consumption era in one's life. Investing in education, raising a family, buying a house and other significant financial obligations put a damper on any attempt to really save for the long run.

True enough, saving throughout 20's and 30's will result in compounding interest working for us but who of us has managed to save significantly without sacrificing our present? Amassing a considerable amount of money requires many concessions, maybe too many.

The illusion of saving early is frustrating since saving at such an age is extremely difficult. For one's good mental health savings should be balanced with consumption. The 40's and 50's are considered periods of wealth accumulation and will serve the purpose of amassing wealth as well (considering you are not intent on retiring at 40 – another illusion of you ask me).

A more balanced life and balanced goals will help achieve inner peace and acceptance that money is truly a means and not an end. This takes work and time. I suppose on cannot escape the slippery slope I've presented but understanding the need for balance early on will save considerable frustration and contribute to early happiness.

Related posts:

Blame the Models? Take a Good Look in the Mirror

noreply@blogger.com (Dorian Wales) — Sat, 21 Nov 2009 16:59:00 +0000

Is financial modeling to blame for the recent crisis? As always the fault does not lie with the tool but rather with the user. When was the last time you took a look at the validity of Net Present Value or Option Pricing?

The recent, or ongoing, financial crisis has been attributed, amongst other things, to over reliance on quantitative financial models which replaced good business judgment instead of supporting it.

The reason behind the failure of models wasn't simply poor modeling, for the most part. The main reason was poor business and risk management processes which placed blind faith in the models.

In this post I begin to explore the reasons why financial modeling increased the severity of the recent crisis and more importantly, what are the lessons we can implement to our personal finances?

The need for Financial Modeling

With the development of computing power advanced mathematical models enabled the creation of complex new financial instruments and professions such as financial engineering. Mathematicians and statisticians found their way to investment banks and hedge funds due to the increased demand and profitability of these endeavors.

These financial instruments included, for the most part, new underlying assets, that require complex financial models to model their pricing and behavior. Financial models which sadly broke during the recent crisis.

That is not to say that financial engineering and the use of models have been proven unsuitable for the financial markets. Much on the contrary, financial engineering and complex financial instruments help, in many cases, to increase the level of perfection in the market and ease the transfer of undesirable risks from one party to the other.

Models as a Representation of Reality

A Model, by its definition, is a representation of reality. Economics, for example, as any 1^st year student knows is based on very simple models of production, supply, demand and price. The strength and importance of these models is their ability to explain economic behavior even under very simplistic assumptions.

Think of the prisoner's dilemma in game theory or Nash's equilibrium which are very simple models that won their authors Noble Prizes. The beauty of the model is its ability to represent reality with a very limited framework.

As modeling advances assumptions are slowly removed creating more and more complex models which require a better understanding of the mathematic complexity. The reason is simple, the more "free" parameters the model needs to explain the higher the complexity.

Naturally, when dealing with financial instruments and their fair value pricing, models need to explain as much of the price as possible to adequately represent the fair value of the instrument. As such, models have grown quite complex as room for assumptions is very small.

What went wrong?

Before we get too judgmental let's consider the simple, commonly used model of Net Present Value. Net present value is a model used to determine how much a certain stream of cash flows is worth today – or, the present value of the cash flow.

Net Present Value is commonly used to determine the economic sense behind undertaking certain projects and investments. All those in the finance profession, as well as personal finance enthusiasts have probably tried to determine the net present value of a certain undertaking. The problem starts when you dig deeper into the model.

Most people are not aware Net Present Value assumes the following due to the very central role of the cost of capital in the model (further reading on NPV is available here):

The existence of an efficient financial market – In order to price correctly an efficient financial market is required. NPV cannot be turned into value in the present if an IPO cannot be performed or valuated correctly.
Access to financial markets– Without access to an efficient financial market the entrepreneur, again, cannot transform NPV to value in the present.
The existence of diversified investors – Adequate pricing of the cost of capital can only be performed by ignoring the specific risk of the investment. A diversified investor, in finance, sees only the market risk when investing (the reason being a diversified portfolio will stay diversified even after investing in this particular project, for example).

When was the last time the Net Present Value calculation you had performed met these requirements? My guess is never.

The model is a helpful tool but the underlying assumptions and limitation cannot be ignored.

The reason behind why many of the financial models broke has to do with the assumption of liquidity and volume in the markets. Pricing models are built to price instruments under a normal market environment, as part of the normal course of business. When stressed scenarios occur the assumptions behind the models cease to exist and the model breaks.

Black and Scholes model very commonly used for option pricing assumes normal distribution of returns (Not true, obviously).
The CAPM Model (Capital asset pricing) which is a corner stone in asset allocation is based, again, on normal distribution of returns but also assumes, amongst others, the following highly debatable assumptions: Perfect availability of information, No taxes or transaction costs and a market portfolio which includes all types of assets (!).

With no liquidity in the markets strange phenomenon start to take place, phenomenon which cannot be analyzed through modeling but rather through good judgment and independent thinking.

The Importance of an Adequate Process

The role of an adequate risk management process cannot be overstated. Financial modeling is a tool, nothing more (and nothing less).

Like any tool the one who uses it needs to understand its capabilities and its limitations. Model limitations are inherent as they are, and only can be, a representation of reality.

Financial modeling will not go away. The need is too strong. What does need to happen is the implementation of robust risk management processes which will continue to remind what are the assumptions and limitation of the models and what the proposed mitigations against these limitations are.

The wisdom of the ancient Greek philosopher Socrates is a fitting quote: "I know that I know nothing" he said, not because he knew nothing because he didn't claim perfect knowledge. A humble state of mind is a very good start.

Carnival of Financial Planning - Edition #116 - November 20, 2009

noreply@blogger.com (Dorian Wales) — Sat, 21 Nov 2009 16:55:00 +0000

This is a guest post by The Skilled Investor – A great source for Personal Finance, Investment Management, and Financial Planning Articles.

Welcome to the November 20, 2009 Edition #116 of the Carnival of Financial Planning.

The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning practices that can lead to lifetime financial security.

This edition is arranged by subject heading, so that you can browse efficiently.

Enjoy!

Featured

I do not normally feature any submissions. However, this one, which was submitted to the Miscellaneous category, deserves to be featured. The title alone warrants that accolade:

Sustainable Life Blog presents The High Cost of Being a Moron posted at Sustainable Life Blog, saying, "Perfect example of how a small mistake can cost you big bucks when selling a car."

Budgeting

Four Pillars presents Get Out Of Debt With YNAB – You Need A Budget Financial Software Review posted at Quest For Four Pillars, saying, "Indepth review of You Need a Budget software."

Susan Saverton presents Personal Budgets posted at Family Financial Planners, saying, "When you don't understand how much you spend and how much you save and invest, you do not have a financial plan. This dramatically increases your family’s long-term financial risk."

Economics

Emily Simmons presents How to Make a Budget That Works posted at Be In Health Now, saying, "A budget is the foundation on which financial freedom is built. Learn the basics here."

Estate Planning

The Financial Blogger presents Estate Planning: 5 Reasons Why You Should Have A Professional Among Your Liquidators posted at The Financial Blogger, saying, "managing an estate is more complicated than simply writing a few checks! Fortunately, for those who can afford it, you can name a professional among your liquidators."

Jeff Rose presents Your Estate Planning Checklist posted at Jeff Rose.

Financial Planning

David Carlson presents Eight Reasons Why Its Hard To Get Rich posted at Dual Income No Kids, saying, "This post describes eight different reasons people do not become rich. When you take these eight reasons into consideration, you can overcome the various roadblocks that prevent people from becoming wealthy."

Roshawn Watson presents Are Wealthy People Dishonest? posted at Watson Inc, saying, "Are the wealthy dishonest? While it is certainly a fair question, it is also a polarizing one. The typical dichotomy is that there are some who feel like there is absolutely no way for honest people to get ahead financially while the wealthy often feel maligned for their prosperity."

James Carter-Truman presents 4 “Must Have” Precious Metals Investment Tips posted at Buy Gold Secrets, saying, "James Carter-Truman is an expert about gold and he writes to share his knowledge about Gold investment"

Susan Saverton presents Financial Advisor Pasadena California posted at Pasadena Financial Planner, saying, "Appropriately setting your personal asset allocation in line with your personal risk tolerance is a critical decision for every investor. The percentages that are allocated to various asset classes tend to change slowly over time, so it is important to get it right at the outset."

Amanda L. Grossman presents The Lazy Person's Guide to Financial Success posted at Frugal Confessions, saying, "This article is all about simplicity and automation in personal finances. Set a plan, automate that plan with specific amounts of time for each step detailed in the article, and leave it! Let compound interest and automatic withdrawals take your finances to the next level."

jim presents Conduct a Financial Fire Drill posted at Blueprint for Financial Prosperity.

Dividend Tree presents Building Core Competency for Long Term Survival posted at Dividend Tree, saying, "whether it is running a business or individuals’ investment portfolio, it is important to build a core competency for long term sustainability. In my case, I focus on good quality companies that consistently pay or have potential to pay growing dividends over time.

Finavigation presents The Right Mindset for Financial Success posted at Finavigation, saying, "For many people, the main thing holding them back from achieving the things they want in life is the way they think. People who are able to build wealth and accomplish the goals they set for themselves continuously think about the world differently than people who are complacent and find themselves stagnant instead of accelerating toward the life they want."

Financing a Home

Joe Manausa, MBA presents How The Cap And Trade Bill Affects Real Estate posted at Tallahassee Real Estate Blog, saying, "I believe that if the American Clean Energy and Security Act of 2009 is enacted, new home construction costs will go up, and home affordability will decline. It appears as if a “national building code” will be created, thus usurping some of the rights of State’s to control building quality as they see fit."

Evolution Of Wealth presents Return On Equity Is Always Zero posted at Evolution of Wealth, saying, "Do you ever wonder what the return on your home equity is? Not your house but the equity that everyone tells you to build up. Well it's zero."

Roshawn Watson presents Should You Buy A House Outright? posted at Watson Inc, saying, "Suppose you find yourself in the somewhat unique predicament of having the resources to purchase your house outright without a mortgage. Is it then financially-wise to make the purchase?"

Brandon Laughridge presents 8000 Tax Credit Extended and Expanded posted at Mortgage Loan Place, saying, "Learn what the new tax credit terms mean for you as a first time home buyer or repeat home buyer."

Alex Fotopoulos presents When to Refinance a Mortgage? posted at My Trader's Journal, saying, "Some key points to consider when refinancing your home."

Financing Education

Praveen presents Will Education Follow the Housing Bust? posted at My Simple Trading System, saying, "Tips for students to avoid excessive loans and debt"

Health Care

Patrick @ Cash Money Life presents Open Enrollment Health Insurance Options posted at Cash Money Life, saying, "what you need to know about the common health insurance options available from most employers during the open enrollment season."

Jeff Rose presents What’s the Best Health Savings Plan For You? posted at Jeff Rose.

Patrick @ Military Money presents Open Enrollment Window Open for Some posted at Military Finance Network, saying, "Open enrollment is the only time of the year that many people are able to make changes to their health insurance elections. Make sure you take advantage of this time to select the best health care option for your needs."

Income

Dividend Tree presents Three Companies with Sustainable Dividends posted at Dividend Tree, saying, "Even in soft economic environment, there are companies out there that are continuing to increase dividends for their shareholders. While dividend increase is good, it is more critical to make sure we understand that companies can sustain their dividends."

MoneyNing presents Take Some Time to Make More Money posted at Money Ning, saying, "While savings is important, taking some time to make money is still critical."

nissim ziv presents Informational Interview Questions: Examples| Request for Informational Interview: Tips posted at Job Interview Guide, saying, "Informational interview is not a job interview. The purpose of this meeting is to find out more about jobs and careers rather than getting a job. It is a meeting in which a career seeker asks for advice about a certain career that interests him."

Investing

Jeff Rose presents Good to Know Rules and Limits for the Traditional IRA posted at Jeff Rose, saying, "As good as the Roth is, the Traditional IRA still has its place."

Brian Terry presents Are You Ready To Buy Gold Bars? posted at Buy Gold Secrets.

