Slow Fortune - Getting wealthy together.

Revolving Debt

Jordan — Sun, 13 Jul 2008 17:03:36 -0700

If you have a credit card, you may have noticed that the required minimum payment increases or decreases as the balance that you owe increases or decreases. This is called revolving debt. If you are using your card, running up a balance, and paying only the minimums each month, you probably curse this state of affairs. If you are attempting to pay off a credit card and not accruing more charges, you might think this is a bonus. As long as you work hard to pay down the card, slowly but surely your minimum payments will go down, leaving you more money at the end of the month. Lowering your monthly bills is always a good thing, right? Wrong.

The trade off for your temporary lighter load of bills costs you a lot more money in the long run. Credit card companies love to make money off of your interest payments as you pay them back for the money they so willing loaned to you. This is why they change the minimum payments as your balance goes down. They know that this is a surefire strategy to keep you in debt longer, and paying much more in interest charges. What is your solution to outsmart those crafty credit cards? If you can make your minimum monthly payment each month, why change it? Keep chugging away at the same rate, even when your minimum due is a little less. You will save yourself all kinds of money on interest payments, not to mention dig yourself out of debt much faster.

Ben Graham Valuation Spreadsheet for Value Investing

Jordan — Thu, 05 Jun 2008 02:52:10 -0700

If you read this blog, you know I am a huge fan of both Warren Buffet and Ben Graham (author of 'The Intelligent Investor', the bible of sound investing).

One of the concepts of value investing is the concept of a 'margin of safety' - or, to purchase at a price which provides a cushion of safety.

Brief Overview

Graham's formula is as follows:

Intrinsic Value = "normal" earnings x (8.5 + (2 x expected 5 yr growth)) x (4.4/20yr AA corp bond)

Sound confusing?

Then don't worry. A smart guy over at Old School Value has created an Excel spreadsheet that will download all the necessary data for you, and perform the calculation. A double threat spreadsheet!

Download it here.

Currency 101 - Money for dummies

Mike — Tue, 20 May 2008 01:16:20 -0700

Money: Orgins

To understand money, its uses, origins and inception is incredibly important. Money is a means of exchange and a store of value. There is a demand for it but contrary to popular belief it is not the demand for money that gives it its value, rather the collective assets that the paper currency represents.

As usual, Wikipedia puts it best.

"The origin of currency is the creation of a circulating medium of exchange based on a unit of account which quickly becomes a store of value. Currency evolved from two basic innovations: the use of counters to assure that shipments arrived with the same goods that were shipped, and later with the use of silver ingots to represent stored value in the form of grain. Both of these developments had occurred by 2000 BC. Originally money was a form of receipting grain stored in temple granaries in ancient Egypt and Mesopotamia. "

Money is a byproduct of evolution, as we lived in increasingly interdependent societies means of exchange had to be developed in order to facilitate survival in “village” life. The first such means of exchange was barter.

Both parties would sit down and decide how much they were willing to trade of what they had for the product they needed, for instance:

"I'll give you three chickens for four sacks of grain"

This would also be the first example of what we know today as a modern day currency exchange rate. The rate between Chickens and Sacks of grain would be 3/4.

Coins were later developed and stamped as some of the first types of “hard” currency. This is a good place to start the illustration of how money is a store of value. Since precious metals have intrinsic value: Rare, Shiney, Malleable, High refining and mining costs. They were convenient as a means of exchang; a small amount of gold would be worth quite a bit in real terms, people could simply carry around a sack of coins rather than a wagon of grain to do their village shopping. Coins were weighed and stamped with images so people could easily recognize their value and transact their business efficiently.

Just like our money today, the first gold currency suffered from inflation, although in a way you might not expect. Criminals would "shave" the edges of coins such that you couldn't tell gold had been taken off. After several many coins shaved, a person would have a respectable pile of gold dust in addition to their stamped coins. Quantity theorists say that those shaved coins would be just as valuable as a means of exchange, however that turned out to be quite the opposite. When store owners weighed their coins and they found that they were much lighter than the stamps on the front would suggest.

Because of coin shaving, the gold currency was devalued and we see our first instance of currency inflation. In response to this problem, minters created coins with grooves on the sides, that way if someone was shaving the coins anyone could quickly tell because the grooves of the coins would be worn away leaving a smooth finish. The grooves on our quarters today are just for looks but at one time they served as an anti inflationary tool.

Currency, Fiat Money and Inflation

The best way to think of paper currency is in the form of an I. O. U. An exchange is when one party needs to trade something of value for something else of comparable value. The keyword here is value.

