7 red flags

Remember March 4, 2014 -- a day that will go down in Wall Street history as the beginning of the end for this latest bull market, which is celebrating its fifth birthday.

On March 4, the Dow Jones Industrial Average ($INDU -0.21%) rose 227 points based on a report that Russian troops were pulling back from Ukraine's border. This "news" lit the market on fire, a sign that the market is heading into a mania stage where it doesn't take much to boost stocks.

Indeed, nowadays instead of the "Nifty Fifty" stocks that defined the late 1960s market, we have the likes of Facebook (FB +3.19%), Tesla Motors (TSLA -2.99%), and Chipotle Mexican Grill (CMG -0.92%) -- the new new things.

Can the market go higher? Sure, although the higher it goes, the more dangerous it becomes. Often, during the latter stages of a bull market, the market separates itself from reality and appears to be on another planet.

Such red flags are everywhere:

1. Retail investors have been pouring money into stock mutual funds. The fear of missing out on the sixth year of a bull market has created something close to a buying panic. Although not as maniacal as we saw in 1999, the stock cheerleaders are back and rooting for their stocks and mutual funds to go higher -- just like they always do before a crash or bear market.

2. The Investor's Intelligence survey is concerning. The closely watched II survey shows a low proportion of bears (less than 20 percent), which some have pointed out is the lowest proportion since just before the 1987 crash.

3. Sentiment indicators are pessimistic. The VIX volatility index, the put-call ratio and other major sentiment indicators suggest that investors and traders are getting complacent. Apparently, market participants believe that the Fed, or their fund manager, will protect them in a worst-case scenario.

4. Fundamentals are being ignored. Obscenely high price-to-earnings (P/E) ratios are passed over, along with soft economic readings (i.e. GDP and ISM). When the fundamentals are weaker than expected, the weather is blamed.

5. The stock market crash of 2008 has been forgotten. Investors forget, but the market never does. Those who do not heed the lessons of the past will once again learn a painful lesson.

6. The Nasdaq is soaring. The three-year chart of the Nasdaq ($COMPX -0.04%) has gone nearly parabolic, hitting a 14-year high of 4,351 on March 4. It's the Go-Go years all over again. (And that late 1960s bull market ended with the 1973-74 bear market.)

7. Fear and greed are taking over. When the market reaches the tipping point (and we're getting closer), investors and traders buy "ATM" (anything that moves). The fear of missing out causes a buying panic.

What to do now
There have been numerous crash predictions over the last five years. As a result, many investors have closed their ears, and who can blame them? The market has ignored the warnings and continued to go up. One thing about crashes: They can't be predicted (but it won't stop people from trying). However, it is possible to recognize a dangerous market, which is what we have now.

The market is wearing no clothes

Just like the emperor, the market is wearing no clothes. Right now, many people see only what they want to believe. It's been a long time since investors felt full-throated fear, and many have forgotten what it feels like. The panic to buy will be replaced by the urgency to get out at any price. No one can know what will cause perceptions to change, but they will.

At the moment, emerging markets are in deep trouble, and what is happening in Ukraine didn't help. Nevertheless, the CEOs of several major brokerage firms have urged investors to "go long" emerging markets because they are so "cheap." Once again, these well-educated salesmen are wrong. Emerging markets will recover one day, but not soon. Urging investors to buy on the dip is disgraceful.

Sit and wait?
If we are in the mini-mania stage of the bull market, the market will continue to go higher based on rumors, hope, and greed. Sitting on the sidelines and waiting for the bull market to top out takes tremendous discipline. Trying to capture that final 5 percent can be costly if you get the timing wrong (and most people do). Be prepared for increased volatility as we get closer to the end.

Of course, it's not easy to sit on the sidelines when everyone else seems to be making money. Although many investors are dreaming of another 30 percent return this year, the odds are good that it will be a difficult year. Yes, during a mania stage anything is possible, but with each passing week, the clock is ticking.

Those who have studied market history have seen this story before, and the ending is always the same. No matter how many warnings you give, no many how you urge people to avoid buying the speculative Go-Go stocks and move to the sidelines, few listen until it is too late.

[on the other hand, Here's how the S&P 500 gets to 2,600 next year]

The S&P 500 is currently at 1877.  We'll see how much it goes up from here before tanking (who knows when)?

***

Some comments:

David Strait The market will go down eventually but believing your prediction is no different than believing others who say it's going to continue to go up. If you say the same thing long enough if will eventually come true. The one thing I find is that there is no where else to put your money and get any kind of return so if you keep it on the sidelines you are losing money already anyway.    

Smeado Trying to predict market tops and bottoms is a fool's game.

robin1620 It's time to go all in.

***

Here's what Hulbert says to do:

Few investors find solace from knowing that, if they wait long enough, stocks will eventually recover from a bear market. After all, as Keynes famously said, in the long run, we are all dead.

Yet history shows that typical bear-market recovery times are hardly “the long run.” Since 1926, it has taken an average of 3.3 years for stocks to surpass their high set before the typical bear market began.

Unless you think the next bear market and subsequent recovery will be worse than average, sticking with stocks is the best response to the certainty that, sooner or later, the current bull market will come to an end.

***

And what am I doing?  I'm taking small profits bit-by-bit as the market goes higher and higher.  What am I selling?  Stuff that I won't really mind purging out of my portfolio plus trimming stuff that is looking expensive.

dividend stocks

Investing in dividend stocks isn't just for retirees. If you're serious about generating strong long-term returns, then dividend stocks need to be a big part of your portfolio.

Not only do dividend stocks have less volatility year-to-year, they outperform non-dividend paying stocks over time too. That's right - those "boring" dividend stocks offer lower risk and higher total returns over the long run than those glamorous non-payers.

After last year's nearly +30% run up in the market, you might have forgotten that total return comes from two sources: price appreciation and dividends.

And believe it or not, over the last 80+ years, dividends have accounted for more than 40% of the total return equation.

A recent study by Ned Davis Research shows that dividend-paying stocks outperform their non-paying counterparts by a dramatic amount. From 1972 through 2013, non-dividend paying stocks earned a measly +2.3% return per year. But dividend-paying stocks crushed it with a +9.3% average annual return. And those that paid a dividend and raised it year after year did even better - generating a compound annual return of +10.1%!