Darwin presents 2009 Stock Market Returns YTD from Around the World – Shocking! posted at Darwin's Finance, saying, "This comprehensive analysis of global stock market returns shows some emerging markets in triple digits year to date and surprisingly, the US is toward the bottom of the heap even following its meteoric rise from the March lows."

Silicon Valley Blogger presents Scottrade Review: Top Brokerage For Small Investors posted at The Digerati Life, saying, "Reviewing an outstanding online broker. Scottrade is great for new investors."

ABC presents Top Down Investment Approach posted at ABCs of Investing, saying, "An explanation of the "top down" investment method."

Jules Wells presents Best Investment Strategy posted at Financial Planning Software, saying, "Personal investing seems incredibly complex, but the best investment strategy also tends to be a more simple investment strategy."

Zach Scheidt presents Blue Nile Reports Growth posted at ZachStocks, saying, "Blue Nile Inc. (NILE) reported earnings growth in the third quarter. The company is growing market share but the stock is simply overpriced. Watch for a 50% drop in the coming months."

MoneyNing presents How to Get Your Wife to Invest posted at Money Ning, saying, "Talk and discuss. Learn how to get your significant other to invest!"

FMF presents Portfolio Recommendation Beats S&P 500 by 9.4% posted at Free Money Finance, saying, "Suggestions on a market-beating portfolio."

Zach Scheidt presents Blackstone Sees Improving Trends posted at ZachStocks, saying, "The Blackstone Group, LP (BX) reported earnings and the stock is trading sharply higher. The environment is improving for the private equity company as liquidity and risk premiums increase."

Frank Vertin presents Low Cost Index Fund posted at Best Index Fund, saying, "Buying an S&P 500 index fund through an investment counselor can substantially increase your initial purchasing costs and and drive up your annual management expense fees. Unfortunately, the vast majority of individual investors buy mutual funds and ETFs through brokers and investment advisers. Rarely do financial advisors recommend that you buy index funds with low fees. This is because low cost, no load mutual funds do not pay them as well as loaded, high fee mutual funds."

Praveen presents Just Bought Hyatt Hotels (H) posted at My Simple Trading System, saying, "About Hyatt's recent IPO and why its a good stock."

ABC presents More Exciting Facts About Stock Indexes posted at ABCs of Investing, saying, "Some interesting facts about stock indexes."

Super Saver presents Asset Allocation Investing Based on Time posted at My Wealth Builder, saying, "Here's a strategy that diversifies risk by time."

Steve Patterson presents Gold: Don’t Fight the Trend posted at FastSwings.com - Steve Patterson, saying, "Inflation is also a concern for traders who are predicting a rise in consumer costs as the dollar continues to fall."

Manshu presents S&P 500 ETF List posted at OneMint, saying, "A list of ETFs that track the S&P 500."

Dividends4Life presents 4 Stocks With Higher Dividends posted at Dividends Value, saying, "Investing in Dividend Stocks is a long-term strategy. Frequent buying and selling of dividend stocks can significantly increase your expenses and taxes, thus lowering your returns. A growing dividend is a strong indication of a company’s increasing intrinsic value."

Tomas Escent presents Professional Investment Management posted at Nerds on Wall Street, saying, "Think of this book as sort of a Hitchhiker’s Guide to Wired Markets. There are no robots parking cars for six million years, but there are robots trading millions of shares in six milliseconds, so maybe that’s close enough."

ABC presents “Bottoms Up” Investment Method posted at ABCs of Investing, saying, "A short description of "bottom's up" investing style."

April presents The Roth IRA Made Easy posted at Get Rich Slowly, saying, "Starting a Roth IRA is one of the easiest — and best — steps you can take to save for retirement! A great guide on what they are, the rules that govern them, and how you can start one today."

Zach Scheidt presents China Drug Research Company Reports Stellar Earnings posted at ZachStocks, saying, "Wuxi PharmaTech Inc. (WX) reported strong third quarter earnings. The China drug research and manufacturing company is investing heavily to drive future growth and should see significant earnings appreciation."

The Financial Blogger presents The Financial Blogger » Blog Archive » Canadian ETFs That Pays Dividends – Am I in Heaven? posted at The Financial Blogger, saying, "There are a lot of people that love dividends. There are 2 major reasons why so many investors love them. #1 they are usually issued by very stable companies which mean less volatility in a stock portfolio. #2 they pay quarterly income, which is great for revenue seekers."

Mike presents Living in the Fast Lane posted at Minting Pennies - Personal Finance, Investing, and Microfinance, saying, "How adequate planning and preparation can lead to successful investing."

The Skilled Investor presents Investing Strategy posted at Personal Investment Manager, saying, "Investors more easily understand investment costs that are directly measurable, such as fees deducted on investment statements. However, many investors ignore or are unaware of the opportunity costs of their sub-optimal investment behaviors. Opportunity costs are usually much more difficult to measure directly, but these investment costs can be even higher than more visible investment fees."

Tushar Mathur presents Can't Control the Markets? Try controlling the Costs posted at Everything Finance, saying, "As 2008 proved, the financial markets are prone to unpredictable periods of turbulence. That can make investing feel a bit like a roller-coaster ride. The disappointing results that many mutual funds posted in 2008 and at the outset of 2009 may have left you feeling concerned over your financial future. You're not alone."

Dividends4Life presents 9 Dividend Stocks Sending More Cash To Shareholders posted at Dividends Value, saying, "Looking for the perfect dividend stock? In an utopian world, the perfect dividend stock would be one that is both high-yield and provide a high dividend growth rate. Its share price would appreciate with its increasing dividend. All of this would be driven by increasing earnings and cash flow."

Larry Russell presents NoLoad Mutual Funds posted at Best No Load Mutual Funds, saying, "Taken as a whole, the vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Steve Alexander presents Magic Formula Stocks in Forbes Top 200 Small Companies 2009 posted at MagicDiligence - Optimizing Joel Greenblatts Value Stock Strategy, saying, "Every year, Forbes creates a list of the top 200 best small companies in America. Which current Magic Formula stocks are part of the list, and which ones have been a part of MFI in 2009?"

Managing Debt

The Smarter Wallet presents Use Secured Credit Cards To Develop Your Credit History posted at The Smarter Wallet, saying, "On using secured credit cards to establish credit history."

Miscellaneous

Tom @ Canadian Finance Blog presents Do You Know If You Are Owed Money From A Bankruptcy? | The Canadian Finance Blog posted at The Canadian Finance Blog, saying, "To help you find out if you are owed money from bankrupt debtors, the Office of the Superintendent of Bankruptcy maintains an Unclaimed Funds Database."

Peak Personal Finance presents 5 Financial Rules for Women posted at Peak Personal Finance, saying, "Good advice for women, and men too!"

Dorian Wales presents A Temple Restaurant and a Clearing House for Tickets – Two Observations of New York City posted at The Personal Financier, saying, "New York City is my favorite destination in the world. Any opportunity to visit again, whether on business or pleasure is a joy. With each visit a new light is shed on some other aspect of the city. I'd like to share two such spotlights with you." (Editor's note: Dorian is right about Peter Luger. Best steakhouse around.)

FMF presents How to Buy a New Furnace and Air Conditioner posted at Free Money Finance, saying, "Keys steps to buying a great furnace and AC unit at a great price."

Frank Knight presents Identity Theft Prevention posted at Personal Financial Planning Software, saying, "Financial Planning and Identity Theft Prevention -- Identity theft prevention is a key, but often overlooked, component of a prudent financial plan."

No Load Bond Funds presents Low Cost Bond Funds posted at Bond Index Fund, saying, "Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a deadweight loss to you. The best bond fund buying strategy is to pick only very low-cost no load bond funds."

Patrick @ Cash Money Life presents Netflix Review - Online DVD Rentals posted at Cash Money Life, saying, "Netflix is a great way to save money on movie rentals, especially with the $8.99 unlimited plan that comes with unlimited DVD rentals and unlimited video streaming. Check it out with a free trial if you've never used it."

Susan Saverton presents Personal Financial Strategy posted at Family Financial Planner, saying, "When pursuing optimal financial planning and investing strategies and controlling your costs and capital gains taxes, you also need to establish a time-efficient system to monitor, adjust, and adhere to your financial plan."

Retirement Planning

FMF presents The World's Best Places to Retire posted at Free Money Finance, saying, "One way to make your retirement savings go farther is to retire overseas."

Top Stock Index Mutual Funds presents Stock Index Funds posted at Top 10 Index Fund, saying, "To build your retirement portfolio, buy some of these top 10 very low cost no load S&P 500 index mutual funds directly. You do not have to pay the heavy added expenses of buying through a stock broker, financial adviser, investment adviser, or investment counselor."

Frank Knight presents Roth IRA Retirement Planning posted at Financial Planning Software, saying, "Roth IRA Retirement Planning -- Deciding between traditional retirement plan contributions and Roth retirement plan contributions"

Risk Management and Insurance

Patrick @ Military Money presents COBRA Benefits 2009 Economic Stimulus Recovery Act posted at Military Finance Network, saying, "The 2009 Economic Stimulus Plan includes additional COBRA and unemployment benefits."

Evolution Of Wealth presents Do You And Your Child a Favor posted at Evolution of Wealth, saying, "Do you depend on your child? That's what life insurance is for, to protect those that depend on you. What about the people you depend on?"

Patrick @ Cash Money Life presents Save Money on Auto Insurance Rates posted at Cash Money Life, saying, "Tips on how to save money on your auto insurance rates, including multi car discounts, multi-line policies, defensive driving courses, and more."

Savings

The Smarter Wallet presents HSBC Direct Review: Top Savings Account posted at The Smarter Wallet, saying, "Reviewing an online savings account"

KCLau presents Are You Rich in Internal Assets? posted at KCLau's Money Tips, saying, "pay attention to the internal assets"

Four Pillars presents $8,000 Credit For First-Time Homebuyers Extended 6 Months – Not Increased To $15k posted at Quest For Four Pillars, saying, "Home buyers credit extended 6 months."

KCLau presents Caring for the Elderly posted at KCLau's Money Tips, saying, "Problems faced by the elderly"

Taxes

Jeff Rose presents How to Qualify For a Tax Deduction on Your Traditional IRA Contribution posted at Jeff Rose.

Jacqulyn Richey presents First Time Home Buyer Tax Credit Extended posted at Las Vegas Real Estate News, saying, "A breakdown of the extension of the First Time Home Buyer Tax Credit. Now current homeowner may qualify for a credit under the new bill."

Super Saver presents End of Year Tax Planning - Deductions posted at My Wealth Builder, saying, "For me, October is a good time to review my 2009 financial status for tax return filing purposes. It gives me a few months to make any changes that can lower my taxes."

Mike Piper presents Tax Diversification: Roth IRA vs. Traditional IRA posted at The Oblivious Investor, saying, "Sometimes the best answer to "Roth IRA or Traditional IRA?" is "a little bit of both.""

That concludes this edition. Submit your blog article to the next edition of Carnival of Financial Planning using our carnival submission form. Past posts and future hosts can be found on our blog carnival index page.

Technorati tags: carnival of financial planning, blog carnival.

From concerns over unprecedented levels of government debt to making money from your old books @ The RoundUp

noreply@blogger.com (Dorian Wales) — Fri, 20 Nov 2009 16:15:00 +0000

As I've posted last week I've sold the vast majority of my 6 month dollar cost averaging portfolio. The economic environment is too shaky for my taste. I'm willing to risk losing potential return since the risk I consider is a quick drop back to March 2009 levels. Assuming jobs won't improve any time soon I find it hard to see how governments will sustain growth through government spending alone. With each passing day risk of stagflation grows higher. Macroeconomic indicators aren't really proving any strong indication of the future.

The Stock market seems pretty relaxed, though. VIX volatility is down and things are calm. This may be attributable to the 2009 year end.

I'm on the sidelines waiting for a good opportunity to jump back in, slowly (Starting dollar cost averaging on a monthly basis all over again).

Interesting articles from leading economic and business magazines:

Stemming the tide @ The Economist – Concerns about Unprecedented levels of government debt (similar to those I expressed a week ago).

Managing A Portfolio With Hedgeable.com @ NY Times – A valuable portfolio management tool reviewed by the NY Times.