Money is given its worth by the real intrinsic value of the assets or claim to assets that the paper represents. Inflation only happens if the underlying assets that the printed currency represent do not move in step with the printing of the paper money.

Let us first make a personal example. Say you’re out at a restaurant with your friend Rich McMoney and its time to settle up the bill. To Rich’s horror, it appears that he has forgotten his wallet on his fifty foot yacht, right next to Faberge Eggs and pile of diamonds. In exchange for you paying for lunch,Rich sign’s and dates an I. O. U. saying he will pay you back his share of lunch, with interest, the next time you see him.

The next day you have lunch with your other friend: Deadbeat Dave. Now Dave is an honest man but he lives at a men’s shelter, has nothing to his name and barely scrapes by making a living at McDonalds. He too has forgotten his wallet and creates the same I. O. U. that Rich did the previous day.

What has happened in both cases is creation of currency. They have both given their word that they will pay back the sum owed, so hypothetically both pieces of paper should be worth the same amount, but you and I both know that they are not, for obvious reasons.

The piece of paper isn’t given any value by either mans word, rather it is only as good as the man’s ability to redeem it for the real assets he has. Since both you and Deadbeat Dave know there is no way he will be able to afford to pay you back in this millennia, the piece of paper he gave you is totally worthless.

However, since Rich is known as a man about town, you could very easily take the I. O. U. to another friend or a local pawn shop that knows Rich and redeem it for the amount owed. Since the pawnshop owner knows that Rich can easily repay the debt, his I. O. U. is as good as gold.

Back in the real world this example applies since paper currency has been in use. Intrinsically it’s worthless; hence its worth is derived from the issuer’s real assets backing it. Currency is made everyday: by Banks, The Government and stores like Canadian tire (i. e. Canadian Tire Dollars) and the GAP (i. e. Coupons, Gift Certificates, etc).

Every case of extreme inflation in history can be traced back to a lack of backing:from the Free Banking days of the early Americas, to the French Assignat, to the great inflation in Germany.

But how does the US government back it’s currency you ask? Well, for starters, the United States has the biggest gold reserves in the world, but this pales in comparison to its ability to tax the American people.

In short, the US dollar is given its worth from the hard work and industrious exploits of the American people.

Paper shillings in Massachusetts

“In 1690, the colony of Massachusetts faced a financial crisis. The colony had sent soldiers to raid the French, but the raid had failed. The colony had expected to defeat the French and pay the soldiers with the spoils of war, but instead they were faced with an empty treasury, and angry soldiers demanding their wages.

In desperation, the colony decided to pay the soldiers with paper IOU’s. For example, the colony would print “1 shilling” on a piece of paper, and pay it to a soldier. To encourage the paper shillings to circulate at par with silver shilling coins, the legislature declared that paper shillings would be acceptable for taxes just as silver shillings were. To a colonist, this meant that if he owed 1 silver shilling in taxes, he could pay his tax with a paper shilling instead. It might not seem like these paper shillings were backed, but they were backed by taxes. As long as the tax collector had the ability to take one silver shilling from a colonist, and as long as that same tax collector was willing to accept one paper shilling in place of a silver shilling, the paper shillings were backed just as surely as if the colony held a silver shilling against every paper shilling it issued. ”

- Michael Sproul

To understand properly how taxes back dollars one must first understand how a balance sheet works. Think of it like Newtons law:“ For every action there is an equal and opposite reaction. ”It works the same for your finances in the forms of assets and liabilities. If you have a credit card and make a thousand dollar purchase of creamed corn, your balance sheet would read 1000$ worth of sweet, sweet creamed corn under assets and 1000$ worth of credit card debt under liabilities. Any transaction on a balance sheet must match.

Now as you can imagine life doesn’t always fall into neat piles of assets and liabilities – what if you just have a bunch of cash lying around?For the purpose of neatness on the balance sheet extra liquid assets are balanced in the liabilities column by counting them as owners equity. This won’t make sense unless you have taken a finance class, so just take my word for it.

Below, lets say is the balance sheet of the federal reserve and its interactions with Farmer John and some pissed off soldiers. The USD is currently valued at 1oz of Gold to 1 USD.

Assets

Liabilities

10,000 OZ of Gold

10,000USD Issued by FED

Exchange Rate:1/1

Now say everyone is happy in the economy, but some soldiers come back from far, far away land and they expect to be paid for their services. Now since the FED has no cash reserves to spare, it cannot readily pay their soldiers their wages of 5000 USD. If the government didn’t have the means to tax its citizens, they would be forced to print 5000 USD in order to pay their wages.

In this case the assets did not move in step with the liabilities of the FED as an issuer and in turn the each of the 15,000 issued dollars only have 10,000 worth of gold laying claim to them. Although everything balances, we see inflation.