Historically, companies have paid out a little over half of their earnings in the form of dividends, while the stock market has averaged a dividend yield of 4.4%. But the roaring bull market of the 1980s and 90s shifted focus away from dividends. By the year 2000, the payout ratio was hovering around 30%, while the market was yielding just 1.2%.

But after a decade of negative price returns, dividends appear to be making a bit of a comeback. The number of companies in the S&P 500 paying dividends (418) is at a 16-year high. And the current payout ratio of 32% is near a 10-year non-recessionary high as the dollar amount of dividends paid has more than doubled since 2004. Despite record high prices, the S&P currently yields 2.0%.

-- Todd Bunton, Zacks Weekend Wisdom

6 big myths about millionaires

While doing research for my book, "The Eventual Millionaire," I interviewed more than 100 millionaires. They came from all walks of life and made their first million in dozens of different ways, from starting their own businesses to investing in the stock market or real estate. And those aren't the only paths to becoming a millionaire, either: Others hit the mark by simply living below their means and saving portions of each paycheck.

Before you can make a million, though, you need to get past the mystique and the myths surrounding it. Here are six common myths about millionaires debunked.

Myth 1: Millionaires are smarter

People tend to put millionaires on a pedestal: They must be better or smarter than everyone else in order to achieve that goal. But that general statement simply isn't true. Millionaires are ordinary people who have achieved extraordinary goals, but they make mistakes like everyone else. They may misspell words; they may even have learning disabilities. They've likely been in debt and had to dig themselves out. They've had ideas and businesses fail. Most of the ones I interviewed for my book have worked their way up the ladder, learning and stumbling along the way.

Rather than having lots of book smarts, what most millionaires have is a knack for setting goals for themselves and working toward them, without letting excuses get in their way.

Myth 2: Millionaires are just luckier

Millionaires are the luckiest among us, right? They won the lottery, struck gold with their very first attempt at launching a business or haphazardly landed their dream jobs with massive salaries. Not so: Pure luck is not a factor in achieving success. Rather, truly successful people make their own luck. After all, a million-dollar idea is worth nothing without execution.

Myth 3: Millionaires live lavishly

When you think of millionaires, you may picture people living in luxurious mansions and driving expensive sports cars. The reality? Millionaires are often the people next door: They drive Hondas and Volvos. They're frugal (57 percent of the ones I interviewed described themselves as such). They often spend their money on necessities and a few things that are very important to them. Think Warren Buffett: The celebrated multi-billionaire famously still lives in the Omaha, Neb., house he bought in 1958 for $31,500.

In most cases, millionaires have gotten to where they are precisely because they've practiced excellent savings habits and live frugally. They learn to make smart choices, and they don't stop just because they hit the $1 million mark.

Myth 4: Most millionaires were born into money

Another common myth is that millionaires were born into money or inherited it. But that's not often the case. In a recent survey, Fidelity Investments found that 86 percent of millionaires are self-made. And among the more than 100 millionaires I interviewed for my book, each was self-made and only 26 percent of them said they even had connections to important people beforehand.

Myth 5: Millionaires have to be fearless

Though it may seem like the only way to become a millionaire is to forge full-steam ahead and assume a lot of risk, fears are totally normal, even for the ultra-successful. Fifty-seven percent of the millionaires I surveyed said they were scared before starting their own business: scared of failure, disappointing their spouses or their families, scared of losing everything.

Success requires some risk, but wise millionaires don't want to take uncalculated gambles. Millionaires have learned how to examine an opportunity and analyze the risk. They will even do small tests beforehand to see if an idea will work before going all in. They prefer to know as much information as they can ahead of time so they don't make a bad investment.

Most millionaires find a happy medium between optimism and pessimism; they figure out how to examine opportunities realistically. They acknowledge amazing potential, but work tirelessly to learn and predict beforehand to make sure their investments pay off.

Myth 6: They earn million-dollar paychecks

It's true that many millionaires have earned their money by starting (or selling) their own businesses or finding high-paying positions within organizations. But this certainly isn't the only way to amass $1 million. In his book "Millionaire Teacher," Andrew Hallam explains how he saved over $1 million as a teacher well before retirement age, outlining how he used low-cost index funds and a disciplined approach to saving, investing and living on a budget to build a nest egg most of his fellow teachers would envy.

In addition to investing in the stock market, like Hallam, other millionaires boost their bottom lines by adding second jobs or passive streams of income.

*** [10/25/14]

see also 5 Things Most People Don't Realize About Millionaires

Myths about millionaires abound: they're all greedy, or trust-fund babies, or like to flaunt their wealth.

Many people think "that millionaires are a lot like Kim Kardashian," says Cathy McBreen, managing director of Spectrem, which has tracked and polled the nation's richest households for years. "But they tend to be conservative with their spending," she says. "They're not out there buying mink coats and jewelry every day."

In fact, most millionaires spend more on charity than on bling. Spectrem has also found that most millionaires didn't inherit money, and that the percentage that did is actually shrinking as the number of millionaires grows.

When asked how their wealth was created, a whopping 94% of millionaires surveyed by Spectrem credited hard work. The number two factor? Education, cited by 87%. That ranked it ahead of smart investing (83%), frugality (78%) and risk-taking (60%).

Much farther down on the list: being in the right place at the right time (40%), luck (36%), inheritance (31%), and family connections (8%).

The percentage of millionaires who inherited some of their wealth has dropped to 18% as the number of millionaire households hit a record high last year of 9.63 million, McBreen says.

Wall Street should hate Warren Buffett

The best course of action is to take almost no action, in Buffett's view. Stick to what you know, which is probably nothing. Buy a basket of 500 stocks, a smattering of bonds, and forget about it for the next 100 years or so. Treat investing this way and you'll actually beat the experts in the long run, Buffett says.

"The goal of the nonprofessional should not be to pick winners -- neither he nor his 'helpers' can do that -- but should rather be to own a cross section of businesses that in aggregate are bound to do well," Buffett writes. "A low-cost S&P 500 index fund will achieve this goal."