Money Issues That Can Test Even a Rock-Solid Marriage @ NY Times

Great personal finance posts from the past week's carnivals:

The Carnival of Personal Finance was hosted by M is for Money. Here are my favorite posts:

10 Things Your Baby Doesn’t Need that Can Fund Their College Education @ Fiscal Geek – Seems like many parents are frustrated with people trying to capitalize on their parenting instinct.

How Our Consumer Debt Problems Got Out of Control @ The Digerati Life – A quick recap of the consumption craze.

The Carnival of Money Stories was hosted by Out of Debt Again. These posts caught my eye:

Buying an Engagement Ring @ Dual Income No Kids Finance – Great story.

Why Do People Pay More Money for the Top of the Line Model? Incremental Value Analysis @ Darwin's Finance – Interesting analysis of the premium paid on top of the line models vs. the incremental utility.

More from fellow personal finance bloggers:

Do Emerging Market Funds Belong In Your Portfolio? @ Amateur Asset Allocator – My answer would be – yes. How big an exposure would be the more difficult question. A good spotlight on the role of emerging market funds in your portfolio.

Sell Your Used Textbooks and Old Books Online @ Money Blue Book – Great guide on making some extra money on old textbooks and books.

How I Bought My Son $150 Worth of Cardboard Boxes (Or Free Box With Each Toy!)

noreply@blogger.com (Dorian Wales) — Sat, 14 Nov 2009 15:56:00 +0000

Admiring the ability to enjoy the simpler things in life

As a child one of favorite sights was that of the suitcase my uncle had brought back with him from his travels. We always knew that bloated suitcase represented many mysterious and exciting gifts (toys of course) that can only be found abroad.

We were always very polite and waited patiently for the suitcase opening ceremony during which each of us received a present, thoroughly packed in wrapping paper bearing funny looking writing and smells of faraway places.

During the past decade I've been fortunate enough to visit my share of the world. However, only recently, with the birth of my Son I've been able to replicate those exiting moments. My wife and I are the only excited ones right now (he's 6 months old) but that didn't stop me.
Suffice to say walking into Manhattan's Toys R Us and FAO Schwartz had me leaving with a brand new 29" Samsonite and several pounds overweight.

Coming home, chest swollen with a new Father's pride I couldn't wait to show my wife my recent acquisitions. I knew she'd be proud of my toy hunting abilities and the new arsenal at the disposal of my Son.

I never noticed but it seems Duplo and Playmobil have really fascinating boxes. Apparently the contents were not nearly as exciting as the box that kept him busy for hours. Each corner, string and picture provided hours of fun either through banging or staring.

The mobile phone I bought, with numbers, letters and music which are activated by many colorful buttons came in a real neat packaging. It even stood upright by itself! The phone was cast away in minutes in favor of colorful yellow cardboard.

Seriously, I'm thinking of starting up my own toy factory for toddlers. Dorian's boxes and packages - all shapes and sizes. Why spend a small fortune on useless toys just for the packaging when you can buy as many as you'd like for the price of a single toy?

I'm currently in the seed level looking for investors. Would you be interested?

I guess I should be content. This phase won't last very long before toys get much more expansive, very fast. In fact, I've been trying to convince my wife we need a Playstation 3 since our son was born. I'm still counting on him to convince her we need it.

There's something beautiful about the total lack of materiality in babies. They are truly able to appreciate the free things in life such as a hug, a package, a tree branch or anything else of this sort. For some reason we lose it along the way.

6 Figures at 28, Leveraged portfolios & causation @ The RoundUp

noreply@blogger.com (Dorian Wales) — Sat, 14 Nov 2009 08:28:00 +0000

The better posts from fellow bloggers this past week include:

The Financial Fallacy of Patterns, Causation & Correlation @ The Financial Philosopher
Great post. The problem with patterns runs even deeper. Even if a pattern has been spotted it says nothing as to the related causality. Correlation is the bane of many of the social sciences, including economics. I've written quite a bit about it. Hume's brilliant analysis of the problem of induction is perhaps one my most favorite philosophical text as it leaves you shaken by the sheer truth of the arbitrariness of empiricist life. A fascinating subject. My thoughts On Causality and Correlation in Economics can be found here.

Five things to do for the baby before returning to work @ The BagLady
This topic has grown very close to me these days. I'd add: Prepare Mommy for post maternal leave life – The level of how our priorities changed amazed me even though I had given this issue much though. Suddenly we're there for another. That is a significant change I've yet to fully comprehend (after 6 months).

Hitting 6 Figures Income at 28! @ The Financial Blogger
Congratulations on hitting your mark! I believe 6 figure income is a state of mind, so to speak. The post includes several tips on how to achieve such a goal. From my experience, everything amounts to commitment and understanding of the broader picture. Adopting a pragmatic point of view according to which you have to earn rather than hope to get recognized is crucial. Too many employees believe they are entitled to much more than they are getting. This is a self-destructive point of view. The pragmatic approach suggests doing your best in a given job or seeking out alternatives on your way forward. Career management is an active endeavor and one should not hope for things to improve but work to improve those.

Are you as leveraged as Goldman Sachs? @ Gather little by little – On the importance of understanding leverage and one's real portfolio.

Retirement Investing Advice For Late Start Investors @ The Digerati Life

Dow Hits 13 Month High on Decision to Keep Aid Flowing to the World Economy

noreply@blogger.com (Dorian Wales) — Mon, 09 Nov 2009 21:26:00 +0000

My fundemental reasons for concern

As several of my last posts indicate I have whole heartedly adopted Dollar Cost Averaging as my investment strategy. The reasons have been discussed in length a few posts ago.

Today I thought about liquidating some of the investments I've made in the past 6 months due to the negative vibe in the market encouraged by leading economists and investment gurus such as Noriel Roubini, George Soros and Bill Gross who all attribute a certain bubbly taint in the markets.

Good thing I didn’t. I might, though, tomorrow.

The reason that kept me from selling today was my attempt at disciplined investing and self restraint. Still, my fear of a near drop in stock prices only grew today. The reasons for my fears are:

The low interest rate environment as a catalyst to bubbles – Low interest rate drives investors wild. Risk appetite is gradually growing seeking alternative means of generating returns slowly yet surely forgetting the risks involved. In a 0.25% interest rate environment an 8% return reflects a 7.75% (!) risk premium. We must not forget that.

Many stocks have regain past losses and some are close to 2007 levels than ever before – There is no sign the economic growth is stable enough for the long term to justify such a prices level.

The markets are running on the government expense fuel – Bank earnings and growth is generated mainly through increase government expense with no signs of private sector backing or growth. How long can governments keep this up?

Fear of stagflation is real – Stagflation, the situation in which both inflation and economic stagnation are present is more and more a reality with each passing day. Price levels are bound to rise eventually due the huge amount of money being dumped on the markets by the government. Eventually the weak dollar may get weaker while the economy hasn't regained in full (again, very dependent on government expense).

Technical analysis points to diminishing volume of trade in recent stock price increase – The trade volume does not support the trend. This is cause for concern from a technical analysis perspective. Just look at the trade volume today.

The markets rejoice as government aid continues. This is a risky game. Any market position, whether short or long is a risky wager. I'm seriously thinking of adapting my strategy for the short term. Tomorrow I plan on restarting my dollar cost averaging after realizing some of the gains I had made during the past 6 months.

Related Posts:

A Temple Restaurant and a Clearing House for Tickets – Two Observations of New York City

noreply@blogger.com (Dorian Wales) — Sat, 07 Nov 2009 13:11:00 +0000

Best City in the World

New York City is my favorite destination in the world. Any opportunity to visit again, whether on business or pleasure is a joy. With each visit a new light is shed on some other aspect of the city. I'd like to share two such spotlights with you.

In case you have been wondering The Personal Financier is very much alive. It may not seem so but I'm doing my best on getting back on track. It's amazing how life changes once you have a child.

Peter Luger – The Mystery of Building a Lasting Brand

Peter Luger offers the best steak I've had my entire life. That's a fact on my part. I may be biased but I don't believe the brand has enough influence on me to force such a belief. It is truly remarkable.

Still, that rarely justifies the lasting brand name Peter Luger has made for itself and has been successful at maintaining for the last century. We all had great meals at great restaurants, some more hidden than others. Still, such a strong, international brand name for a steakhouse is a remarkable phenomenon.

Location? What is so great about a 15 minute train ride from Manhattan down a grimy Brooklyn Staircase only to walk 5-10 more minutes in the rather unattractive surroundings of Brooklyn's Broadway Street?

The restaurant? I've seen much better looking classic restaurants preserving the glory of days past in wooden furnishings.

The service? It may be characterized as slightly snooty with a "thank us for considering you a potential diner" attitude at times.

The food? I've already mentioned the food but that is not enough. It is probably the best Steak I've ever eaten but I've eaten ones that got pretty close to it as well.

It seems the Peter Luger charm is a complex one. And as always, the answer with complex is everything. Everything from the location to the design and attitude constitute the brand which is Peter Luger and assure my returning on any chance I get.

The relatively remote location suggests a good thing deserves the effort. It gently insinuates that the steak is that good it does not need a prime location and subtly differentiates between the connoisseurs and the herd (You being the connoisseur if you've understood the trip to be worthwhile). It suggests the steakhouse is a temple for meat lovers who would gladly take the pilgrimage to pray at the altar of porterhouse.

The restaurant's classic design supports these gentle innuendoes with classic appearance and sacred design. The temple of meat will forever be as it is. A holy place, unchanged with time.

The service is suggestive, as if you acknowledge the sanctity of the place and its guardians and decided to entrust yourself with their capable hands. They simply know their steak is that good.

TKTS – Ingenious Broadway Clearing House

I believe the first thing a tourist planning a visit to Manhattan writes down is "Get Broadway show tickets at TKTS". To his or her content a blow has been struck against the Tyranny of Broadway theaters and their exorbitant pricing. Simply wait for the last minute and the giants of Broadway will fold offering 50% discounts to the witty traveler.

The lines at 47^th Street and Broadway are always full of conscious, self-assured consumers who know how to enjoy a show at a reasonable price. I used to be one of those standing in line, content to have purchased discounted show tickets thinking I had outsmarted the world.

TKTS provides a good deal and an important service. The fact is, however, that much better deals are available with little or no line at all, and better yet, you can select the date on your own. These are ironically available at the theaters themselves. The same ones we thought we had outsmarted.

On my recent trip I learned visiting the different theaters is much more worthwhile than waiting the TKTS line. All theaters offer much cheaper Balcony prices for all available dates. Usually, for most shows, an upgrade to better seating is available once the show had started, curtsy of the usher. At TKTS you'll get good prices but on much more expensive tickets, usually ending up seating in the same location.

TKTS is ingenious. Broadway owes much to whoever came up with this successful clearing house for theater TKTS. In my opinion this is the main idea behind this initiative. Broadway tickets were standardized, seating availability made common and all that was left was centralizing the selling point in the prime location it is currently located in.

Curtsey of the Theater Development Fund Broadway theaters enjoy a great selling point, cleverly marketed and ideally located. The stress on theaters boxes is lessened and tickets are sold throughout the day assuring seating is maxed out for every show.

The selling technique also contributes to TKTS performance as the pressure on the client is significant as he or she is holding up the line. Prices are quoted rapidly for each show with little time to ask or wonder. Decisions are made and tickets are sold.

Dollar Cost Averaging – Practical Lessons From Recent Experience

noreply@blogger.com (Dorian Wales) — Sat, 15 Aug 2009 16:15:00 +0000

My recent experience with Dollar Cost Averaging and the lessons I learned

Several posts ago I discussed my considerations on Dollar Cost Averaging and why I had selected it as my long term investment strategy.

I've been at it for 4 months and have shown the necessary self restraint, avoiding any impulse buying and selling and sticking to my original investment plan which includes investing a fixed, identical sum at the start of every month into a well diversified ETF portfolio.

It hasn't been as easy as it may seem. This is a good indication on my part. "Easy" usually doesn't lead to good results.

After short 4 months I've already learned several lessons I'd like to share in case some of you have decided to try Dollar Cost Averaging as well.

Lesson #1 - Speaking about self discipline and exercising it are two different matters

The idea is simple. Invest a fixed sum of money at each given period and average out sharp movements in asset prices. Drops in prices will be smoothed out by investments made during times of low prices (and the other way around as well, of course). Dollar Cost Averaging exposes an investor to less risk and therefore less return.