Assets

Liabilities

10,000 OZ of Gold

10,000USD Issued by FED

-5000 Wages Payable

+5000 USD Issued by FED

Exchange Rate:. 66/1

However, the government does have the ability to tax its citizens, for neatness sake we will say that they fall due to the tune of 5000 USD. At present, the dollar is still valued as 1/1. Remember taxes are not taken in terms of number of USD per year, but in percentage of earnings. The government taxes a percentage of the intrinsic value of their citizen’s hard work as the price they pay for being a citizen. Because of this, taxes can be listed as a real world asset with intrinsic value.

Assets

Liabilities

10,000 OZ of Gold

5,000 Taxes Due

10,000USD Issued by FED

5,000 USD Issued by Fed

-5,000 USD Wages Payable

Exchange Rate:1/1

Assets move in step with liabilities and the dollar remains at a 1/1 exchange rate. This is what happens every day but on a macro scale and infinitely more convoluted -- however, now you at least have a rudimentary understanding of how paper money is given its value.

6 Investing Books for the Beginner Investor

Jordan — Mon, 05 May 2008 15:55:34 -0700

Credit Suisse lost billions of dollars last week. I don't think those millions of dollars would have been lost if they used their education instead of two of the seven sins (e.g. Greed, Sloth). 'Don't invest in something you don't understand' clearly was thrown out the window by oh-so-many banks around the world.

Education about investing is very important because it allows you to build a framework of knowledge from which you can utilise to drive your investment decision making.

As investors, it is our responsbility to be aware of the risks, potential rewards, implications, and costs of all of our decisions.

The good news is you don't need to go to business school to aquire this knowledge. The Internet and the Bookstore are your friends and with a small investment of your time and effort, you can get educated fast.

Morningstar, one of my favourite resources for all things educational, recently published an article entitled 'A Beginning Investor's Reading List'. It is a great summary of books that really capture the essence of what we are trying to do here at Slow Fortune. This article really excited me because I had not read four out of six, and I am eager to read them.

The Only Investment Guide You'll Ever Need
by Andrew Tobias

Buffett: The Making of an American Capitalist
by Roger Lowenstein

The Bogleheads' Guide to Investing
by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf

A Random Walk Down Wall Street
by Burton G. Malkiel

Stocks for the Long Run
by Jeremy Siegel

All About Asset Allocation
by Richard A. Ferri

Two great tips for examining managed funds

Jordan — Wed, 30 Apr 2008 04:52:06 -0700

Managed funds, are mutual funds or exchanged traded funds that are managed by professionals.

On the whole, index funds are much cheaper (i.e. lower management fees) than professionally managed funds. However, managed funds can be utilised so make up a smaller component of your overall portfolio (This is called the 'Funny Money' section of my portfolio)

One interesting piece of research on managed funds was presented by John C. Bogle in “The Relentless Rules of Humble Arithmetic,” in the Financial Analyst Journal,
November/December 2005.

Two charts he presented in the article struck me as really insightful and offer some guidance in selecting a managed fund.

The more funds a company offers, the lower the returns

Funds from private companies perform better than Financial Conglomorates and Publically Traded companies

Suck down this data with a grain of salt. Correlation does not always imply causation.

This provides you with another two additional perspectives, in which you can use to analyze a managed fund and whether or not to invest. However, you will also need to do the standard due dilligence by reading the fund prospectus, background checking the fund manager, considering tax implications and many other factors.

Interesting stuff.

I can haz bailout? is hilarious

Jordan — Fri, 18 Apr 2008 02:13:10 -0700

Anyone who is anyone on the internets knows about lolcats and icanhascheezburger.com.

But combining hilarous kitten speak with commentary on the credit crunch and financial markets? Now that is funny (and creative).

Laugh more at http://icanhazbailout.com/

Short Termism and the Struggle of the Long Term Investor

Jordan — Thu, 17 Apr 2008 16:02:18 -0700

Wall Street has a tendency to overemphasize short-term benefits at the expense of long-term benefits . . . There is a reward given to pursue short-term actions that provide a short-term benefit at the expense of long-term value to your company.

- Doug Geoga, Hyatt Hotels

I am a long term investor, but I find myself living in a short-term world. The stock market feels more like my manic ex-girlfriend: Always moody, always demanding performance, and totally unpredictable (Oh, and she took my money away too).

A few years ago, I came across a timeless article published by Legg Mason Capital Management. Frankly, I don't know anything about them other than the fact that they write damn good thought leadership articles. I would like to share it with you.