Oh, and you should definitely stop listening to those experts, he writes:

"Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits -- and, worse yet, important to consider acting upon their comments," Buffett writes, adding: "In the 54 years [partner Charlie Munger and I] have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people."

This is a direct shot at CNBC, Bloomberg TV and any other outlet full of talking heads claiming to tell you how to make money. It's a direct shot at the hedge funds charging huge fees for their supposed investing wizardry, even as they are consistently trounced by those dumb S&P 500 index funds. It's a direct shot at the brokers who make commissions on unnecessary and unhelpful trades and at mutual funds that rake in fees with "active management." It's a direct shot at the newsletter writers and tea-leaf readers who claim they can time the market using Hindenburg Omens or Death Crosses or zodiac signs or whatever.

Here's another shot at the business model of CNBC, and much of the financial-news industry:

"If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays," he advises.

Zing! It's true, though. It's hard to think of information much less useful to you than daily stock prices. Unless, of course, those stock prices are collapsing, in which case it's usually a great time to buy more stocks.

new home sales

New home sales rose 9.6% month-over-month (m/m) in January, to an annual rate of 468,000 units-the highest level since July 2008-from December's upwardly revised 427,000 unit pace, from the initially reported 414,000 rate. Economists surveyed by Bloomberg had expected a decline to a 400,000 rate for last month. Within the report, the median home price was up 3.4% y/y but 2.2% lower m/m at $260,100. The inventory of new homes was 23.5% higher y/y, but unchanged m/m, at 184,000 units. This represents 4.7 months of supply at the current sales rate, from 5.2 months in December and 3.9 in January 2013. New home sales are considered a timely indicator of conditions in the housing market as they are based on contract signings instead of closings. Regionally, m/m sales were higher across most regions, led by a 73.7% surge in the Northeast, but sales in the Midwest fell 17.2%. Compared to the same period a year ago, sales in the Northeast and South were higher, while sales in the Midwest and West were lower.

Schwab Closing Market View, 2/26/14  

*** [then again, comes this from Credit Suisse..]

Reported new home sales up a questionable 10% in January; inconsistent with actual market trends: The Census Bureau reported new home sales of 468,000 in January, an increase of 10% from 427,000 homes in December (revised up 3% from 414,000 homes originally reported). This is well above our expectation for 385,000 homes and consensus for 400,000 homes, and again points to both the volatility (confidence interval was +/- 18%) and the lack of credibility for this Census Bureau report. Trends in sales typically follow trends in construction, and single-family starts fell 16% in January. Especially amusing is the reported 74% increase in the Northeast, which appears odd given the weather. We would expect January sales to be revised in the coming months.

the Mt. Gox shutdown

The reason that Bitcoin plunged on Mt. Gox was similar to a bank run -- there simply weren't enough Bitcoins in circulation to allow everyone to cash out at the same time. Bank runs usually occur when a bank invests too much of its clients' money elsewhere, leaving so little cash on hand that it can't survive a mass withdrawal.

Mt. Gox's possible insolvency, on the other hand, was rumored to be caused by a hack that resulted in the loss of 744,000 Bitcoins ($409.2 million). This isn't the first time it happened, either -- Mt. Gox was possibly hacked in 2011 for 400,000 Bitcoins (now worth $220 million). Mt. Gox customers have also reported troubles since early February, when CoinDesk reported that 68% of its customers had been waiting for months to withdraw their funds.

Therefore, even though exchanges like Mt. Gox might not be making risky bets with their clients' cash, their doors can be pried open by legions of hackers on the Internet instead. In the case of a bank failure or data breach, a depositor is insured by the FDIC for $250,000. In Bitcoin accounts, no such insurance policy exists.

tips from P.T. Barnum

P.T. Barnum knew how to make money. By the middle of the 19^th century, the master showman had become America's second millionaire, and his estate was valued at over $10,000,000 prior to his death in 1891.

Fortunately for us, Barnum – who is still remembered today for his "greatest show on earth" -- shared his secrets for getting rich. In the short work "The Art of Money Getting" published in 1880, he laid out his rules for creating wealth. After reading them, I was struck by how applicable they remain today. Here are nine golden rules for making money, according to Barnum.

1. Spend less than you earn. Barnum writes that the key to wealth is quite simple: "it consists simply in spending less than we earn." Despite the simplicity of this maxim, he notes, "more cases of failure arise from mistakes on this point than almost any other." [see Andrew Tobias]

2. Take care of your health. Good health is the foundation of success in life and is also the basis of happiness, according to Barnum. Without good health, a person is very unlikely to accumulate a fortune – he'll have "no ambition; no incentive; no force." He recommends avoiding alcohol and tobacco, while also making other healthy choices when possible.

3. Persevere. To illustrate this rule, Barnum shares a line from Davy Crockett, "This thing remember: when I am dead: Be sure you are right, then go ahead."

4. Be cautious and bold. This one appears to be a paradox, but it is not, writes Barnum. He believes "you must exercise caution in laying out your plans, but be bold in carrying them out." A man who is all caution won't take on the risks necessary for success, while a man who is "all boldness, is merely reckless, and must eventually fail."

5. Use the best tools. Barnum believes that workers must always have the very best tools to do their work. As a businessman, he feels there is no tool he should be, "so particular about as living tools." When looking for employees, therefore, one "should be careful to get the best."

6. Be focused. Barnum urges the aspiring entrepreneur to focus on "one kind of business only, and stick to it faithfully until you succeed, or until your experience shows that you should abandon it."

7. Advertise your business. Barnum was a remarkable pioneer in the field of advertising. For one of his promotions, he was able to transform a five-year-old dwarf named Charles Sherwood Stratton into "General Tom Thumb, Man in Miniature." Tom Thumb eventually became a gigantic hit in Europe, and was received by Queen Victoria and numerous other crowned heads-of-state.

Barnum with General Tom Thumb

8. Be polite and kind to your customers. P.T. Barnum actually never said "there's a sucker born every minute." Instead, he had great respect for his customers. He writes, "the man who gives the greatest amount of goods of a corresponding quality for the least sum (still reserving for himself a profit) will generally succeed in the long run."