The challenge begins when we decide to implement Dollar Cost Averaging. When we save for retirement we usually take the money invested each period as a given and constant sum which we don't really have to think consider since this is a life term investment.

When investing our monthly savings things change. The level of commitment required from us is higher as we are in control of the funds invested. Suddenly we have to make the investment ourselves; committing to the asset of our choice and accepting the fact we are locking money for the long term.

Keeping to Dollar Cost Averaging when markets are peaking is challenging as well. Investing when you are sure the market faces a breather and a period of earning realizations is not an easy feat.

It is important to keep in mind our initial investment strategy and stray as little as possible. Remember why you adopted it at the first place. So far I've been able to keep to decision making but it was not as easy as I had though it to be.

Lesson #2 - Timing the markets is inherent in our psychology and is difficult to root out

I simply can't avoid timing the markets. Dollar Cost Averaging is probably one of the investment strategies which offer the most temptation to time the market as investments are made periodically.

Think of a scenario in which the market has rallied for 3 months (Like the past 3 months). Would invest, yet again, knowing full well the market is scheduled to take a breather? The same goes for bearish markets during which the temptation to buy more increases significantly.

Again self discipline is crucial for succeeding. Deciding to utilize Dollar Cost Averaging means abandoning the effort to time the market and recognizing them to be futile.

Lesson #3 - The long term is an obscure concept which is counter-intuitive to the human psychology

Again, my experience has taught me the long-term is one of the most obscure concepts in investing. Often mentioned but only rarely understood.

I believe long term investment actually contradicts human psychology and is very hard to maintain. When managing your own portfolio the urge to keep tabs is enormous. I haven't met anyone who can resist the temptation to monitor the portfolio daily or at best weekly or monthly.

In all sincerity, we may say long term but hope for short term. Again, self discipline and restraint are key traits for success.

In the meantime, and due to my rather lucky starting point I've managed to generate just over 10% in returns over the past 4 months which have been exceptionally well. I hope for a long term average of a yearly return of 6%.

Making money online, Confirmation Bias and Lifestyle inflation @ Saturday Round Up

noreply@blogger.com (Dorian Wales) — Fri, 14 Aug 2009 19:00:00 +0000

2 year recap and interesting reading from fellow bloggers

It has been a hectic year. My job takes up the best part of my life and between it and my 4 month old boy I have had little time to maintain The Personal Financier as I’d like.

I have been writing, here at The Personal Financier, for almost 2 years now and would like to think I’ve gathered a small crowd that enjoys my posts. I try to be innovative in my posting and avoid the shallowness which sometimes characterizes personal finance blogging.

I would like to believe my posts are useful and hold added value. I strive to walk off the beaten path as far as personal finance blogs are concerned. I would appreciate your comments and thoughts on the matter.

Interesting reading at fellow personal finance blogs:

Beware of 'Confirmation Bias' @ The Financial Philosopher (One of my favourite blogs)
GDP, Potential, and Debt Forecasts -- and Implied Multipliers @ EconBrowser (Excellent economy blog)
Avoid Lifestyle Inflation: Create an Artificial Sense of Scarcity @ Five cent nickel (Interesting concept of lifestyle inflation)
Simple ways to make money online @ Gather Little by Little
Exotic Investing: Master Limited Partnerships @ dqydj.net (Don’t quit your day job)
The time budget @ Blunt Money

Recent personal finance carnivals of interest:

Famous money quotes edition of the COPF @ ChristianPF (made editor’s pick!)
Carnival of Financial Planning - Edition #102 - August 14, 2009 @ The Skilled Investor
Carnival Of Twenty Something Finances @ How I Save Money

Buy on the Rumor – Sell on the News: Our Psychology at Work

noreply@blogger.com (Dorian Wales) — Sat, 01 Aug 2009 10:50:00 +0000

A counter intuitive rule of thumb explained

Rumors of new products, earnings, takeovers and mergers immediately raise share prices. This is understandable as the value of the company is expected to rise as a result and so investors who believe the rumor to be true (or true enough) can buy on the rumor with the hope of generate significant returns in a short time.

Sell on the news is more intriguing. Usually this tested rule of thumb works. Many times after the news the share’s price shows signs of uncertainty and fear of the recent height it had attained. The reasons why can shed some light on how our psychologies play yet another trick on us.

Shouldn’t buying on the news be more appealing?

Solid investors should not buy on the rumor. Rumors have a tendency to turn out to be false and the share’s price soon follows to previous or lower levels. Still, buying on the news is more often than not too late for any short-term profit. Shouldn’t buying on the news be more appealing?

It seems rumors excite the imagination of investors so that by the time the news gets out it’s often disappointing by the mere fact it is grounded to a certain reality. I think something deeper, rooted in our psychology is at work, and I will expand on it shortly.

For the value investor buying on the news is the sound path for the long term. It is understandable how buying on the rumor may generate higher short-term returns as the associated risk is much higher since rumors may turn out to be false. Still, if you are not a speculator look for the hidden value in the news.

It is important to remember that many times the thought or idea of a certain takeover or merger is more exciting than the actual results. As we know everything is personal and merging two companies, two boards and two managements is hardly an easy task. An idea of a merger may be brilliant at first but if the operational and practical side is weak the merger is doomed.

Buy on the rumor sell on the news – the psychology at work

The more interesting aspect of buy on the rumor – sell on the news is the psychological aspect at play. This rule gives us another good example of how fragile our minds are and why the market is a place for the more rational.

Over and under corrections and the confidence bias – Think of the first think that comes to your mind when you hear a rumor regarding a company. We all believe the share prices will sky rocket and are sorry for missing the opportunity. A rumor of an opportunity has a very strong effect on us. Our psychology usually leads us to see the up side of such an event ignoring the limits and limitations that exist. Our optimistic view is quickly generated into a peak in the share’s price only to later face reality and correct the price back downwards to reflect reality and overshooting.

Expectations and reward pursuit – Strangely enough we seem to value some thing more when we wait for it to come true than we do when it finally does. This psychological bias has been demonstrated in research and is rather intuitive once you consider it.

When you plan a trip and consider all the wonderful activities you will enjoy your perceived utility is much higher than it actually is when participating in these activities. When expecting a raise, for example, its perceived value is higher than when you’ve already received it. The mechanism seems to be intuitive as well. Evolution has programmed us to constantly seek new rewards and never settle for what we already achieved.

Therefore, the perceived value of a certain rumor is more often higher than the actually value once it turns out to be true.

Psychology and investing go hand in hand. I find this connection fascinating and I’ve written quite a few posts about it exploring the different aspects and tricks our minds play on us. We can’t always control our psychologies but we can try to offset some of the bias and use it for our benefit.

Related posts:

Challenging Happiness – Exploring the Irony of Human Nature

Behavioral Finance in Everyday Life – The Lottery as a Case Study

Is Rationalization the Key to Happiness?

How Can they Possibly Afford That? Or Is Money in the Eye of the Beholder?

Coming To Terms with Never Getting Rich – A Look at the Pre-Requirements

Past week Round Up

noreply@blogger.com (Dorian Wales) — Sat, 01 Aug 2009 10:28:00 +0000

The finance carnivals were, as usual, very productive. I'd like to note the following two:

Carnival of Personal Finance: The House of Rose Edition @ Good Financial Cents
The 98th Carnival of Finanical Planning @ Living Almost Large

Other great posts of the past week include the following:

Discouraging News about SP 500 @ The Financial Blogger - Presenting another look into the lost decade of the US stock markets through one simple chart. An important lesson to all of us.
Great Stock Market Performace, But Will Dow 9,200 Hold? @ The Digerati Life - A good fundemental review of the market. Rememebr the trend is your friend.
Been down so long it looks like up @ Econbrowser - Another good fundemental review.
How to Brew Your Own Beer and Maybe Even Save Some Money – Equipment @ GenX Finance - Fun post to read.

Diversification is Dead. Long live Diversification

noreply@blogger.com (Dorian Wales) — Sat, 25 Jul 2009 16:59:00 +0000

Don’t give up on diversification through asset allocation just yet

A short introduction to asset allocation and diversification

Assets allocation is said to be the optimal investment method for household investors. As household investors we lack both the time and knowledge to handpick assets and build and maintain a long term investment portfolio on our own. Unless you have a significant enough portfolio brokers and financial consultants will also professionally manage your portfolio through one asset allocation or another.

Asset allocation relies on diversification and the benefits it presents. If finance diversification is aimed to lower the specific risks of an investment and capture only the market risk, which cannot be eliminated. Specific risks are the risks associated with a single investment and include the risk the company we invested in will lose a major client, for example, or lose their successful CEO.

Diversifying is aimed to maximize the return with a given level of risk. The math behind this model is based on the correlation between the assets we invest in and this is one of the ways portfolios are built.

The bad news

If you’ve managed such a diversified and allocated portfolio over the past couple of years you must have noticed diversification didn’t quite work, to say the least. Each and every portfolio crashed and burned, regardless of the asset allocation (unless you went short on the market).

All major stock indices, commodities, oil and almost every asset that comes to mind plummeted. Diversification over assets, geographies and currencies hasn’t saved our portfolios from significant losses.

Some hoped that the emerging markets will be strong enough and independent enough to balance out the devastating impact of the recent crisis. Another economic motor would have created two semi-correlated financial drivers which might have offset some of the damages. It appears that it is too early to nominate China (and the European Union) as the next economic powers that be.

The reasons may be abundant but it seems that with globalization came increased correlation between assets and swept our precious diversification away. What are we to do now? How can household investors invest in such a turbulent market atmosphere?

Well, aside from increasing the risk free asset portion of the portfolio (such as deposits and government bonds) I believe there are also good news to be had.

The good news

First and foremost what crashed and burned together would probably rise back together. As such, anything we’ll put our hands and money on will probably generate decent returns on the upcoming investment horizon.

Some of us remember the good times back at 2005-2007 where all the assets generated decent returns and stock picking was never as needless.

Moreover, on the geo-political side of things, the increased co-dependence between our countries’ economies will hopefully lead to increased cooperation and mutual consideration of our impacts on one another.

How should households invest?

I’ve tried answering this question in my previous posts. I’m still a big supporter of good asset allocation. As I’ve written before good asset allocation includes allocation of investments over time not just over assets. Time allocation or dollar cost averaging helps us smooth the behavior of our portfolio by constantly averaging the buying price of shares and bonds.

I believe that other markets will emerge as economic engines of growth and will hopefully serve the world economy alongside the USA.

Related Posts:

Personal Finance Management: Budget vs. Net Worth

noreply@blogger.com (Dorian Wales) — Sat, 20 Jun 2009 09:50:00 +0000

While it may be recommended to manage both a budget and net-worth sometimes focus leads to better results.

I've been keeping a detailed budget for over two years now. My budget served me mostly in tracking my family's expenditures and investments rather than in setting goals but I tried to "course correct" whenever I noticed exaggerated expenditures in any area.

Another aspect of my financial management is tracking my net worth. A budget can be considered more of a profit and loss statement while net worth could be considered the balance sheet of household finances.

Still, since I took my recent job, I had very little time to invest in my budgeting efforts (and writing, unfortunately) and I had to focus my efforts on what I considered most valuable in terms of personal finance management.

My main consideration where the nature of my financial goals, the time and effort required and the marginal contribution I believed these tools had for me. The following discussion presents, in a concise manner the key considerations in net worth management and budget management.

Net worth management or budget management?

As any complex questions the answer is: it depends.

Personal finance management should complement one's lifestyle and financial goals. Considering my own led me to the conclusion net worth management is more suitable than budgeting (Still, had I the time I'd do both). Here are my considerations:

Personal finance management through budgeting is more of a short-term management focusing on specific goals, such as meeting one's financial abilities, paying off a credit card or short-term loan, regaining financial balance and generally meeting timely financial goals such as saving $1,000 a month, for example.

The key considerations for budget management are:

Profit and loss management.
Useful for achieving short term goals.
Requires a significant time investment and management.
Should be performed on a monthly basis, at the most.
Budget management requires attentive analysis of the breakdown of expenses and creative thinking on how to lower them.
Budget management keeps you focused on the savings side, leading to penny pinching and frugality which are good tools for savings as they have a cumulative impact.
Budget management without goal setting is simply tracking expenses with no corrective action.

