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European bond risk growing

June 4, 2017 admin Investing Comments Off

European junk bonds now yield 2.77%. Yes, the worst-rated bond trash in Europe has a yield that is only a speck higher than the U.S. government 10-year treasury bonds, considered among the safest investments in the world, at 2.33%.

So how can the best and worst bonds have nearly identical yields??

If you were a European bond manager, you have a puzzle to solve. Central Banks are buying all of the sovereign bonds and much of the corporate bonds, pushing yields on them negative. So there is only one place left to get any positive yield (theoretically at least) and that is corporate junk bonds. These are bonds highly likely to default, they are non-investment grade (meaning fiduciaries cannot buy them), and their yield is so tiny, a portfolio of them is a guaranteed loss. Buying these bonds is an exact fit for the Wall Street risk/reward saying, “like picking up pennies in front of a steamroller.”

Negative interest-rates are imperiling pension funds, insurance companies, and other institutions who must purchase bonds. Even though junk bonds in the U.S. are very low (3.9%), U.S. companies are now racing to sell their junk bonds in Europe because their rates are so much lower. These bonds are nick-named “Reverse Yankee Bonds” in the industry but in my opinion, they are a failures looking for a sucker.

What all of this points to is: colossal systemic risk in the European bond market. When this bubble pops, there will be tears for any investors with European bond exposure.

California’s new government shell game

May 28, 2017 admin Government Finance Comments Off

You can’t make this up. The state of California is going to raid its rainy-day fund just to pay half of one year’s pension-payment shortfall. And this payment isn’t nearly enough to get the pensions on a path to solvency. Where will next year’s shortfall payment come from? How will the principal, let alone the interest, ever be paid back to the Rainy Day Fund?

Let’s start at the beginning. In 2014, Californians passed a voter-ballot proposition in 2014, called the Rainy Day Stabilization Fund; 69% voted yes. This ongoing new tax was sold with these claims:

Safeguard public schools and infrastructure
Protect the public from future property tax increases
Pay down long-term school debt avoid devastating budget cuts
Requires politicians to live within their means
Smooth out the boom-bust cycles of the economy on schools and police/fire departments

Who spent the $18 million to get this proposition approved? Government and unions. It turns out that each of the advertised claims were false.

The latest Governmental Accounting Standards Board ruling requires pension plan audits to include retiree healthcare benefits and more realistic investment return assumptions. These changes increased California’s pension liabilities by $172.5 billion. California’s pensions were already underfunded by $228 billion, said another way, the pension fund only has 65% of what is needed to sustainably pay retirees. This jump in debt forces higher annual contribution payment to the state’s pension funds, nearly doubling from $5.8 billion to $11.8 billion a year.

Not so fast Skippy. Where did California get the extra $6 billion to double its pension payment up to $11.8 billion? It will borrow the money from the Rainy Day Fund. The state’s plan to “repay” half of the money it took from The Rainy Day Fund is to relabel the normal ongoing contributions to the Rainy Day Fund as a “repayment”. Um, that isn’t a repayment at all.

This shell game is the OPPOSITE of how the Rainy Day Fund was promised to operate. To be clear: the state politicians can now overspend on anything they want and short change the pension payment. Then steal money from the Rainy Day Fund to pay for the pension payment because it is “an emergency;” and never pay it back. All the while, racking up more interest charges from loans that reduce money available for services from the state. I call this a shell game but it’s really financial fraud to hide financial mismanagement; and partly why the state of California is always in the bottom 3 states for financial standing.

Never, ever, be tempted to go “All-In” an investment

May 21, 2017 admin Investing Comments Off

Every asset and investment is inherently fraught with risks. These include price risk, theft, fraud, damage, obsolescence, bankruptcy, hyper-inflation, taxes, mismanagement, stock market crash, new regulations, interest-rate risk, and many others. There is no single location for money where it is prudent to place all of it and expect it to earn money, free from all risks. Not gold, not cash under your mattress, not even stock in the legendary company, Berkshire Hathaway.