9. Preserve your integrity. Barnum concludes his work by saying to all men and women, "make money honestly." He sincerely believed that the desire for wealth is laudable as long as the "possessor of it accepts its responsibilities, and uses it as a friend to humanity."

Facebook and the S&P 500

Question: I heard that Facebook (FB) will soon be added to the S&P 500 even though the company went public just last year. What are the rules regarding when a company joins or leaves the index?

Answer: Given the S&P 500's role as one of the most widely used measures of U.S. stock market performance, one might assume that the index's composition doesn't change much from year to year, but that's not necessarily the case. In fact, this year alone [2013] the S&P 500, which tracks the stocks of many of the largest U.S. companies and weights them by market value, has already swapped out 15 constituent companies in exchange for others.

Companies added in 2013 include clothing maker Michael Kors Holdings (KORS), Delta Air Lines (DAL), News Corp (NWSA), oil-services company Transocean (RIG), and Vertex Pharmaceuticals (VRTX). Meanwhile, those leaving the index included Dell, Sprint (S), J.C. Penney (JCP), Dean Foods (DF), and NYSE Euronext. The index will change further Dec. 20 as social-media giant Facebook, marketing and loyalty-program services firm Alliance Data Systems (ADS), and flooring manufacturer Mohawk Industries (MHK) join the index, replacing Teradyne (TER), Abercrombie & Fitch (ANF), and JDS Uniphase (JDSU).

According to the S&P Dow Jones Indices website, the composition of the S&P 500 is maintained by a committee of economists and analysts whose goal is "to ensure that the S&P 500 remains a leading indicator of U.S. equities, reflecting the risk and return characteristics of the broader large-cap universe on an ongoing basis."

To be included in the index, companies must meet the following criteria:

• Must be a U.S. company
• Must have a market capitalization of at least $4.6 billion (the limit as of September but subject to change)
• At least 50% of the company must be publicly held
• Must have four consecutive quarters of positive reported earnings
• Stock must be relatively liquid, trading at least 250,000 shares per month for six months
• Company must contribute to the index's sector balance
• Must be listed on the New York Stock Exchange or Nasdaq, or be a non-mortgage REIT or business-development company

Companies may be booted from the index for violating any of the above criteria. For example, J.C. Penney, the struggling department store chain that has seen its market cap plummet from $7.5 billion to $2.6 billion in just two years, got the boot last month (at the same time it was added to the S&P MidCap 400 Index). These criteria also came into play during the late 1990s, when many tech companies saw their stock prices soar, lifting their market capitalizations to well within range of the index. Yet those companies were left out because they didn't meet the index's profitability rules.

The index committee takes into account short- and medium-term historical market-cap trends for a company and its industry before adding it to the S&P 500. The index's methodology states that following an IPO, companies must wait at least six to 12 months before being considered for the index. Members obviously believed that Facebook, with a market cap of around $130 billion, was ready despite its relatively short history as a public company; Facebook's IPO took place in May 2012. Changes to the index are made as needed and not on any set schedule, according to the methodology.

the risk of stocks

Retired investors seeking high income to live off of during retirement face greater challenges today than almost ever before. The days of high yields available from bonds and other fixed income vehicles are long gone. Consequently, generating an adequate level of current income on retirement portfolios is difficult to say the least. This is especially tricky for those investors with a low tolerance for risk.

Moreover, there’s no question that equity investments technically carry more risk than fixed income investments. This is widely acknowledged, and in the general sense, an unarguable position. However, this begs the question as to exactly how much more risk do equity investments carry versus fixed income investments? In other words, is the risk of investing in equities (common stocks) versus a fixed income instrument (bonds, CDs, etc.) 100% more risky, 50% more risky, 25% more risky, 10% more risky, etc?

These seem like important questions to ask and have answered. However, I have personally not come across any truly cogent analysis that precisely quantifies the greater risk of a stock or equity over a bond or other fixed income instruments. But with this said, my more than 40 years of experience investing in equities lead me to conclude that most people overestimate the greater level of risk that equities possess. This is especially true regarding equities with long histories of paying dividends. Yes, I agree that there is greater risk, but I do not agree that the risk of owning equities is as great as many people contend or believe.

... when evaluating the risk of investing in stocks, many investors are referencing price volatility. And usually, by volatility they mean the risk of the price of the stock dropping. However, I contend that if the price of a high-quality company does drop, but the underlying fundamentals of the business remain strong, that it represents opportunity rather than risk. About a year ago I wrote extensively on the subject found here.

Additionally, I also authored a two-part series on how investors can mitigate the investment risk associated with owning stocks. In part 1 I elaborated more on the concept of volatility risk.

Then, in part 2 I expanded my discussion on risk to include numerous other risks associated with investing in common stocks.

And, for those interested in learning more about the volatility aspect of risk, I authored another article in April 2012.

The primary point I expressed in this last article is my contention that it is not the volatility itself that establishes the risk of owning a stock; rather the greater risk rests in how people react to that volatility. The following excerpts from a comment shared by a regular reader of mine on my most recent article nicely summarizes this point.

“My objective is to earn an income stream that is reliable, predictable and increasing. It's all about the income stream, what I refer to as my pension from Mr. Market. I need to know what that pension is going to pay me in the distribution phase of my life. I can do that with dividend growth investing…

This year has seen the market correct to where it is down for the year. The Dow was down over 5% in January alone. Although the market continues to fall, my pension payment continues to rise. I will establish an all-time high in dividend income this month, and it has nothing to do with share prices. Market falls, I get a pay raise…”

-- Chuck Carnevale

Wall Street analysis vs. asset allocation

The truth is, no one can say for sure when the market will go down or go up. An interesting study by Bloomberg showed that the companies Wall Street analysts said to “sell” outperformed the market by 25 percent, while the stocks they said to “buy” underperformed by 7 percent. In other words, if you had followed the opposite advice of Wall Street professionals, you would have outperformed the S&P 500 by 7 percent!

Then what is the best way to make money in the stock market?