Personal finance management in terms of net worth is more long-term management focusing on major life goals such as retirement, children savings, portfolio management and others.

The key considerations for net worth management are:

Balance sheet management – Capital as a function of assets and liabilities.
Useful for achieving medium and long term goals.
Requires little maintenance but significant time in portfolio management.
Net worth requires tracking various balances of assets and liabilities on a timely basis - bank balance, deposits, investment portfolio, value of a house on one side and mortgage, loans and other liabilities on the other.
Net worth management is focused on the long term on or growth of capital through investments. Net worth management may ignore the short term and does not aid in managing a budget – Just the bottom line of money saved at each period.
As with budget, net worth management without goal setting is simply tracking various balances.
Net worth management can be performed on a quarterly basis. Shorter periods may lead to frustration as funds and investments take time to grow.

My conclusion

While many recommend financial management which looks at both the short term and long term I believe that one may distract you of the other. For me, time invested in budgeting meant less time to invest in portfolio management and analysis.

Managing net worth when trying to meet a budget and repay loans may very well end in frustration seeing net worth on the negative side of the balance sheet.

Related Posts:

Image by: OneBlackBird

How Should Households Invest? Sharing My Asset Allocation

noreply@blogger.com (Dorian Wales) — Sat, 30 May 2009 13:56:00 +0000

Investing without an asset allocation in mind is more likely gambling than actual investing

A sound asset allocation is a key component in any investment portfolio. To put it bluntly investing without an asset allocation in mind is more likely gambling than actual investing.

Two weeks ago I wrote about my decision to gradually increase my exposure to the stock market as the low interest rate levels make it impossible to generate any real return on investment. Some may say low interest rates are a poor advisor. Still, I am quite confident in my decision to increase exposure to stocks in the long term using dollar cost averaging.

Having made up my mind on the question of when I turned to the question of what should I invest in or in other words: what would be a good asset allocation for me?

Asset allocation actually answers the very basic question of investing: What is the return I expect on my investment and, hand in hand, what is the risk I am willing to take?

A short introduction to asset allocation

I feel a short introduction is in order for those less familiar with the concept of asset allocation. I will avoid a deeper methodological discussion at this time.

Asset allocation is the strategy chosen by an investor to distribute his or her investment portfolio among various financial assets to achieve the investment goals. Asset allocation is the corner stone to investing.

Asset allocation has several goals the most important of which is to express the risk appetite of the investor in terms of allocation of funds to different financial assets through which the investment will achieve its goal taking into account the risk involved.

In finance theory, asset allocation is a means of minimizing the specific risk a certain financial asset has. Since various financial assets are not perfectly correlated diversification of the portfolio to several financial assets may (and perhaps should) result in a portfolio which is complete diversified with as little specific risk as possible (specific risk is the risk a certain stock has such as the death of a successful CEO). The diversified portfolio remains with the market risk only – the risk that characterizes the entire market.

Assets may and should be allocated according to several parameters for adequate diversification:

The level of risk of the financial asset – From derivatives to government bonds financial assets holds varying levels of risk. Through asset allocation one risky instrument may offset another.
Specific characteristics of the financial asset (usually associated with risk) – Stocks of different types vary immensely in risk and return. Large-caps are usually considered more conservative while small-cap or emerging markets are traditionally considered riskier. Risk levels in bonds vary as well with government bonds on the safer side (depends on government of course) and high-yield junk bonds are sometimes riskier than stocks.
Foreign currencies – Allocation across currencies is important as well to reduce exposure to a single currency and increase exposure to other powerful or promising currencies.
Other parameters such as industries, geographies, commodities, real estate and more.
Asset allocation holds infinite possibilities. The guideline, as I mentioned, should be the risk appetite of the investor.

My asset allocation

If you've read my previous post on my decision to return to stocks you are aware of my choice to invest through ETF's and index funds. I believe that household investors with as little time on their hands to manage investments should not try to identify value investments in stocks simply because we don't have the time.

Chances of beating the market are slim to none so my recommendation to household investors, such as myself is to join the market (other than try and beat it).

Thus the allocation I will present will be achieved through investing in ETF's and index funds which track a certain index which suits my desired allocation.

It is important to remember that the following allocation is one I built for my own risk appetite and financial situation. Is may serve as an example but should be adapted for anyone else. The purpose of this post is to share my investment management with my readers.

The following is the asset allocation I have chosen for my investment portfolio:

I plan on reaching this asset allocation within 6 months of gradually increasing my exposure to ETF's and index funds in each category.

My considerations for choosing this asset allocation

My considerations for allocating my assets as such are comprised of the following:

I believe the US will emerge first from the current crisis with Europe lagging behind. I believe that the US economy is much more flexible and open to allow for rapid return to growth. The European economy is heavier and less flexible and will suffer more through the coming period. The level of money printed by the US government and the low interest rate environment are frightening as inflation my quickly be upon us. Still, I believe the US economy is resilient enough to withstand such impacts. Hopefully the situation would allow for rapid correction of interest rates to combat inflation after growth has been achieved.

Emerging markets present a long term opportunity which I would hate to miss. This is quite a risky investment but for the longer term (over 15 years) emerging markets such as China, India and others look very promising.

The financial sectors should rebound first if it survives. Banks are usually the first to capitalize on return to growth through credit issued and investments made.

As I mentioned I don't believe in beating the markets so I've decided to join them by investing the rest in ETF's and index funds which track country leading indices such as the S&P500, FTSE, DAX and others.

Monitoring my asset allocation

Setting up an asset allocation is not enough. As values of assets change the allocation shifts. Imagine a strong bullish period in stock markets. The percentage of investment in stock increases as stocks rise thus slowly shifting your asset allocation towards this instrument.
I've written a post in the past on how to monitor a portfolio which I strongly recommend as a supplement to this post.

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Carnival of Financial Planning - May 16, 2009 Edition

noreply@blogger.com (Dorian Wales) — Sun, 17 May 2009 19:01:00 +0000

Welcome to the May 16, 2009 edition of the Carnival of Financial Planning.

Today I'm having the pleasure of hosting the Carnival of Financial Planning on The Personal Financier. The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. We focus on efficient and sustainable personal financial planning ractices that can lead to lifetime financial security.

If this is your first time here, at The Personal Financier, welcome! Please check out my Top Posts and consider subscribing to RSS Updates.

This edition is arranged by subject heading, so that you can browse efficiently.

Enjoy!

This Edition of the Carnival was kindly edited by The Skilled Investor.

Budgeting

Barry presents Tips To Curb Impulse Buying posted at Associate Money.

Beth Dargis presents What to Do When Laid Off posted at My Simpler Life - Simple Living, saying, "What steps can you take to help your finances when you get laid off"

Silicon Valley Blogger presents The Dave Ramsey Budget: Budgeting Tips For Successful Savers posted at The Digerati Life

Pasadena Financial Advisor presents Financial Planning Reading List posted at Pasadena Financial Advisor, saying "When I work with clients to develop their customized lifetime
financial and investment plans, they often ask what they should read to improve their financial literacy. This article provides a list of recommended reading from among the many hundreds of articles that I have authored in the past several years."

Economics

Dana presents Is the Era of Rising Real Estate Prices Over? posted at Investoralist, saying, "Is this the end of rising real estate prices? Some demographic factors to consider."

Dorian Wales presents On Causality and Correlation in Economics posted at The Personal
Financier, saying, "Causality is perhaps the most fundamental element of empirical evidence available to economists. However, it is also the source of many misconceptions due to its elusive nature."

PicktheBrain presents Gallows Humor: 21 Economy Inspired Cartoons posted at School Loans.

Estate Planning

jim presents Comparing Fixed Annuities & Certificates of Deposit posted at Blueprint for Financial Prosperity.

Tushar Mathur presents Getting finances in order posted at Everything Finance,
saying, "Keeping organized records is a gift to your family and to yourself. It helps ensure that your wishes are followed, that your assets are accounted for, and that your money is available to meet your family's needs in a timely fashion."

Financial Planning

jim presents What Is A Good Credit Score? posted at Blueprint for Financial Prosperity.

The Dough Roller presents Dave Ramsey Unleashed: How to Apply Ramsey’s ‘Baby Steps’ to Grown Up Finances posted at The Dough Roller, saying, "See how to apply Dave Ramsey's Baby Steps for those already on their way to retirement."

Todd presents FMyLife Financial Advice posted at Gloomberg News, saying, "Some of the most valuable lessons are learned when things hit rock bottom. FMyLife & Gloomberg present you with 3 Financial Mistakes and How to Prevent them!"

Jeff Rose presents How Long Should You Keep Your Financial Statements? posted at Jeff Rose.
Chris McClelland presents 10 Reasons Your Bank Never Wanted You to Read This posted at Lucrative Investing.

FMF presents Free eBook -- Everything You Ever Really Needed to Know About Personal Finance On Just One Page posted at Free Money Finance, saying, "The key's to financial success are very simple to detail and understand."

Tushar Mathur presents How to choose a financial planner posted at Everything Finance,
saying, "There's retirement to plan for and college tuition for the kids. Insurance. Estate planning. And, oh, don't forget a wedding for your daughter. If all this sounds familiar, it may be time for you to start shopping around for a financial planner."

Financing a Home

Dan Green presents Trends: Mortgage Rates Tend To Rise Between May And August posted at The Mortgage Reports, saying, "If history is an indicator, mortgage rates won't be this low again until after the summer."

Alex Fotopoulos presents When is it Smart to Refinance a Mortgage? posted at My Trader's
Journal, saying, "Some key points to consider when refinancing your home."

Financing Education

Patrick @ Military Money presents Watch Out For Stimulus Check and Government Grant Fraud! posted at Military Finance Network, saying, "Tips on how to guard your identity and avoid online rip off scams like the infamous government grant scheme."

Ted presents Saving Money: 50 Tips for College Students posted at CampusGrotto, saying, "50 ideas on ways to save money as a college student."

Income

KCLau presents The Most Common Habit of Rich People posted at KCLau's Money Tips, saying, "About the common habits of the rich".

Investing

ABC presents Commodities posted at ABCs of Investing, saying, "A brief explanation of commodities."

Manshu presents Value Traps posted at OneMint.

Zach Scheidt presents Synaptics Staying Ahead of Expectations posted at ZachStocks,
saying, "Synaptics Incorporated (SYNA) manufactures touchscreen and touch pad technology used on iPhones and laptop mouse applications. The company is beating estimates and the stock should offer an exceptional opportunity."

Frank Vertin presents Just Buy Index Funds Directly posted at No Load Index Funds, saying, "Buying an S&P 500 index fund through an investment counselor can substantially increase your initial purchasing costs and and drive up your annual management expense fees. Unfortunately, the vast majority of individual investors buy mutual funds and ETFs through
brokers and investment advisers. Rarely do financial advisors recommend that you buy index funds with low fees. This is because low cost, no load mutual funds do not pay them as well as loaded, high fee mutual funds.".

Four Pillars presents BMO InvestorLine Discount Brokerage Review posted at Quest For Four Pillars, saying, "Review of BMO InvestorLine discount brokerage."

Dividends4Life presents PepsiCo Sustains Its String Of Dividend Increases posted at Dividends Value, saying, "Dividend investors love companies that can sustain consistent
dividend growth through the good times and the bad. For three years in a row PepsiCo (PEP) has been named to the Dow Jones Sustainability Index in recognition of the company’s economic, environmental and social performance."

Four Pillars presents Asset Allocation - Include Future Contributions? posted at Quest For Four Pillars, saying, "Can a small investor ignore asset allocation?"

Alex Fotopoulos presents SPY Chart - Premarket posted at Chart Analysis, saying, "Chart of the large S&P 500 ETF, SPY. Alex analyzes the SPY chart using trend lines, moving averages and the Williams %R indicator."

Larry Russell presents 7 Ways to Pick the Best Noload Mutual Funds and ETFs posted at NoLoad Mutual Funds, saying, "Taken as a whole, the vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Four Pillars presents Transfer In Kind posted at ABCs of Investing, saying, "An explanation of transfering your investments "in kind"."