The article, "How Psychology and Incentives Shape the Investment Industry", was published in May 2006 by Michael J. Mauboussin and does a great job of explaining exactly why the market is so similar to my ex-girlfriend in the short term.

Mauboussin introduces the concept of Short Termism, which he defines as 'a heavy focus on short-term results'. It is not hard to think of examples of Short Termism when looking at the Markets (e.g. Investors dumping or buying up shares on earnings announcements, Day Traders, etc). Mauboussin continues to describe the causes of Short Termism as a consequence of Incentives (i.e. CEO Pay is More Tied to the Stock Price than Ever Before), Psychology (i.e. Human stress and fear response), Information (i.e. Media and Wallstreet are paid to generate information), and Rate of Change (i.e. The apparent acceleration of the rate of change for businesses creates a final source of shorter time horizons).

Short Term Sucks

Why do we care? Short term thinking sucks for a number of reasons:

Short term thinking results in more trading, which cost you more money and kills your portfolio returns. It is irrelevant that activity (i.e. trading) is cheaper than ever before.
Short term predictions are based on limited data and are inherently more risky. We humans are natural patterns seekers, and "have a well-documented tendency to believe that a small series of numbers, or results, reflect the larger series." Psychologists have shown how this belief leads to suboptimal decisions (E.g. many investors buy high and sell low)
For Executives of publically traded companies, decisions to make short-term targets at the expense of a business’s long-term competitive position can inflict irreversible damage. Companies "fixate more on short-term EPS, often to the detriment of long-term value, and some investment managers prioritize asset gathering over investment results"

There is Hope

But hold the phone kids. Mike Mauboussin is a glass half full kind of guy, and indicates that "Individuals who can, under the proper conditions, think and act with a long-term perspective stand to benefit from the short-term focus of others." However, he warns to not mix strategies by attempting to deliver superior long-term returns with strategies and behaviors rooted in short termism.

His big method for this is Time Arbitrage.

Scary name right? I know. But seriously, it is pretty simple stuff. Mauboussin uses the example of a coin toss to explain this. Check it: Mauboussin describes a coin toss where after 20 tosses, heads came up 35% of the time. That is the short term results. If you keep tossing the coin over and over, eventually you will get closer and closer to 50% chance of heads (or tails for that matter). Mauboussin's point is that the shorter the time horizon, the more 'noise' (volatility) you get which can deviate from the real long-term signal (Which is 50% in the case of the coin toss).

Time Arbitrage simply means that most investors (i.e. Bankers, individuals, and fund managers) tend to suffer from short termism, and therefore have high turnover or are trying to exploit very short-term anomalies in the stock market.

To summarize, Mauboussin is just stating that Time Arbitrage enables Value Investing (i.e. Buying good stocks at cheap prices).

Forget What You Know About The Quantity Theory of Money

Mike — Sun, 13 Apr 2008 12:40:13 -0700

I'm sure when people imagine the professional world of economics, they envision stout white men with male pattern baldness, sitting in a room jabbering about the Nikkei and suppressing the proletariat.

In actuality, it's more like a grown up version of the real world - cliques, disses and hookups are more common than people think. Like Coral was the real world roommate you love to hate, the "Real Bills Doctrine", the theory about the value of money and the cause of real inflation has been the whipping boy of the economics world for years.

Henry Thornton (1801), David Ricardo (1810) and Lloyd Mints (1945), espousers of the widely accepted "Quantity Theory of Money" and critics of the Real Bills Doctrine are the cast members that will stop at nothing to drive their pariah housemate into economic obscurity. However T.R.B.D. has the advantage of logic on its side.

For those who don't know, the Quantity Theory of money says that Currency as we know it only has value as a means of exchange and when you boil it down an American dollar is inherently worthless (See Fiat Money). Hence any creation of money, no matter the circumstances is inflationary.

M x V = P x T

The equation above is the backbone of the Q-theory. It stands for the quantity of money in circulation, multiplied by the velocity (the number of transactions in which the currency is used) is equal to the nominal price level multiplied by the aggregate real value of goods and services used in exchanges.

This is a tautology tantamount to " the rain that falls from the sky is the rain that hits the ground." There is no causal link in this model between the creation of money and inflation, it is just assumed that any creation of money is inflationary.

The conceit in this is that the types of money used to calculate inflation (M1 and M2) are just a portion of the money that is created in North America every day. Credit cards, food stamps, coupons, IOU's and sometimes even specially designed store currencies(Canadian tire dollars anyone?) exist and are exchanged for goods of real value, yet we don't have a huge unexplained jump in inflation due to the creation and use of these currencies.

