You know the grass is always greener on the other side of the fence because when you look at the lawn next door you’re getting a side view of one blade of grass next to and after another.  It’s just a sea of green.  But, when you look straight down at your own lawn you can only see the tips of each blade and ground all around.  When you jump the fence and look back across at your own lawn, you see that the grass suddenly appears much lusher and greener there than the grass now under foot.

Investors have a tendency to view investments in the same light.  They hop from one investment to another with better recent performance.  By the time they do so, they’ve missed most of the upside and start scouting all over again.  This pursuit of illusory returns handicaps most investors; but it creates profit potential for the peddlers of financial products.

Increasingly popular ETFs that invest in high-dividend-paying stocks offer a good example.  With interest rates scraping the very bottom of their potential these days, income hungry investors are peering over the fence at what appear lusher sources of interest and dividends.  Savvy marketers in the mutual fund industry have taken notice and begun hotly promoting funds that invest in companies who rather than plow their earnings back into their mature industries, pay them out to shareholders in the form of generous dividends.  

Stocks in these companies have done very well over the past several decades, because as interest rates on bonds and CDs have steadily declined, their stable dividends have become increasingly more attractive.  Additionally, because investors enjoy an unabated flow of income even when prices are depressed, these stocks have exhibited less downside risk than the market in general.   As they attracted more and more investors over the years, their prices rose.  Thus, owners of these stocks reaped the best of both worlds: superior income and capital appreciation.

So, while these wonderful investments are being promoted to an ever-increasing number of investors these days, let me share with you the other side to the story.  Suppose interest rates stopped declining at some point in the future.  Suppose they actually began to rise.  Then the yield on these stocks would become increasingly less attractive.  After a while, people who recently bought them through these ETFs might begin comparing their losses with the rising interest rates on the bonds and CDs on the other side of the fence.  Prices on their ETFs would begin to decline.   They’d be experiencing the worst of both worlds: inferior income and capital depreciation.  At some point, perhaps near a top in interest rates, they might tire of looking down at losses and leap over another fence into a new batch of ETFs that invest in… well, variable-rate bonds will have done well recently.

Now, what happens to the income on variable-rate bonds as interest rates begin to decline again?  The moral to this story?  Build high fences you can’t see through.  We have a name for these fences.  We call them “discipline.”

Our home more or less overlooks the Connecticut River.  When I say, “overlooks” I mean from a height of perhaps half a mile.  The last time the river flooded, I think it may have risen a dozen feet.  So, Jeanette and I were a little startled and somewhat perplexed to learn from one of our neighbors that they had purchased flood insurance on their home following Hurricane Irene’s visit (which, by the way, missed our neighborhood completely).

I have no idea what the price of flood insurance is for a home half a mile above the nearest body of water and atop a hill (no more chance of water running down to us from above than of it rising up from below).  Whatever the price for the additional peace of mind, it is too high.  It seems akin to the druggist selling sugar pills at the price of expensive real medicine.  You must charge the price for the placebo to be convincing, I suppose.

Isn’t it funny how extreme events, even those that are extremely rare, cause us to behave as if they were commonplace and apt to occur again in the not-too-distant future?  The financial crisis and consequent stock market collapse of 2008-09 was an example of just such an instance.  Most investors remain skittish about the stock market, fearing another once-in-a-lifetime crash, when what they should be worrying about is the other side of their portfolios.

Thirty years of declining interest rates and rising bond values seems to have instilled in most folks an unhealthy level of confident that their fixed-income investments still provide a safety net for their otherwise aggressively invested portfolios.  With interest rates clearly about as low as they can fall, most fixed-income investments offer practically zero upside and virtually unlimited downside.  Yet, folks keep buying them through mutual funds, annuities, and individual bonds.  

This is the precisely the sort of human nature that sabotages most individual investors and convinces us to buy insurance the way we buy mega-bucks tickets.  Odds of a payoff – pretty nearly zero unless you happen to be the insurance company or lottery sponsor.

Now, don’t panic.  Just make sure the kinds of fixed-income investments you have in your portfolio are relatively short in duration, indexed to inflation, carry variable rates, or are otherwise buttressed to withstand a prolonged rising tide.

It was not until my colleague Barry, here at the office and later my wife, Jeanette, complained about and explained their ailment that I discovered what all that hissing and buzzing I kept hearing really was.  I had been for years blissfully ignoring what I presumed to be the ballast in a nearby fluorescent lamp or some other electronic nuisance.  Now, suddenly, knowing it was all coming from inside my head and there was nothing that could be done for it, the tinnitus began driving me nuts. 