Praveen presents Successful Trading is About More than Generating A Buy Signal.. posted at Stock Trading Riches, saying, "FINBLOGGER - When buying stocks, your initial purchase is the
least important part of successful investing. Your return is determined by how well you manage the trade - i.e. knowing when to add to your position and when to take profits."

ABC presents Warning - Not All Index Funds and ETFs Are Low Cost posted at ABCs of Investing, saying, "Some index funds and etfs are too expensive."

Wally Fouse presents 7 Ways to Pick the Best Noload Mutual Funds and ETFs posted at Best Index Funds, saying, "The vast body of investment research studies show that there really are better approaches to buying and owning mutual funds and ETFs. You do not need to frantically chase fund performance. Performance chasing simply does not work."

Praveen presents Options Basics posted at Stock Trading Riches, saying, "FINBLOGGER - A blog reader asked me this question: Can any one explain about options trading in a simple manner?"

Richard M. Rothschild presents Low Cost Taxable Bond Mutual Funds posted at Best Bond Index Funds, saying, "The top 14 low cost taxable US fixed income funds with a $10,000 or lower initial deposit. Low investment management fees are very important with fixed income funds. Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a deadweight loss to you. When you pay more in bond mutual fund
fees, you are just wasting your money."

Zach Scheidt presents IntercontinentalExchange (ICE) Sharply Higher on Earnings posted at ZachStocks, saying, "IntercontinentalExchange, Inc. (ICE) reported earnings and investors bid the stock higher. Futures clearing and Credit Derivatives Swaps accounted for much of the strength. Management has an excellent track record with acquisitions."

MoneyNing presents TradeKing Review posted at Money Ning, saying, "TradeKing is quickly becoming one of the best stock brokers out there. Find out why."

Alex Fotopoulos presents DIA 3 Month Chart - April 29, 2009 posted at Chart Analysis,
saying, "Alex charted the Dow Jones tracking ETF, DIA, this week and highlights where near term resistance could surface."

Alex Fotopoulos presents RSP Chart - May 7, 2009 posted at Chart Analysis, saying, "Alex analyzes the RSP chart for the past three months to attempt to pick an entry point."

Zach Scheidt presents Bankruptcies, M&A, and Playing Defense posted at ZachStocks,
saying, "A discussion on current economic reports and their effect on the markets, Bank stress tests as a catalyst for selling, and defensive strategies to protect your portfolio from losses."

Managing Debt

Madison presents Making Home Affordable Q & A posted at My Dollar Plan.

Pinyo presents 7 Steps Debt Reduction Illustrated posted at Moolanomy, saying, "Illustrative guide to help you effectively manage and pay down your credit card debt"

KCLau presents Do You Have a Wedding Debt? posted at KCLau's Money Tips, saying, "Most couples want to begin their married life auspiciously and free from the problems. However, it is not uncommon to hear about married couples who go into debt just to get married. Article explores the reasons."

Miscellaneous

GrrlScientist presents Tough Love for City's Homeless: Pay Rent or Get Out! posted at Living the Scientific Life, saying, "Sounding like a story that is fresh out of the satirical newspaper, The Onion, the eighth richest person in America tells thousands of homeless families in NYC to pay rent to live in a shelter or GET OUT!"

Retirement Planning

Darwin presents Start Investing Today: An Amazing Comparison of 25 vs 35 Year Old Starters posted at Darwin's Finance, saying, "This article shares some poignant numerical and graphical
representations of the stark differences between an investor/saver starting at 25 vs 35 years old."

Mike Pastore presents Ways to Stress Test Your Retirement posted at Mikes Millions.com.

Risk Management and Insurance

nickel presents How to Save Money on Car Insurance posted at fivecentnickel.com, saying, "Six surefire tips for reducing your car insurance premiums."

puneetkapoor presents UNDERSTANDING RISK posted at KuberKhana -Indian Stock Fundamental Analysis, saying, "If we understand risk, we prosper."

Silicon Valley Blogger presents Lower Your Car Insurance Rates! How To Cut Insurance Premiums In Half posted at The Digerati Life, saying, "I offer some suggestions and tips for lowering your car insurance and keeping your car related costs (and budget) to a minimum."

KCLau presents Bad Experience of Car Insurance Claim posted at KCLau's Money Tips,
saying, "a story of bad experience with vehicle insurance claim"

MoneyNing presents 20 Different Areas to Think About for a Cheaper Auto Insurance Policy
posted at Money Ning, saying, "Insurance is something we usually forget, yet we pay quite a
bit for it regularly. If you can spend a few minutes and save big, why not?"

Savings

The Skilled Investor presents Most Individual Investors Are Poor Personal Portfolio Managers Personal Investment Management posted at Personal Investment Manager,
saying, "Investors more easily understand investment costs that are directly measurable, such as fees deducted on investment statements. However, many investors ignore or are unaware of the opportunity costs of their sub-optimal investment behaviors. Opportunity costs are usually much more difficult to measure directly, but these investment costs can be even higher than more visible investment fees."

Taxes

Robert D Flach presents HERE’S SOMETHING TO THINK ABOUT posted at THE WANDERING TAX PRO.

Barb A. Ryan presents Asset Allocation, Investment Asset Tax Location, and Emergency Cash Management posted at Independent Financial Planner, saying As you move your cash, bond, and stock financial assets into lower cost, more broadly diversified investment mutual funds and/or ETFs, you should also consider how to locate your investment asset allocation with respect to more optimal taxation. This article will discusses some ideas about where and how to hold your cash assets and how to make emergency cash available."

Technorati tags:
carnival of financial planning, blog carnival.

What is the Recommended Investment Strategy for Household Investors?

noreply@blogger.com (Dorian Wales) — Sat, 16 May 2009 12:22:00 +0000

I've promised to update you, my readers, on my investment decisions. I've decided.

After months of deliberation I've finally decided on getting my feet wet again and bought some stocks on Monday. As readers of The Personal Financier know I am a big fan of investment vehicles that track certain indices such as index funds or ETF's so I've decided on gradually increasing my exposure to the markets via these financial instruments.

Needless to say I have a gift for timing the market, the other way around. Since my recent purchase leading indicators, such as the S&P500 had shed over 5%. That was rather expected as the markets rallied these past couple of months.

In this post I'll share my personal considerations behind my recent decision to increase exposure to stocks. If I breakdown my decision into three main lines of consideration they would be:

My considerations regarding my desired investment style.
My considerations regarding the market environment.
My decision to use index funds and ETF's and invest gradually using dollar cost averaging (Investing a certain sum each period).

My considerations regarding my desired investment style

So why did I decide to reinvest in stocks again? The reasons behind my newly discovered enthusiasm about the markets and why I decided on gradually increasing my exposure to stocks has a lot to do with what I consider a desired or suitable investment style for me and many other household investors (in my opinion, of course).

During the past couple of years I've been fortunate enough (ironically) to not have to worry about my savings and investments as I had none. I'd bought an apartment and literally invested my funds there releasing me of my need to consider alternative investments. Luckily enough the apartment I had bought has yet to suffer the impact of the housing crisis.

Now, two years later I've managed to save up a sum which necessitates more serious consideration regarding where to invest it and how to both preserve it and grow it, if possible.
Naturally, the state of the markets was enough cause of concern for me to seriously consider my investment plans. Losing my hard earned money is not an option.

The more I thought of it I understood I was failing to obey my view on investments, a view that I had learned after paying "tuition" in investment losses in my early investment years.

#1 I decided sitting on the fence won't get me far
I find out I was literally sitting on the fence. Avoiding decision allowed me to remain unscathed during the recent plummet but I did not earn anything either. I've written a post titled "Who Dares Wins" but failed to follow it.

There is no need to take huge risks for huge profits, just thought out risk for a better chance of meeting my personal financial goals.
Sitting on the fence is not a solution to anything. It's a very easy way out. Usually when I avoid deciding I know something is wrong. So I decided to slowly climb down from the fence.

It does feel much better to have decided and to have the feeling of taking a path and having a purpose. My savings were idling in a short term deposit which barely covers the bank's fees with the low interest rate environment. I had to do something and feel like I'm doing something.

#2 I was guilty of timing the market
I just can't help it. I don't think many can. I always try and time the market. Since one does not usually keep objective score of one's efforts of timing the market we never know whether we are any good at it. I most certainly am not.

No one thought the market would rally 50% after Citi's March earning release. Missing out on such a rally is very costly in terms of investment. And now, having raced 50% up the more probable scenario is a downward technical correction in prices… and then? Timing the market almost never works so I've decide to stop and just invest a portion at a time thus averaging these corrections out and enjoying the long trend in prices which will hopefully be a bullish one.

#3 I finally remembered I am a long term investor
It took some time but I've finally remembered I'm actually a long term investor. I think it's hard on humans to invest for the long term. We are programmed to be impatient and impatience is a bane for investors.

I think the birth of my baby boy had something to do with it. I've decided on treating my investments as his. An 18 year investment term should be enough to be considered long term (some may argue).

My considerations regarding the market environment

In my recent posts I've written about a correction in prices which is probable to follow the recent rally. I had thought the stress tests will give enough reason for sophisticated investors to realize profits and change the trend. This hasn't happed, yet. Markets have shed 5% but this can be considered only profit taking on an uptrend.

I still believe a correction is in order but since I've decided on quitting my market timing efforts I've decided to ignore this belief. This is actually a great relief. No one seems to really know what's going on anyway.

It certainly wasn't short-term considerations regarding the economy which got me to reinvest. There seem to be fundamental reasons to believe the global economy will get better in the near future (2-3 years).

#1 Very low interest rate environment leaves little choice
There is money out there looking for reasonable returns. With interest rates this low this money has little choice of investment and will turn, eventually, to the stock market. Interest rates on deposits are so ridicules many investors will find it very hard to accept.

This low interest rate environment will hopefully serve to set the markets back in motion with cheaper credit more motivation to capitalize on this opportunity.

There are risks to such a low interest rate environment, together with increasing influx of money into the markets. Inflation will follow and will have to be controlled but hopefully we'll be on a correct course by then.

#2 Risk appetite seems to be returning to the markets
One of the effects of the recent crisis has been a dramatic impact on risk appetite. When risks seem to be that high no return is justifiable. Risk appetite is perhaps the most important thing for the stock market which is, in essence, a risk-return tradeoff.

Recently there seems to have been a shift in trend and the risk appetite is reappearing. The public's share in the stock markets is increasing through institutional investors and, hopefully, it won't be long before the mass market will find stocks appealing again.

#3 Cyclicality
As my market timing days are over I am better equipped to use one of the characteristics of financial markets in my advantage. Cyclicality is a common trait of financial markets. Though it never seems so in times of prosperity or times of depressions, the tide will turn and the markets will change.

Keeping a presence in the market is vital for long term success and profiting of cyclicality.

My decision to use index funds and dollar cost averaging

My considerations should be clear by now in light of my investment style and market beliefs.

#1 Beating the market is as hard as timing it
Chances are you or the institutional investor you've chosen though a fund or IRA cannot beat the market. For this reason buying the market is the way to go. Fees and commissions paid are often unjustified and hurt portfolio performance with no real abnormal returns over the market.

Index funds are cheap in fees, are simple to follow I believe serve best the needs of household investors.

#2 Dollar cost averaging is a good way to gradually increase exposure
Uncertainty rules the markets, especially today. I would be very nervous had I invested my entire savings in one period. The market is still very fickle and dangerous. Naturally the risk – return equations dictates that averaging investments over time will yield lower returns, and it does, but it is important for sleeping at night.

Dollar cost averaging enables me to remain content even when markets correct themselves downwards. I'll just buy more, cheaply. When markets are bullish again I'll profit on the average investment.

I believe the outlines I've described to be the optimal solution for independent household investors under the current market conditions. I am not recommending anything to anyone. I'm simply describing my strategy as I've promised to do in the past.

I would not like to expose the size of my investments but rather the portion. I've invested 10% of my portfolio in stocks (US Index) and will continue to do so on a monthly basis.

I will update my readers on how my portfolio progresses. By next week I will hopefully have finalized my planned asset allocation and will share it as well.

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Stress Tests and Capital Adequacy Explained

noreply@blogger.com (Dorian Wales) — Sat, 25 Apr 2009 10:07:00 +0000

The highly anticipated FED stress test results may very well serve as fuel for further gains or, more likely in my opinion, as a sought after excuse for turning the tide (in the short run).