How can this be while the quantity theory of money holds true? According to the Q-theory all of this currency creation should be incredibly inflationary and yet to date it remains ignored. Where the Q-theory of money fails the Real Bills Doctrine picks up.

In a nutshell, the Real Bills Doctrine says: Money created in exchange for "Real Bills" is not inflationary. Or, to put it another way, if you were to go to the US Mint and say "here is 100USD worth of gold" and they printed you 100USD, the creation of this money would not be inflationary. Why? Because the creation of money moved in step with the amount of assets under lock and key.

So you see, money that is backed by assets has worth because of the real value of the underlying assets. Doesn't that make more sense than magic worthless money that is somehow valuable because unconsciously we all agree that it's useful? There is no such thing as Fiat money.

Inflation happens when the underlying assets are destroyed or devalued. If a crazy US Mint employee destroyed half of the gold you gave for your printed money, there would only be 50USD worth of gold laying claim to 100 US paper dollars, hence the purchasing power of the paper dollars would be halved. Isn't that simple?

I've attached the paper that brought me to this school of thinking and it explains T.R.B.D. much more elegantly than I can. Most convincing are the historical examples that Sproul draws upon. I assure you if you read and digest it, it becomes very difficult not to see the logic staring you in the face.

http://129.3.20.41/eps/mac/papers/9711/9711001.html

Why does it take a 'recession' for people to start getting smart about personal finance?

Jordan — Tue, 25 Mar 2008 16:23:48 -0700

The world is freaking out about the U.S. Recession. The doomsdayers and headline creators are leveraging the mass fear to gain a few extra clicks or newspapers (The linkbait reminds me of watching CNN).

I find it humorous that the The 'Wisdom' Journal website, posted a blog posting called 5 Ways I Plan To Survive The Recession. Don't get me wrong: The advice this blog offers is sound, and mirrors what I have been saying on this blog.

Here is the difference. The Wisdom Journal (and many other personal finance blogs) are giving the message that only in the face of a recession should one be concerned with eliminating debt, spending less than one earns, diversification and building an emergency fund.

All these actions are part of the 8 steps to build wealth slowly. If you follow them always, and not just in the face of a potential recession, then any economic jitters should worry you about as much as a hibernating bear.

Ups and downs. Boom and bust. This is the reality we live in, and you need to be prepared to survive in both by having good personal financial habits that don't change with the violitility of the econonmy or the market.

What the One Minute Manager taught me about Investing.

Jordan — Wed, 19 Mar 2008 02:25:12 -0700

The One Minute Manager is a book by Kenneth Blanchard and Spencer Johnson, which reveals three secrets to productive and efficient managing as told through a young man's search for the perfect managing and leading skills.

This great short read, which I recommend that everyone should read, helps people manage their managers (Manage up!), and anyone they supervise.

But what can the one minute manager teach us about investing and managing ourselves?

The first management secret in the book is One Minute Goals. This involves a meeting of the manager and the employee where goals are agreed on, written down in a brief statement, and occasionally reviewed to ensure that productivity is occurring.

Before starting to invest, it is important for you to set goals regarding what you are trying to accomplish, and then deriving actions from those goals. Take the time to actually write out your investing goals and investment strategy in a brief statement, and regularly audit yourself against your investing goals to ensure that you are adhering to them. Your actions need to be aligned to these goals.

The second secret to one minute managing is One Minute Praisings. This involves being open with people about their performance. When you catch someone doing something right, a goal of the one minute manager, you praise them immediately, telling them specifically what they did correctly.

While investing, try to catch yourself doing "something right". For example, if you execute a trade, but researched effectively and the action is in line with your goals -- then remind yourself that you did the right thing (Action based on knowledge and understanding of risk). Take a moment out of your day to give yourself a positive affirmation.

The third secret is the one minute reprimand. Being honest with those around you involves reprimanding when a wrong has occurred.

We are humans. We crave excitement. We have emotions. As such, investing mistakes occur. However, if you do make a mistake, take one minute to reflect on why the mistake occured. Inform yourself what you did wrong, what drove you to do it, and how you will update your goals to ensure it does not happen again. Furthermore, remind yourself that you are becoming a seasoned investor, and that this will only prevent you from making the same mistake in the future.

If you are in a position (I.e. you are still holdings the shares) make a action for them, based off of your goals.

As an entertaining real life example, let's say you drank one too many glasses of red wine one night and started to foolishly buy some Exchange Traded Funds (ETFs) on Margin (Loan). Leverage is not inline with your goals, although buying a balanced portfolio of index funds was. You reprimand yourself for the margin use, and establish a new goal that you can never trade while drinking ever again. You praise yourself for having good intentions -- after all, what you were trying to buy was in line with your one minute goals.