Why is a single location for money such an imprudent action to take? Because a single unfavorable event can wipe you out, take you out of the investor game, and destroy all that you’ve worked to accumulate. It is similar to gambling all your money by putting it on the color red and spinning the roulette wheel. Although any particular investment may play out over a longer time-frame, the concept is identical – your gamble either wins or loses based upon the outcome of a single item. Going all in is the opposite of your most important assignment as a money manager: to safeguard your savings and investments.

When a Ponzi scheme inevitably collapses, there will be victims revealed who had put their entire life savings into the fraudulent investment. When a stock goes bankrupt, some reporter will find an investor who had placed all of their retirement money into it. When a string of homes is leveled by a tornado, anyone who held cash in a secret hiding spot in their home lost it all.

This week, there is a story on bitcoin news sites of someone with a terminal illness who just borrowed $325,000 on his home in order to put it all into bitcoin. He did this based upon the hope that bitcoin will launch from its current $1,800 price to beyond $10,000; whereupon he would sell the bitcoin. I do not know if this story is true, but there are likely to be people who have done this.

The prudent way to hold your savings and investments is to place them in several different types of assets, and additionally, diversify among those assets. The term “asset type” refers to items such as: real estate, stocks, bonds, precious metals, cash, cash equivalents like savings accounts or Treasury bills, private placements, or specialty ETFs or mutual funds (such as commodities or unique investment strategies). There are many alternative asset classes as well: hedge funds, options, currencies, futures, and collectibles from stamps to wine, art, and watches. I probably have 6 different asset types where I place money so that a catastrophe in one or two of them will not permanently impair my net worth. There is no single asset or investment that is so attractive and risk-free that anyone should “go all-in,” let alone leverage up by borrowing money to purchase even more of that investment. Wall Street doesn’t go a few years without a collapsed hedge funds because it went all in on a single investment idea: Greek economy turnaround, a sovereign bailout that didn’t materialize, a technology that failed, a sector that ‘should’ have gone up/down but didn’t, and many more. Do not follow their folly, going all in is the path to going broke.

When is the last time you interviewed a bank?

May 14, 2017 admin Personal Finance Comments Off

The financial institution that is best for your needs will be determined by the complexity and cost of your financial transaction types. Every bank or credit union has strengths and weaknesses, and these do change over time. There is a spectrum of services that banks offer and I periodically review and interview banks to determine if I should alter where I do some or all of my banking.

There is no one-size-fits-all all bank to keep everyone happy. There are local banks, regional banks, large money center banks, and a similar variation in credit unions. On one end you have the three largest U.S. banks – Wells Fargo, Chase, and Bank of America. They have the most resources, most technology offerings, and also the most expensive fees. Begin by matching up your needs with the banking fee schedule. Most bank websites have a fee schedule; access that to scan for the prices of services you’ll expect to be using. The next step is to list all of the features, amenities, and services that you require, and make sure that those can be adequately met by the bank. For example, one item I insist upon is next-day check clearing (banks don’t start this until a brand-new account has been open for 30-45 days). However, many banks physically cannot offer less than 2 or 3-day check clearing, ever. Another feature I prefer is a smart-phone app check deposit capability with a limit above $10,000. Only by putting all of these puzzle pieces together you can you arrive with best offering to meet your needs.

I had an account at a large bank and it seemed like if I glanced in their direction I was charged another $50. However, I was once in Asia when I had to wire 2,500 Euros to an Italian law firm within 24 hours. It was just a few online steps with my large bank – no regional or small bank could have possibly accommodated this. In another example, I interviewed a large regional bank and they were “going to debut a mobile app probably this summer,” while my primary bank account has had one for 9 years.

Even for a small business with simple transactions, research pays off. For example, earlier this year I prompted a colleague to move from a large bank to a credit union business checking account. At the prior bank, she was paying $588 a month in fees. But the credit union cost for her is now only $375 per month. Switching banks saves her nearly $2,600 a year. Was that worth 2 days of research? I think so.