The idea of stress testing is an intuitive one. You test something to determine whether or not it is able to withstand various types of shocks without falling apart. The recent financial crisis has brought the issue of stress testing of financial institutions, predominantly banks, closer to the public eye but what really lies behind these stress tests?

The notion of capital adequacy

Banks and other financial institutions are, in their basic form, mediators of money accepting deposits from the public on one hand and issuing credit on the other. Banks earn, again very basically, from a financial spread between the interest rate of credit issued to that paid on deposits accepted. As any other corporation the net of a bank's asset and liabilities is the bank's capital.

This capital plays a very significant role in assuring the soundness and viability of a bank as it can be perceived as a cushion, of sorts, which absorbs various losses the bank may have due to the risks involved in its operations.

Regretfully, I don't have to explain the importance the soundness and viability of the banking system has in any economy. Therefore, the capital held by banks is highly regulated by the government.

Any company, when bankrupt, may cause heavy losses to its close economic environment. But the companies that were in business with the bankrupt company had, or should have had the ability to manage the risks in doing business with that particular company and were compensated for that risks by profits generated through that business.

When a bank goes bankrupt the general public, which had trusted the bank to be conservative enough to keep the deposit side intact, suffers. The public has very little in the way of tools to ensure and manage the risks in their dealings with banks (other than carefully choosing our bank).

Capital adequacy in banks is therefore highly important and closely monitored. A bank should have, in essence, adequate capital to cover the risks it incurs in its lending and financing operations.

Risks are abundant in banks and include mainly the credit risk incurred in lending activities of not being repaid by the lender but also significant market risks due to the financial nature of the business and significant operational risks due to the complexity of banks' operations.
Banks are also exposed to many other risks such as legal risks, liquidity risk, business risk, reputational risk and endless others.

How is capital adequacy regulated?

In order to regulate capital adequacy very detailed requirements of how a bank should handle its capital are issued by regulators everywhere. The most famous of these regulations are the Basel regulations published by the Basel committee of the Bank for International Settlements (BIS) which is an international organization that promotes international cooperation in monetary and financial issues and which central banks turn to for regulatory guidance and insight.

The regulation regarding capital adequacy issued by the BIS are known as Basel I and Basel II and contain detailed requirements and guidance on capital adequacy.

Essentially, this guidance break down the bank's off and on balance sheet items and translates these items into what are known as Risk Weighted Assets (RWA) where each asset receives a certain weighting dependant on the risk associated with it.

For example, a US government bond will receive a negligible risk weight while credit issued to a non-ranked company will be weighted as 100% risky asset. These risk weighted assets are than summed to receive the total risk weighted assets of the bank and are translated into a capital requirement accordingly.

The regulation is very detailed and includes requirements both on the risk weighted asset side and the capital side. Banks cannot recognize, for example, any sort of capital as regulatory capital for the purpose of demonstrating capital adequacy.

Banks are expected to have capital buffers which are excess capital a bank holds, over the regulatory requirements, to withstand unexpected risks and scenarios.

The problem, as we've experienced, begins when banks get involved in business that has not yet received proper regulatory treatment. This issue will always be an open issue as regulators usually react to market developments, thus always lagging behind.

For the purpose of calculating capital adequacy a detailed and common segmentation of business is published and regulated by the regulator. When something does not fit the mold it usually receives a treatment that is not necessarily appropriate or no treatment at all.

This is how financial crisis spring to life.

What are stress tests?

Stress tests are tests performed by banks and regulators to examine the capital adequacy of a bank under various stressed scenarios which may present difficulties for the bank's business. The goal of the stress test is to examine whether a bank has sufficient capital buffers to withstand the impact certain economic and business scenarios may have on it.

Stress tests are conducted by banks on a routine basis to make sure they can adequately handle adverse changes in their business and positions in the market and withstand any reasonable impact unexpected materializations of risks may have.

The results of stress tests serve banks in determining the capital buffer they should hold, as a function of the banks conservatism and regulatory environment.

Most regulators have published specific generic scenarios banks should use for stress testing their capital adequacy. These include adverse market conditions, usually in the form of combinations of historic worse case macro-economic parameters. This, however, is not enough.
Banks must adopt stress tests which specifically target the weakest points in the bank's strategy and balance sheet to ensure the viability of the bank's business in more turbulent times.

For example, in a utopian world banks that issues complex financial instruments would have considered the ramifications a liquidity problem may cause thus limiting this once very profitable business. Alas, we are not living in a utopian world and banks went bankrupt for all intents and purposes only to be bailed out by the government.

The BIS (Basel Committee) has recently published the Principles for sound stress testing practices and supervision (after the crisis had stuck, naturally). According to these principles stress tests play a role in:

providing forward-looking assessments of risk;
overcoming limitations of models and historical data;
supporting internal and external communication;
feeding into capital and liquidity planning procedures;
informing the setting of a banks’ risk tolerance; and
facilitating the development of risk mitigation or contingency plans across a range of stressed conditions.

Stress tests are a very important tool for risk management in banks and serve many aspects of it as demonstrated above.

The Supervisory Capital Assessment Program - The Fed's stress tests

The FED has conducted stress tests in the biggest banks in the US to determine their capital adequacy and the adequacy of their capital buffers under the current crisis. The NY times had published the guidance on How to Design and Conduct a Bank Stress Test as released by the FED.

The results are highly expected in the market and will be published in May, 4. So far the Fed had hardly commented on the results of the tests conducted.
The scenarios examined include changes in Real GDP, unemployment rate and housing prices.

Black Swans – The problem with stress tests

Conducting stress tests is very much like preparing future wars based on the experience gathered in past wars. Future wars will always be different and scenarios will always be surprising.

There are two basic types of stress tests: Historically based stress tests which are essentially worst case scenarios and User defined stress tests which are more fitted to each bank but are usually limited to the imagination of banks and, again, their experience.

The black swan theory, which has gained increased popularity in the recent crisis, targets the key weakness of stress tests. The black swan theory argues, in this context, that models cannot capture hard to predict, large scale and rare events which are exactly the events that shape our world and our financial markets (like the recent crisis).

Model must assume certain distributions and assumptions and will always miss on something. Usually the even they were built to capture.

Awaiting the results

The stock market anxiously awaits the results of stress tests and their impact on the capital of the largest banks in the US. It is important to note that failing a stress test does not mean the bank is bankrupt, or in trouble. It is a measure of how prepared banks are to handle adverse economic situations.

I believe the results will be highly ambiguous and will be taken by the markets depending on sentiment. If market plays want to sell the results will be interpreted as terrible and if a continuation of the recent rally is in order that the results will be surprisingly good.

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On Causality and Correlation in Economics

noreply@blogger.com (Dorian Wales) — Sat, 18 Apr 2009 11:46:00 +0000

Causality is perhaps the most fundamental element of empirical evidence available to economists. However, it is also the source of many misconceptions due to its elusive nature.

There are some things we take for granted. The relationship between cause and effect is so deeply rooted in us we sometimes forget they are merely a result of a clever induction made through observation on the repetitive nature of the two.

Causality is a fundamental corner stone to any empirical science. In economics causality is the basis for models and theories observed ranging from basic supply and demand curves to the most sophisticated economic models around.

The social science of Economics is more formal than other social sciences in the sense it includes theoretical models which are not directly dependent on correlations but rather on assumptions of maximization of utility at their basis. Nevertheless, at the end, utility maximization and its behavioral associations are bound to end include causality as a central assumptions of the coherency of nature.

More intricate relationships between various economic indicators such as interest rates, inflation, expectations, government spending, private consumption and many others are based on observations on different correlations between these parameters over time.

The problem of induction

David Hume is a famous Scottish philosopher known for its strict empiricism (A theory in philosophy which asserts all knowledge arises from experience rather than innate ideas and reason). The following may clear up this issue of the sources of knowledge a bit more.

David Hume, being the strict empiricist that he was, pointed out the problem with the logical problem embedded within the inductions we make based on experience. To put it simply, any attempt at proving our inductions to be correct will ultimately be based on induction itself and therefore cannot be constituted a logical reasoning. The argument would look something like:

Every time I've dropped an object it fell to the ground
Hidden statement: Nature is coherent/consistent or "that which has been is that which will be".
Therefore, when dropped, all objects fall to the ground.

To justify my hidden statement I must turn to the same statement assuming that if nature has been consistent so far it will continue to be.

In Hume's eyes there is no logical justification to assume the sun will rise tomorrow simply because it had done so in the past.

Needless to say induction is crucial to science and the problem of induction presented by Hume has received great attention from philosophers ever since. Karl Popper, a famous philosopher of science (among others) suggested a clever way out of this problem by stating science will advance through efforts of disproving existing theories thus strengthening the correct ones and correcting the false ones. For example, the argument that all swans are white is correct until a black swan will be spotted.

Causality and Correlation

David Hume also took a swing at Causality or Causation following his treatment of induction. Hume stays committed to his reasoning all the way to the skeptic conclusion which is unavoidable according to which causality as a concept has no meaning as we cannot conceive the connection between cause and effect in any means available to us (I will explain shortly).

"…It appears that, in single instances of the operation of bodies, we never can, by our utmost scrutiny, discover anything but one event following another, without being able to comprehend any force or power by which the cause operates, or any connection between it and its supposed effect… All events seem entirely loose and separate. One event follows another; but we never can observe any tie between them. They seemed conjoined, but never connected. And as we can have no idea of anything which never appeared to our outward sense or inward sentiment, the necessary conclusion seems to be that we have no idea of connections or force at all, and that these words are absolutely without meaning, when employed either in philosophical reasoning or common life".

Trying to explain cause and effect in terms of experience is bound to lead us to Hume's reasoning. The connection between cause and effect can be described as either proximity in time, proximity in space, an obligatory connection or any combination of these. Still there will always be examples of events which answer to all these criteria and are not cause and effect. Hume gives us the example of the rooster that believes he bring out the sun with his cry every morning.

In order to lead our lives we all assume causality exists and will hopefully continue to govern our structured world. Many false theories however, are the result of assuming causality where only correlation exists. In economics and other social sciences the risk of erring in this way are very significant.

From the explanation above and the rooster example the difference between correlation and causality should be clear by now. The fact two phenomenon display certain similarities in their behavior, either in time, space or a connection does not mean they are, indeed, cause and effect. They may be simply correlated.

Correlation

Correlation is an important statistical figure which indicates the strength and direction of a relationship between two phenomenon or variables. For example, the price of wheat and bread are correlated. Putting the philosophical discussion aside, we believe these prices are correlated because the price of wheat serves as a cause for the price of bread. However, the prices of bread may be correlated with the daily yield on the Iranian government bond. There is no justification to assume causality here.

No less dangerous is assuming, perhaps, that the prices of bread influence the price of wheat. Getting the direction of the correlation wrong is a very easy mistake. Especially when we are researching variables we don't know much about.

Rudi Giuliani's fight against crime

A good example of the problems with assuming causality and using correlation is that of the significant decrease in crime in New York in the 1990's. The crime rate in New York had dropped significantly seemingly due to Mayor Giuliani's strict zero tolerance policy and the "broken window" thesis.

Researches today argue as to the real cause behind the decrease in crime rates in 1990's NY. Apparently some researches today claim Giuliani's success had merely been coincidental and that crime rates all over the country were dropping due to the economic growth in the 1990's and the decrease in the relative share of certain age-groups in the population. Several cities across the US have shown even more dramatic decrease in crime rates whit out Giuliani's fight against crime.

In their fascinating book Freakonomics (which is a must for any economics enthusiast) Steven Levitt and Stephen Dubner are presenting a very unconventional approach to economics and have presented a theory correlating legalization of abortions in America with the famous decrease in crime presented above. According to Levitt and Dubner the legalization of abortions has led to fewer unwanted births and to a decrease of the number of youths in the population exactly in the 1990's which in turn led to less crime and Giuliani's credit for the fight.
Although I agree with Giuliani's "broken window" thesis there is no real way to know what the cause behind the effect was.

This example serves to show how difficult and confusing it can be to prove causality between two variables and to incorporate that into any successful theory.

Conclusion

As always, all theories, especially when it comes to the social sciences need to be taken with a grain, or a whole bag, of salt. Adopting a skeptic attitude towards surprising findings will quickly sharpen your instincts and ability to tell reasonable from fantasy.