First and foremost, getting out of the market completely is not the answer. The greatest risk facing Americans today is longevity risk – running out of money. Investing in the stock market over the long term is one of the best ways to keep up with inflation and, if invested smartly, reduce your risks while maximizing returns and income.

Here are the steps to follow for long-term success in the stock market.

* Don’t try to pick stocks
* Don’t try to time the market
* Invest in a low-cost portfolio with a diversified asset allocation

According to a study by Ibbotson Associates, a portfolio’s performance is based on:

* Asset Allocation Policy – 91.5 percent
* Security Selection – 4.6 percent
* Market Timing – 1.8 percent
* Other Factors – 2.1 percent

Trying to pick the right stocks and timing the market only make up for only about 6 percent of a portfolio’s performance, yet make up a considerable amount of a portfolio’s losses! You have a greater chance of losing money than making money if you try to actively beat the stock market. In fact, over a three-year period, 90 percent of actively managed mutual funds lag behind the market.

A portfolio’s long-term performance is determined primarily by the percentage of investments in each class: cash, stocks, bonds and alternative investments. This helps protect your assets while maximizing growth potential. This percentage is based on your time horizon, risk tolerance, goals and financial plan.

-- David Chang, MidWeek, January 15, 2014

AAII Asset Allocation Models

why people are awful at managing money

People usually get better at things over time. We're better farmers, faster runners, safer pilots, and more accurate weather forecasters than we were 50 years ago.

But there's something about money that gets the better of us. If you look at the rate of personal bankruptcies, financial crises, bubbles, student loans, debt defaults, and savings rates, I wonder whether people are just as bad at managing money today as they were in previous generations, maybe even worse. It's one of the only areas in life we seem to get progressively dumber at.

Here are 77 reasons why people are awful at managing money.

3. You suffer from the Dunnig-Kruger effect, lacking enough basic financial knowledge to even realize that you're making mistakes. People's lack of understanding about things like compound interest and inflation can lead them to believe they're making good financial decisions when in reality they're tripping over themselves with failure.

4. For every $1 raise you receive, your desires rise by $2 or more.

5. You spend lots of money on material stuff to impress other people without realizing those other people couldn't care less about you. You'd be shocked at how few people care where your purse was made or how much noise your car makes.

13. The single largest expense you'll pay in life is interest. You'll spend more money on interest than food, vacations, cars, school, clothes, dinners out, and all forms of entertainment. You do this because you don't save enough and demand a lifestyle you can't actually afford. The future owns your income.

14. You're thrilled that the credit card you're paying 22% interest on offers 1% cash back on all purchases.

15. You spent the last five years arguing why Keynesian/Austrian economists were all wrong. The S&P 500 (SNPINDEX: ^GSPC  ) spent the last five years rallying 177%.

16. You think dollar-cost averaging is boring without realizing that the purpose of investing isn't to minimize boredom; it's to maximize returns.

17. Your work in a stressful job in order to make enough money to have a stress-free life. You see no irony in this.

18. You're a pessimist in a world where far more people wake up in the morning trying to make things better than wake up thinking we're all doomed.

19. You try to keep up with the Jonses without realizing the Jonses are buried in debt and can probably never retire.

21. You associate all of your financial successes with skill and all of your financial failures with bad luck.

22. Rather than admitting and learning from your mistakes, you ignore them, bury them, make excuses for them, and blame them on others.

23. You anchor to whatever price you bought a stock for, without realizing that the market neither knows nor cares what you think is a "fair" price.

27. You say you'll be greedy when others are fearful, then seek the fetal position when the market falls 2%.

30. You let confirmation bias take control of your mind by only seeking out information from sources that agree with your pre-existing beliefs.

31. You think you're too young to start saving for retirement when every day that passes makes compound interest a little bit less effective.

32. You spend a month researching the best washing machine, then invest twice as much money in a penny stock based solely on a tip from a person you don't know and shouldn't trust.

33. You're investing for the next 50 years but get stressed when the market has a bad day.

34. You're willing to work hard for $15 an hour, but too lazy to spend four minutes to fill out your company's 401(k) paperwork that could result in thousands of dollars of free money from matching contributions.

39. You don't respect the idea that "do nothing" are two of the most powerful words in investing.

41. You feel especially smart after last year's 30% market rally without realizing that you had nothing to do with it.

42. You surround yourself with 18 hours a day of live market TV in a game that requires decades of doing almost nothing but waiting.

45. You think financial news is published because it has useful information you need to know. In reality, it's published only because the publisher knows you'll read it.

46. You forget that the single most valuable asset you have as an investor is time. A 20-year-old has an asset Warren Buffett couldn't dream about.

50. You think it's impossible to live on less than $35,000 a year without realizing that literally 99% of the world does, even adjusted for purchasing power parity.

51. Your definition of a middle-class lifestyle is a 3,000-square foot home, more bathrooms than family members, three SUVs, private colleges, annual trips to Hawaii and Vail, Evian water, and yoga lessons. (Seriously, just stretch in your own living room.)

52. You can't acknowledge the role luck plays when making the occasional successful investment. (Also true when worshiping investors who made one big call that happened to be right.)

53. You suffer from hard-core belief bias. It's the tendency to accept or reject an argument based on how well it fits your pre-defined beliefs, rather than the objective facts of the situation. Pointing out that inflation has been low for the last five years is still met with suspicion by those who believe the Federal Reserve's actions must be causing hyperinflation.

56. You think the stock market is too risky because it's volatile, without realizing that the biggest risk you face isn't volatility; It's not growing you assets by enough over the next several decades.

57. You've never been to a poor country, robbing you of the realization that the world doesn't care how entitled you feel, what you think is "fair," or what a real financial hardship is.

58. You think blowing money on frivolous stuff impresses people, when in reality it makes you look like an insecure, pompous, jerk. (This is particularly common among young people who come into money for the first time.)

59. You're unable to realize that a 10% return for 20 years generates more money than a 20% return for 10 years. Time can be a more important factor than return when building wealth -- and it's the one thing you have control over.

60. You don't respect the mountains of evidence showing that once basic needs are met, the amount of happiness each additional dollar of income provides diminishes quickly. This causes you to spend most of your life chasing "the number" you think will make you happy, but probably won't.