Be aware that there are a few large banks and credit unions are that are removing some or all of their tellers and replacing them with super-ATMs. These new machines can perform all kinds of transactions, even allowing customers to speak to a live teller for additional services. If this doesn’t appeal to you, then you may want to confirm whether tellers will remain. One branch I interviewed reluctantly revealed their plans to eliminate their tellers soon, but only after I asked them about it.

Remember that bank policies and procedures change over time; some become more relaxed, some become more restrictive. These changes may prompt you to start a new bank search. One word the banking industry loves is “relationship.” Banks always want to upsell you with more accounts and services (relationships) because you’ll be less likely to leave them. I use the word a lot when I’m interviewing banks so they offer me more perks and benefits; you should, too. But if they no longer meet my needs best, then I move on without hesitation.

Puerto Rico files for bankruptcy

May 7, 2017 admin Government Finance Comments Off

The U.S. island territory of Puerto Rico just entered history books as the largest municipal bankruptcy in U.S. history. Puerto Rico’s default on $73 billion in bonds is almost 4 times larger than the next largest municipal bankruptcy, Detroit in 2013. How did this happen? Puerto Rico implemented every unaffordable socialist program that they could find:

Public health care and heavily subsidized public university
40% of all workers are employed by the government
Ever-growing union and government employee benefits
Pension plans underfunded by 96%
High minimum wage makes island labor uncompetitive in the region
Welfare payments make up 20% of the island’s personal income
High-speed train boondoggles to nowhere

Adding to their economic troubles, the legislature made Spanish the official language in 1991 for all school and government use. Since English literacy has now fallen to only 14%, U.S. businesses cannot expand there, not even for low-skilled call centers. This leaves Puerto Rico with a horrifically-high unemployment rate of 45%, even if you include an estimate for their “informal economy.”

Now, Puerto Rico and its allies now call all the bond investors “Vultures” for suing the government for what they are owed. Sure, some money managers recently bought their imperiled bonds for 30 cents on the dollar, hoping for a big score if the U.S. federal government bails them out. It is hard to sympathize with the island’s leaders who have refused to restructure or get on a financially sustainable path for the last decade. Instead, Puerto Rico’s leaders have sprinted even faster toward the financial precipice that it now finds itself.

If you want to reduce something, tax it

April 30, 2017 admin Government Finance Comments Off

Politicians seeking to achieve a social goal frequently use taxes as one of their tools. This tool is always a double-edged sword causing predictable side-effects that politicians routinely ignore. It is a lesson as old as civilization and quickly forgotten in spite of numerous examples.

My favorite two examples highlight an immediate and sharp behavioral response:

U.S. Congress passed a 10% luxury tax on yacht sales in 1991, intending to grab easy money from the very rich. What actually happened? The rich bought their yachts from overseas instead so U.S. yacht sales fell by 56%. This eliminated 125,000 American jobs in the marine industry as yacht manufacturers went bankrupt or shrank. The policy was so disastrous that the luxury tax was repealed only 2.5 years after it was implemented; but it took decades for the industry to rebound.
Sweden passed a 0.50% financial transaction tax in 1984 on stocks and bond trades to raise easy money from the wealthy. Trading dropped so quickly that the tax it raised wasn’t enough to fund the government department in charge of tracking the tax. So the government doubled the tax and expanded it to other kinds of trading. What actually happened? Stock and bond trading dropped by 85%, futures trading dropped by 98%, and options trading went to zero. Within a few years the majority of Swedish securities trading had all moved to London. Since trading plummeted, capital gains tax revenue disappeared and brokerage jobs disappeared. But these weren’t sufficient reasons to repeal the tax to the true believers of tax-the-rich. It wasn’t until the market illiquidity forced the government to pay a higher interest rate to sell their bonds that the tax was finally repealed in 1991. But it took nearly two decades for the industry to return from overseas.

So those tax examples were from long ago, what about right now?