This experience and education has enabled me to much more easily recognize that the incessant buzz over the ‘fiscal cliff’ is nothing more than financial tinnitus.  We all know that at some point in time, taxes are going up and government spending is coming down.  It is either that or national bankruptcy, and even in bankruptcy spending is cut and new sources of revenue required. Our economy has thrived in periods of higher taxes and lower federal spending in the past.  It is not higher taxes or lower federal spending that is troubling business and the financial markets.  It is uncertainty.  Eventually we will have our certainty and the markets will be back to business as usual. 

Rather than quietly debating a compromise solution within the walls of Congress and the White House, an incessant  irritating chatter over a myriad of possible outcomes is being relentlessly emitted from televisions, radios, iPads, and smart phones.  Like a wobbling top about to lose momentum and balance, no one can know precisely when or where it will all settle.  If we knew, we could play the markets and get rich!   But, settle it will; and no matter what anyone speculates, the outcome is bound to be some combination of higher taxes and reduced spending.

The beauty, however, is that unlike the buzzing inside my head, financial tinnitus can be shut off with the press of a remote control, the swipe of a finger across an iPad or Smart Phone, and the button on my radio alarm clock.  Ah, there, that’s better.

Isaac battered portions of the southeastern United States last week. Neither the force of the storm or the locations to be impacted could be anticipated with precision; however estimates ranged from a Tropical Storm to a Category 2 hurricane with landfall somewhere between Miami and New Orleans. It would have been both impractical and imprudent to evacuate the entire southeast, so most folks simply took what precautions made sense and settled in for the duration.

The next big storm is predicted to make landfall within the next few months, and will be centered in the vicinity of Wall Street in New York City. Its breadth will likely impact the entire nation’s both economic and political landscape, with gale force winds primarily pounding the financial markets. What can we do to prepare?

As with Isaac, it would be both impractical and imprudent to act hastily by making dramatic changes to our financial plan or investment portfolio without knowing when, precisely where, or how destructive the storm might be. If our financial affairs and portfolios are built on solid foundations and we have effectively diversified our risks, then we have already made our appropriate preparations and can settle in for whatever comes. Ferociously volatile markets and political uncertainty are always every bit as unpleasant as the roar of pounding waves and howling winds. But, this storm too will pass and the sun will shine once more. We don’t want to be deep underground in a dark cave when the sun comes up.

Of course, if our financial affairs are in dishevel and our investment portfolio inadequately diversified and hedged against interest rate, inflation, currency and other risks… Well, there may still be time…and always hope for a last-minute lifeboat.

I just wanted to update you that the bill to transfer control of fee-only investment advisors like The Conservatory, introduced by Congressman Spencer Bachus and reported to you by me in an earlier email has been mercifully tabled by its sponsor.  As you will recall, the bill was an attempt by the retail brokerage wirehouses to squash the growing threat to their business model (which relies upon commissions, mark-ups, and hidden fees to extract their profits from often unsuspecting consumers) posed by fee-only advisors whose business model relies solely upon fully disclosed and transparent fees paid by their clients for objective and non-conflicted advice.  The bill would have transferred oversight of fee-only advisors from the U.S. Securities & Exchange Commission to the retail brokerages themselves through their self-regulatory organization, FINRA.

Many recipients of my earlier email contacted their representatives and voiced opposition to the anti-consumer bill, and I have no doubt but that had a favorable impact.  The war between the consumer and the retail brokerage industry has not been won, as they have considerable money and influence.  But, the beast has at least been effectively beaten back in this battle!  I very much appreciate your support.

All eyes are upon Europe and China, and what economic impact dissolution of the Euro and a slowing of the Chinese economy might have upon us here in the United States. Retail investors are understandably scared silly, and have been pulling money out of equity mutual funds and pouring it into bond funds at a dizzying rate. And, yet, the Dow Jones Industrial Average remains well above 12,000 – up from 6500 just a few years ago. Why?  Continue reading →

Like you, I was a very young lad when I first heard the story of the little boy who cried wolf too many times. The concept stuck. So, I don’t very often ring an alarm bell. As a staunch consumer advocate, however, I really need to bring this issue to your attention. I have watched the giant brokerage houses fleece consumers for decades, and made offering you and them alternative more than my business. It is my life’s calling. Continue reading →

What on Earth is going on?

Financial markets in the year 2011 did almost precisely opposite that which everyone had expected.  Should we be surprised?

Interest rates, which had reached historic lows by the end of 2010 and were expected to rise, fell even further.  Continue reading →

Imagine chefs suing their restaurant for being forced to eat their own cooking…  What could that possibly say about the food? 

Well, here’s one I think you’ll agree takes the cake:  Last week a group of Ameriprise employees filed a lawsuit against their employer for offering only Ameriprise mutual funds in their 401(k) plan — funds that were much more expensive than those offered by other fund managers.  Continue reading →