62. You think of the stock market as numbers that go up and down rather than an ownership stake in real businesses with real assets.

63. You think renting a home is throwing money away when for many it's one of the smartest financial decisions they can make.

64. Your investment decisions are guided by what the economy is doing, when the two really have very little correlation.

66. You're unable to have a good time going for a hike, a bike ride, a swim, reading a book, or anything else that's free (or cheap). Having cheap hobbies is a large, yet hidden, asset on your personal balance sheet.

68. To paraphrase Carl Richards, you ignore history, basing your actions on your own very limited experience.

71. You think that not changing your opinion about markets, the economy, and your investments is somehow noble, when it's really just shutting your brain off to the reality that things are always changing.

72. You ignore that how elderly Americans who have seen it all view money is almost the opposite of how most young Americans view money. This goes back to not learning vicariously.

74. You underestimate how fast a company can go from "blue chip" to bankrupt.

75. You don't realize that when you say you want to be a millionaire, what you probably mean is that you want to spend a million dollars, which is literally the opposite of being a millionaire.

76. You're unaware that the business models of the vast majority of financial companies rely on exploiting the fears, emotions, and lack of intelligence of its customers.

77. You nodded along to all 77 of these points without realizing I'm talking about you. That goes for me, too.

dividends in America

AIG nearly went out of business in 2008. In nine months, the world's largest insurance company lost more money than it made in the previous 18 years combined.

But something strange happened: During most of this meltdown, AIG kept raising its dividend payout. Three times, in fact. In a year that erased nearly two decades of profits, AIG paid its shareholders $2.1 billion in dividends. It wasn't until the company was taken over by the U.S. Treasury that dividends finally ceased, by congressional order.

"We are being asked why we raised the dividend," former CEO Martin Sullivan said during a conference call in May 2008, after reporting a record loss. "The answer is that the dividend increase is a reflection of ... management's long-term view of the strength of the company's business."

I'm picking on AIG, but this kind of thinking isn't unusual among CEOs. Companies will jump through hoops to avoid cutting their dividends. In aggregate, there's only one clear trend in dividends: They usually go up. Since 2004, S&P 500 companies have raised their quarterly dividends 2,854 times, cut them 168 times, and stopped paying them just 46 times, according to Standard & Poor's. Forty one S&P 500 companies raised their quarterly dividends last month. One company cut its dividend.

This behavior oddly unique to America. Deutsche Bank published a report last decade asking global CEOs how they thought about dividends. Most managers from Europe, Asia, and South America took a pragmatic approach to dividends, and were more than willing to adjust payouts when their earnings were volatile. But American managers responded overwhelmingly that cutting a dividend was to be avoided at almost all costs.

It's also a new phenomenon. While reading old finance books, I kept coming across references to investors dealing with the ups and downs of dividends. Yale economist Robert Shiller's database of historical stock returns shows that dividends were wildly volatile. From 1871 through 1920, aggregate dividends fell in more than one-third of all months. From 1920 to 1950, dividends were cut in 23% of all months. Since 1980, they've declined in less than 10% of all months. The era of stable dividends is unique to the last 30 years.

the market p/e multiple

Since 1950, the P/E multiple of the S&P 500 has been on average 16.3x trailing twelve month earnings and the median value has been 16.6x earnings. Looking at the historical valuation multiples clearly shows that the market is neither expensive nor cheap relative to historical levels.

P/E multiples hit a monthly low in March of 1980 at 7.1 times earnings. P/E multiples hit a high of 29.9x historical earnings in June of 1999, roughly nine months before the dot.com bubble burst. These two time periods correspond very closely to periods of absolute pessimism and absolute optimism in the market. It is clear that sentiment drives valuation multiples. The more excited investors are about the future the higher the P/E multiple and the more pessimistic investors are about the future the lower the valuation multiple. Currently, sentiment is neither bullish nor bearish with many investors doubting the recent rally.

Additionally, bull markets rarely end at P/E multiples that are average. Historically, what has happened is that the optimism in the market during a bull market pushes the S&P 500 to higher than average valuation multiples before ending.

--- by Mitch Zacks, Senior Portfolio Manager, ZIM Weekly Update, 2/9/14

***

The current P/E multiple (according to this article) is 16.6.  So it doesn't appear the the bull market is over.

*** [2/26/14]

Stock valuations today are substantially higher
than historical averages. Wall Street’s pitchmen
work overtime to devise ingenious ways of proving
that the market is reasonably valued or even
“cheap.” However, nearly all these schemes rest on
the proposition that today’s record corporate profit
margins will persist indefinitely.

Plotted below is a far more objective and accurate
gauge for projecting long-term equity returns. The
Price-to-Sales Ratio takes the price of the Standard
& Poor’s 500 index and divides it by the sales (not
profits) of the companies making up the index. By
disregarding profit margins, the P/S ratio tunes
out the wild fluctuations that occur in companies’
reported earnings as the business cycle migrates
from boom to bust and back to boom again.

As you can see [if you have access to the newsletter], the P/S now stands at its highest level of the past decade—and about 65% above its average since 1950.

- Profitable Investing March 2014

*** [2/26/14]

TSLA is acting like a dot.com stock of 15 years ago.  Is the bubble back?

What's the Nasdaq's PE? At year-end 1999, it was about 200, according to analyst Brian Rauscher of Morgan Stanley Dean Witter. Growth companies--with prospects for above-average increases in profits--might be expected to have above-average PEs. Sure. In the late 1980s, the Nasdaq's PE fluctuated between 20 and 25. By 1991, it was about 40. In late 1998, it neared 100 and then doubled in the next year.

According to wsj, the current P/E of the Nasdaq 100 is 21.69.  A year ago it was 16.60.  Forward P/E is 18.76.  Surprisingly, the current P/E of the Russell 2000 is 84.68.  A year ago, it was 32.56.  Forward P/E though is a more reasonable 18.90.