Last year, the City of Philadelphia passed a 1.5 cents/ounce tax on sugary drinks like Coca-Cola, iced tea, Gatorade, fruit punch, energy drinks and some coffee drinks. The city council claimed this would reduce obesity and the $91 million in new tax revenue would be spent on pre-kindergarten programs in poor areas and shore up the city’s budget. What actually happened? Since the tax raised the price of these sugar products by 30-50%, sales have dropped by 32% so far within in the city and skyrocketed outside of the city limits.
The Los Angeles Chinatown area pleaded with Wal-mart for years to open a store near them. Wal-mart finally opened that store in 2013 where customers could access much cheaper food, prescriptions, and other items to reduce their cost of living. But, Los Angeles passed a new minimum wage starting at $15/hour in 2017 and going higher in 2018. Wal-mart operates on tiny profit margins, so rather than lose money they closed the store the first month the tax went into effect. Not only has the area lost a large employer, but their cost-of-living just went up without a discount merchandiser – leaving Chinatown economically worse off than before the wage hike.
San Francisco raised their minimum wage 86% above the federal minimum wage, with additional hikes scheduled up to $15/hour by 2018. The actual result? Unlike the rest of the country, San Francisco has seen prices rise by 10% or more on of all kinds of commodities. What about businesses that rely the most on minimum wage employees? A recent Harvard study concluded that while high-end restaurants are unaffected by a small minimum wage hike, average restaurants are 14% more likely to close for every 10% increase in the minimum wage above the federal level.

There is no magic wand that allows a tax increase to have no impact on behavior. Any price increase is met with a reduction in demand and people will begin searching for alternatives or creating substitutes. Many people still believe there is an immunity bubble around wages and jobs, but +100 years of minimum wage experiments around the world has proven that labor is simply another commodity subject to the rules of basic economics as well. So the next time you hear about a politician’s new tax hike, prepare for the predictable consequences that will blind-side some class of unintentional victims.

A hidden risk in bond funds

April 23, 2017 admin Investing Comments Off

Since 2008, central banks around the world have set their shortest-term interest rates at, or below, zero. In order to provide savers or investors with a higher return, money managers have slowly crept further out in time on the investment-yield curve. For example, while a bond fund previously invested in 2-year bonds , they may now be investing in 5-year bonds to keep their dividend rate competitive. The risk of a 5-year bond is significantly greater than a 2-year bond, and if you’re not paying attention, you may not know that your money manager has been putting your money at far greater interest-rate risk.

The mathematical bond term for time is, “duration.” This refers to the number of years to recover the cost of a current bond purchase. (Calculated by the net-present value of all the bond coupon and principal payments.) This way, the length of bond-like investments can be compared with a single number, their duration. As you can see in the chart, bond fund duration has been continually getting longer since 2009. This longer duration adds enormous risk to any money in funds that are buying longer-dated bonds to increase their yield.

To avoid this duration creep, you can either purchase individual short-term bonds and hold them until maturity, or buy a fund to do this for you. To make it easy for investors, there are now bond funds that target a particular date. Another bond-fund candidate that you may want to consider is RiverPark Strategic Income Fund, ticker symbol, “RSIVX.” This is a 4-year-old bond fund run by an expert on short-term high-yield bonds which currently has a yield over 6%. The fund has minimal exposure to rising rates because of short duration, pays out monthly dividends, and a long track record of buying bonds that always payout in full. You can learn more about this fund at http://www.riverparkfunds.com/Funds/StrategicIncome/Overview.aspx

As always, you must perform your own due diligence to determine if these may be an appropriate fit for your portfolio. If you decide that they are something to invest in, never invest more than 5% of your portfolio into any one alternative strategy; such as this fund.

Baby-Boomer stock-market apocalypse?