Understanding the problems with induction and causality and also the difference between correlation and causality is, perhaps, one of the most important aspects in leading a rational life. It will also help you quickly turn the page on that recent study which shows the amazing relationship between children who ate peanut butter sandwiches and their success in business later in life.

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Challenging Happiness – Exploring the Irony of Human Nature

noreply@blogger.com (Dorian Wales) — Wed, 15 Apr 2009 16:30:00 +0000

The irony of human nature - anxiety for those that have everything and depression for those that have nothing

The human state of mind has been cleverly characterized by someone to be either anxiety or depression. It seems that either you have attained what you desire and you are constantly afraid of losing it or you haven't and therefore you are depressed.

I've read this rather bleak outlook on life yesterday along with another I'd like to share.
It seems that many successful individuals, who are and had "lived their dream", are frustrated and unhappy, even more, perhaps more than the rest of us, common folk, if I may generalize. There is no shortage of examples of successful people who were not able to cope with success and had cracked under it.

Still, I'd like to avoid the course of cliché or the common argument true happiness exists only in the more "noble" things in life like reason, religion, art, love or anything else that comes to mind.
Rather I'd like to question the idea of happiness in itself and hopefully draw some conclusions in the end.

Is there happiness to be had?

Philosophers of language enjoy dissecting words and meanings and happiness is defiantly one of the most interesting concepts we have.

To put is in very simple terms – Is there happiness to be had at all? Couldn't happiness be just a concept embedded in our language misleading us all?

The question of meaning is deep and challenging. Concepts such as happiness, along with truth, god, soul, mind and others are under constant scrutiny. The idea in itself is simple and powerful – The fact a word exists does not deduce any sort of meaning what so ever.

I think we can all agree, empirically speaking, that happiness is not an enduring state of mind but rather comprised of moments. We sometimes feel happiness surging through us but that may well be the effect of our body chemistry. This notion of experienced utility has been discussed and researched by Noble Laureate Daniel Kahneman which argued happiness is the subjective feeling in each moment defined, in turn, as the minimum range of time a person is self-aware of his or her feeling. Readers of The Personal Financier know I'm very fond of his work on psychology and economics.

Hollywood has probably contributed to the western notion of happiness more than any other influence by putting happiness into terms of family, love, success, money, power, freedom etc.
In fact, the state of happiness in individuals, or the capability to be happy, as we relate to it, is considered to be more than 50% genetic in its source. This simply means not all of us were cut out to be happy.

Happiness and worldly possessions

The notion material achievements do no lead to happiness, as demonstrated, with some humor, in the anxiety-depression paradigm is very deeply rooted in human civilization.

The bible, philosophers and modern day cliché coachers have all discussed the inability of worldly possessions to make us happy. While the latter maybe selling something the former have genuinely tried to demonstrate the way to a happier existence.

Contemporary theories reinforce earlier views according to which money, as the essence of worldly possessions has a much lower contribution to happiness that is usually attributed.

The reason, as modern psychologists have demonstrated in empirical experiments, is not that money isn't important. Money plays a significant role, but only up to a certain minimum point. After the point basic needs have been fulfilled it's how much money one has in comparison with others that matters most. People have demonstrated destructive behavior in experiments where one was willing to lose 25% of his or her capital to "destroy" 50% of another's.

Career is very much the same. We measure ourselves on the social scale. How can one be happy when there's always someone younger and ahead?

Frustration – The irony of the human psyche

Our frustration ironically increases when we achieve our dreams and goals. Suddenly the gap in expectations explodes in our faces and we are overwhelmed by the emptiness of the peak.

More often than not our expectations are much grander than reality. Imagine your last vacation, for example, to a beautiful destination. Did its beauty surpass your expectations? It does sometimes, but usually reality has its surprises in store for us.

The irony of human nature and our psyche is apparent. We were programmed, either by God or evolution (take your pick) to constantly seek out new challenges and new goals. We are quickly accustomed to any situation that is, at the moment, our current situation and we always believe happiness is right around the corner.

By constantly striving we (arguably) better ourselves but fail, again and again, to find peace of mind and the sought after happiness.

Conclusions

Well, it seems that if you are lucky genetics has already assured you 50% chance at happiness. The rest of us may have to work a bit harder.

My personal belief is that being aware of our psychological "deficiencies" is one of the better ways to tackle the issue of happiness. By acknowledging the elusive nature of happiness, the need to constantly set and conquer new goals and by learning to appreciate the more humble states of calmness, tranquility and long-term satisfaction we may find peace of mind and general well being.

My personal tendency is to agree with the philosophic arguments according to which reason is the source of long-term well being (I avoid using happiness). The little exercise I suggest here is exactly that. Gaining awareness and employing reason into understanding the elusive nature of happiness and our human limitations.

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The Recent Rally in Stock Prices is Nearly Over

noreply@blogger.com (Dorian Wales) — Sat, 11 Apr 2009 13:59:00 +0000

Stock markets around the world have surged by over 25% during March and April. I believe market players are already looking for a good excuse to start selling again…

During the past month we've witnessed an amazing good old rally in stock prices. The S&P jumped from its recent new low of 676 points to 856 points in a month's time (that's 26%).
A rally like this is typical to a stock market that has taken such severe blows. Unfortunately there is no way of timing it.

Those of us with decent short term memory surely remember a similar rally that took place during December and January 2009 where the S&P rose from its second recent low of 752 to 931 only to crash back to 676, as we know now. That was 23% rally by the way.

Obviously these rallies are impossible to time. Still, I'm sensing something in the air. The financial papers and headlines are usually good proxies for a change in atmosphere. I believe I detected a change in what had recently been a surge in optimism to more sinister financial news.

Recent Developments

To start things off several "financial gurus" have expressed their opinion on the recent rally in stock prices and have characterized it as a "bear market rally". Do not be tempted to believe these guys really know what they're talking about. I believe they don't know where the markets are headed any better than the rest of us. What do they know?

First and foremost we must remember these individuals and institutions hold certain positions in the market and these positions speak for themselves. I am most certainly not accusing anyone of fraud or deliberate misguidance. We just need to keep in mind the facts.

Second, they are probably aware of the influence of their opinion and use it wisely. Third and maybe most important these "predictions" also serve as a method of communicating between the different institutions and market players. Ironically reality is created through these predictions.

Here are some examples of opinions recently published:

The French Bank Societe General had defined the recent rally "a dash for trash" as the stocks that everyone was looking to sell only a month ago have shown price increases of over 60%.
American Investor Marc Faber had expressed his opinion according to which the markets will suffer another 10% drop before rising again.
Famous investor George Soros had stated the recent rally is a bear market rally as the American economy is still struggling with a difficult recession. Furthermore the American banking industry is literally in a state of bankruptcy.
Morgan Stanley analysts have predicted the market is still bearish as corporate profits, housing prices and bank balance sheets have yet to recover adequately.

Bad financial news plays a significant role in setting the course of the markets in either direction. Surprisingly, or not, financial news tends to side with the opinions of leading market players and financial institutions. The following is a collection of the news gathered over the weekend so far:

Goldman Sachs is expected to issue $10 Billion in stocks next week in order to repay government aid funds. From a first glance this seems like good news. The problem is what happens with other financial institutions that are yet unable to repay the government? What does this say about their financial condition? Several articles have taken this tone in reporting about Goldman Sachs' intention.
The Fed and Federal government have asked banks to avoid publishing stress test results and wait for the formal report to be submitted by the government. Such news could be considered ordinary as well but have been speculated upon fearing that several banks may not have enough capital to withstand their stress tests.
The budget deficit of the US has soared in the last six months to unfathomable highs amounting to $956.8 Billion. Apparently this deficit has only been equaled by that of the Second World War.
Two more banks in the US have collapsed. This brings the total of collapsed banks to 23 in 2009 vs. 25 in 2008.

What does this have to do with the long term?

All of these circumstantial evidence points, in my humble opinion only, to the upcoming end of the current rally in favor of a cooler period. Hopefully we won't witness any further sharp declines in stock prices and this might be a good time for me to re-enter the markets after a long period of waiting. I'm guilty of timing the markets, I know. It's simply irresistible.

We must remember that every period of one way movement in the markets is often corrected by an opposing period, however short, which represents capitalization of profits and "taking air" before conquering new highs.

These are only a handful of opinions regarding the state of the markets. We must keep in mind that the stock market, in theory, doesn't care much about the balance sheets of the upcoming quarter but rather what these represent in the long term.

Soon enough the tide will turn and someone will decide we've had enough. Stock prices will rise expecting the economy to recover and the economy will recover because stock prices are rising in a beautiful, ironic circle of forged reality. The markets are all about expectations. That is why they are unexpected and unforeseeable.

It's a Boy!

noreply@blogger.com (Dorian Wales) — Sat, 04 Apr 2009 11:43:00 +0000

Dear readers,

I'm happy to announce that over the weekend I've become a father. We are DINKS no more. I promise not to have too many "expensive baby stuff" sort of posts.

Back to the hospital then...

Stock Surges Are Usually Unexpected – How To Make Sure You Won't Miss Out

noreply@blogger.com (Dorian Wales) — Sat, 28 Mar 2009 13:18:00 +0000

Historical market data explains why many investors, including myself, missed on the recent surge in stock prices

Since my last post the markets have astonishingly recovered over 20%. A couple of press releases by Citi and Bank of America were enough to send the financial sector sky rocketing with these two banking giants doubling their stock prices.

After witnessing such extreme movements up in stock prices I often try to review my thought and decision making process, or to put it in simpler terms, try to figure out why on earth I wasn't a part of the party?

Two weeks ago it seemed like the biggest retail banks in the US may well be on their way to nationalization. The state of the economy seemed poorer than ever and no hope was in sight. The S&P500 stood at 676 and there were no indications something is about to change.
Still, it is the nature of the markets to be cyclical and what goes down usually comes up. Even in these difficult days we've seen the markets go up by as much as 10% a day only to come crushing down again.

It can be quite frustrating to have your predictions and instincts be proved right on the market while you didn't actually have enough confidence to carry them out. Still, short term trading, whether it is performed on an hourly, daily, monthly or even longer time periods is very risky.
Catching the market at its very low is an impossible mission. No one is able to constantly identify the turning point in the markets while strangely enough many think they can. The legendary Warren Buffet had recently reinvested significantly into the market saying he is almost certain we've got a way to go before the markets turn but he is experienced enough to know that he can't time the market.

A look at the data

As readers of The Personal Financier are surely aware by know psychology plays many tricks on investors.

The human mind is not very good in handling large amounts of data over a historical period. We cannot conclude with success from market data we've heard or read through over a period of time.

Just imagine how many times you've heard of price shifts of a certain stock over a week's period, for example. Most of the time you'll be more than certain that stock's price has risen considerably while it actually didn't gain as much as you'd expect. The reason is we more attuned to positive news on stock than negative and we naturally remember and cling to up movements in prices rather than down movements.

The same phenomenon exists in long term trading. Raw data proves there are only a handful of days in which stocks actually gain or lose significantly. These, therefore, cannot be timed and identified in advance.

There were approximately 4,559 trading days between January 1st 1990 and February 2nd 2008. Only 51 of these days yielded a price change of over 5% in the Nasdaq, and a mere 8 days in the S&P. Maybe 5% is too much to ask for? If we suffice with 3% the numbers change to 238 days for the Nasdaq's and 59 days for the S&P.

What are our chances of catching such days? Very basic statistics quickly determines we have a 1.1% chance of catching a 5% price shift and 5.2% chance of catching a 3% price shift in the Nasdaq. The S&P's statistics are even "worse" 0.2% chance of a 5% price shift and 1.3% chance of a 3% price shift.

The long tail or 80/20 principle work here as well. The numbers are a little different but the principle remains. The majority of days will end in price shifts of fewer than 1% or 1%-3%. That is the long tail of trading days or the "80%".

Smart investing

In order to really capitalize on short term market gains, as the one we had only recently witnessed one must be constantly present in the market. Adjusting portfolio exposure to stock and other financial instruments slowly and gradually is the right way to work.
Sure, you'll experience the short term losses as well but the working assumption is that on average the gain is higher than the loss.

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