What about TSLA?  TSLA has yet to turn a profit, but it's expected to be profitable this year and the forward P/E is "only" 72.5.

suggestions for long-term investors

And then there’s the business news. Serious business news that lacked sensationalism, and thus ratings, has been replaced by a new genre: business entertainment (of course, investors did not get the memo). These shows do a terrific job of filling our need to have explanations for everything, even random events that require no explanation (like daily stock movements). Most information on the business entertainment channels — Bloomberg Television, CNBC, Fox Business — has as much value for investors as daily weather forecasts have for travelers who don’t intend to go anywhere for a year. Yet many managers have CNBC, Fox or Bloomberg on while they work.

You may think you’re able to filter the noise. You cannot; it overwhelms you. So don’t fight the noise — block it. Leave the television off while the markets are open, and at the end of the day, check the business channel websites to see if there were interviews or news events that are worth watching.

Don’t check your stock quotes continuously; doing so shrinks your time horizon. As a long-term investor, you analyze a company and value the business over the next decade, but daily stock volatility will negate all that and turn you into a trader. There is nothing wrong with trading, but investors are rarely good traders.

Numerous studies have found that humans are terrible at multitasking. We have a hard time ignoring irrelevant information and are too sensitive to new information. Focus is the antithesis of multitasking. I find that I’m most productive on an airplane. I put on my headphones and focus on reading or writing. There are no distractions — no e-mails, no Twitter, no Facebook, no instant messages, no phone calls. I get more done in the course of a four-hour flight than in two days at the office. But you don’t need to rack up frequent-flier miles to focus; just go into “off mode” a few hours a day: Kill your Internet, turn off your phone, and do what you need to do.

Investing is not an idea-­per-hour profession; it more likely results in a few ideas per year. A traditional, structured working environment creates pressure to produce an output — an idea, even a forced idea. Warren Buffett (Trades, Portfolio) once said at a Berkshire Hathaway annual meeting: “We don’t get paid for activity; we get paid for being right. As to how long we’ll wait, we’ll wait indefinitely.”

Willie and his chocolate factory

There are many ways to value a company and none of them are incorrect. The more valuation tools you have in your tool chest the better. Just understand the company you are looking at and use the most appropriate valuation technique.

10 lessons from elderly Americans

Karl Pillemer is a gerontologist and a self-described person who "goes directly to the self-help aisle in the megabookstore." He combined these two passions and interviewed more than 1,000 elderly Americans -- most in their 80s and 90s -- seeking out advice on how to live a good life. He calls them "the experts." His book, 30 Lessons for Living, is wonderful, and I'd recommend it to everyone.

The experts give advice on everything from raising kids to a proper diet. But I found their advice on money and work the most fascinating, because it goes against so many maxims younger Americans live by. Here are 10 from Karl's book.

1. Young people obsess about making a lot of money. Older people wonder what they were thinking.

When asked about their prescription for happiness at work, what wasn't mentioned spoke the loudest. And fancy statistics aren't necessary because the results are so clear.
No one -- not a single person out of a thousand -- said that to be happy you should try to work as hard as you can to make money to buy the things you want.
No one -- not a single person -- said it's important to be at least as wealthy as the people around you, and if you have more than they do it's real success.
No one -- not a single person -- said you should choose your work based on your desired future earning power.

2. Money is often at war with time. Balance them appropriately.

The view from the end of the life span is straightforward: time well and enjoyably spent trumps money anytime. They know what it means to make a living, and they are not suggesting that we all become starving artists. But they also know firsthand that most people who decide on a profession because of the material rewards at some point look back and gasp, "What have I done." In their view, we all need a salary to live on. But the experts concur that it's vastly preferable to take home less in your paycheck and enjoy what you are doing rather than live for the weekends and your three weeks (if you get that much) vacation a year. If doing what you love requires living with less, for the experts, that's a no-brainer ...
If you are willing to accept a lower income level, you can gain enormous benefits by choosing part-time work as a lifestyle. Imagine if you suddenly had more leisure than work time. Some experts made this decision: living on much less money, renting rather than owning a house, and forgoing expensive consumer goods to pursue a job and a lifestyle they enjoy.

3. Independence at work is crucial.

When the experts discuss their work lives, two themes go hand in hand: purpose (beyond making a salary) and autonomy. Neither one can be found in every job, every time, but without them work can become a miserable burden...
Career satisfaction is often dependent on how much autonomy you have on the job. Look for the freedom to make decisions and move in directions that interest you, without too much control from the top.

4. You'll spend 40+ hours a week at work for half a century. Make sure you enjoy it.

[Expert:] "No amount of money is worth more than having a job that you're glad to get up and go to every morning, instead of one you dread ... I have learned many lessons, but there are only a few that in the long run are meaningful and which I have tried to pass on to my children and students. If you can't wake up in the morning and want to go to work, you're in the wrong job ..."
You know those nightmares where you are shouting a warning but no sound comes out? Well, that's the intensity with which the experts wanted to tell young people that spending years in a job you dislike is a recipe for regret and a tragic mistake. There was no issue about which the experts were more adamant and forceful.

5. Jump at new work opportunities.

I've seen people who turned down a promotion for fear it would be too time-consuming or taxing, or who rejected a chance to spend a year or two abroad because they were "not the adventurous type" ... The experts' view? This approach to life is a huge mistake. Their advice is to embrace new challenges at every turn, saying yes as often as possible. The most frequently reported regrets about work in particular involved times when opportunity knocked and they kept the door firmly closed. According to our elders, the greatest reward you can receive in your career is the opportunity to do more.

6. Not traveling enough is a key source of regret

I learned that whether [the experts] had visited dozens of counties or stayed put in one place, the experts had one thing in common: they wished they had traveled more.
I came away from my interviews with the realization of the profound meaning travel has at the end of life. To sum up what I learned in a sentence: when your traveling days are over, you will wish you had taken one more trip. Often, after a long narrative about trips taken, I heard an elder say wistfully, "But I always wish I'd visited ..." 

7. To succeed at work, you need to be more than talented. You need to be nice.

The experts come from hundreds of different occupations and employers. They have observed people who succeed at work and those who crash and burn. It is on such experiences that this lesson is based. Their consensus: no matter how talented you are, no matter how brilliant -- you must have interpersonal skills to succeed. Many young people today are so focused on gaining technical expertise that they lose sight of this key to job success: traits like empathy, consideration, listening skills, and the ability to resolve conflicts are fundamental in the workplace.