April 16, 2017 admin Investing Comments Off

For a couple decades, demographic experts have been pointing out a potential stock market risk from the Baby Boomer generation. The theory goes, beginning in the year 2017, the first of the Baby Boomers will be turning age 70 ½. Anyone with an IRA must begin withdrawing money from their account once they reach this age, or pay a stiff penalty. For the next 15 years, the selling pressure of Baby Boomers liquidating some of their IRA investment holdings will be larger than the buying pressure from the next demographic-age bracket. Could this trigger a stock market crash, a downtrend, or prevent the markets from advancing any further?

Since the stock market is already at a high valuation, below are a couple conservative investment candidates that you may want to consider.

Ticker symbol, “TAIL.” This is a brand new Exchange Traded Fund (ETF) by Cambria Research that will profit from a stock market decline. Most of the fund’s assets are earning interest in U.S. Treasury debt. But a portion of the fund will purchase out-of-the-money put-options on the U.S. stock market, the S&P 500 index. The fund expects to lose a little money each year that the stock market is flat or up, but profit greatly from the put options in the event of a sharp stock-market selloff. You can learn more about this at http://www.cambriafunds.com/tail.aspx

Ticker symbol, “DIVY.” This is a 2-year old ETF that uses options to scalp dividend growth out of the stock market with close to no price risk. This fund distributes a large special dividend at the end of the year. When this option-model is back tested over 10 years, the financial result triples the return of the S&P 500 with less volatility. You can learn more about this fund at http://www.realityshares.com/funds/divy

The financial impact of basic maintenance

April 9, 2017 admin Personal Finance Comments Off

While most people do not maintain their possessions very well, those who do have a continual financial advantage. Most physical possessions depreciate in function and value until they need to be repaired or replaced. Repairs and replacement are costly, so the longer you can delay that event, the more money you’ll be able to keep for other spending or saving. By keeping your items closer to pristine condition, you can dramatically reduce the normal depreciation price curve. This maintains the item’s value which keeps more money in your pocket.

So how have you been doing up until now?

When you sell your cars, are they routinely sold for a price that is well under book value or far above book value?
When you lease a car or rent an apartment, do you routinely lose your damage deposit?
When you sell a home, is it under or over the market price per square foot?
I have a relative who cleans and oils his furnace once a year and changes the filter every 2 months. While most furnaces average only 15-20 years before they need to be replaced, his furnace is 41-years old and going strong. How well do you maintain your appliances?
Do you wear your clothes and shoes out relatively fast or slow?
In general, are you a consumer of goods or a steward for them?

The more expensive an item is, the bigger the financial benefit of maintaining it properly. For example, a neighbor wouldn’t clean the leaves from his A/C condenser and had to replace it after only a few years when it should have lasted 20. Meanwhile, for keeping my car well maintained, when I sold my last one a few years ago, the first person who looked at it paid $2,900 over blue book for it. Is $2,900 worth keeping it waxed and vacuumed? Let’s add it up: if you have 8-10 cars in your life, then you may have +$25,000 in extra money – just for vehicle maintenance. You can live however you want, but I highly recommend maintaining what you own.

Save 15-60% on mundane purchases

April 2, 2017 admin Personal Finance Comments Off

I am surprised by how many people people complain about not having enough money, and yet, they do not use eBay, Amazon, and other websites to buy items at a steep discount. These purchases frequently have no shipping cost and/or no sales tax. While running through a store with a credit card, it is easy to grab anything you want and charge it. But this is paying the highest retail prices. (Note that the average person who does not pay off their credit cards each month ends up paying twice the cost for an item because of accumulated interest charges). Instead, use your regular purchases to get discounts by searching online first.

A sample of what you can routinely save money on:

Toiletries
Cosmetics, make-up, and lotions
Hardware items (unless they are very heavy or large)
Nutritional supplements
All apparel and accessories
Toys
Pet supplies
Store-brand gift cards at a discount of 5-10%

Over the course of a year, these savings can become notable. Reducing your cash outlay for these items, without much effort, frees up money to either increase your life-style spending or, even better, make it available for saving and investing.

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Financial Literacy

Timeless concepts to turn financial chaos into clarity