8. Be frugal, but live a little.

[Expert:] "Don't worry so much. There is not enough time in our lives to trade off the gold of our existence for the dust of what-ifs or what-if-nots. I had my first job before I was twenty and saved everything I could from my paychecks. I closed my ears to good advice from a dear woman who told me that I should enjoy my days and not become so absorbed with thrift. I did not understand what she said. Although I used money to attend plays and concerts, I did so knowing that each ticket for a performance meant less money in my savings account. As I grew older, people I knew and loved died, and I began to see how very precious each moment of each day is."

9. Stop worrying about things you can't control.

It seemed reasonable that people who had experienced the Great Depression would want to encourage financial worries ... the reverse is the case, however. The experts see worry as a crippling feature of our daily existence and suggest that we do everything in our power to change it. Most important, they view worrying as a waste of time. They see time as our most precious resource. Worrying about events that may not occur or that are out of our control is viewed by them as an inexcusable waste of our precious and limited lifetime.

10. Long-term thinking is a great way to live as an investor. It's a terrible way to live as a person.

[Expert:} "It seems to take a lifetime to learn how to live in the moment but it shouldn't. I certainly feel that in my own life I have been too future oriented. It's a natural inclination -- of course you think about the future, and I'm not suggesting that that's bad. But boy is there a lot to be gained from just being able to be in the moment and able to appreciate what's going on around you right now, this very second. I've more recently gotten better at this and appreciated it. It brings peace. It helps you find your place. It's calming in a world that is not very peaceful. But I wish I could have learned this in my thirties instead of my sixties -- it would have given me decades more to enjoy life in this world. That would be my lesson for younger people."

Ray Dalio

Warren Buffett once said, "It's never paid to bet against America." The same could have been said for the United Kingdom before World War I or Rome before Commodus' reign. While extrapolating the historical trend line is actually a pretty good prediction strategy, it's not the way to make money. Fortunes are made (or preserved) anticipating big economic shifts, and successful prediction requires good theory. Buffett admits his expertise is not in timing macroeconomic shifts. Ray Dalio's is. And he thinks the United States is an empire in relative decline.

Dalio is probably the best macro investor alive. He has made a fortune anticipating once-in-a-generation shifts, such as the financial crisis, the subsequent bull market in bonds, and the eurozone crisis. His hedge fund Bridgewater Associates is now the world's biggest, and its Daily Observations newsletter is devoured by policymakers and investors alike (your faithful editor included, when he can get his hands on a copy).

Dalio's model is generational. Each stage lasts about 30 years, progressing when the older generation either dies off or retires, allowing the younger generation to set the country's direction. To understand the U.S.' place in the arc of Dalio's model, let's look at each stage in turn.

Countries in the first stage, called early-stage emerging countries, "are poor and think that they are poor." For most people, staying alive is a struggle. Investment usually comes from abroad. Investors demand high returns on their capital as compensation for the big perceived risks. Foreign investors don't trust these countries to maintain the value of their currencies, so the countries peg them to gold or a reserve currency, or even adopt another country's currency wholesale. Much of Africa and parts of Asia and Latin America are in this stage and have been stuck there for decades.

Countries in the second stage, called emerging countries, "are getting rich quickly but still think they are poor." Productivity and income soar, but savings remain high and work hours long because people remember what it was like to be poor. They export more goods than they import and they undervalue their currencies to keep exports cheap. However, the currency peg keeps interest rates too low. As a consequence, debt/income and inflation rise. A country in this stage must eventually break the peg. When a big country goes through this stage, it typically becomes a world power. China is undergoing this transition.

Countries in the third stage, called early-state developed countries, "are rich and think of themselves as rich." Their per-capita incomes are among the highest in the world, and their priorities change to "savoring the fruits of life." They are seen as safe-haven investments. This describes the British Empire during the 19th century and the U.S. after World War II. These countries tend to have big armies to expand and defend their global empires.

Countries in the fourth stage, called late-stage developed countries, are becoming "poorer and still think of themselves as rich." In this stage, debt/income rises in a self-reinforcing cycle. Debt stimulates income and asset price growth, which in turn stimulates even more debt. However, research and development and capital spending decrease; budget and trade deficits increase. Infrastructure is old and less well-maintained. In other words, late-stage developed countries eat the seed corn, setting themselves up for slower growth. In the last few years of this stage, bubbles are frequent because investors extrapolate from recent trends. This stage ends when debt/income can no longer rise; incomes can no longer support bigger debt service.

In the final stage, "countries go through deleveraging and relative decline, which they are slow to accept." The self-reinforcing debt cycle now kicks in reverse: Private actors begin paying down or defaulting on their debts, leading to falling income and asset prices, encouraging more defaults and faster debt repayments. The first phase is dominated by defaults, what Bridgewater calls an "ugly deleveraging." Stocks do terribly; safe-haven bonds soar. Depending on how much monetary and fiscal stimulus is applied, the deleveraging can transition to a "beautiful" phase, where debt monetization, austerity, defaults and wealth transfers from the haves to have-nots are well-balanced. Typically, governments run deficits to make up the slack; central banks slash interest rates to both stimulate the economy and ease the burden of debt service.

It's clear the U.S. from at least 1980 to 2007 was in stage four. Look at our total debt/GDP over time. Since 1980, it rose in two steep jags: first, in the mid-1980s, when the government deregulated financial markets and ran massive deficits and the Federal Reserve began lowering interest rates to bring us out of the Volcker recession; and second, in the 2000s, when the Fed once again aggressively lowered interest rates to prop up the post-dot-com-bubble economy, and the government once again ran massive deficits.

The massive amount of debt the U.S. economy is laboring under will likely take decades to pay off. With more resources going back to paying off creditors, growth will be slower than it otherwise would have been. PIMCO calls it the "New Normal." Dalio calls it a "deleveraging process." Economists call it a "balance-sheet recession."

Dalio's model predicts a decades-long period of relative decline for the U.S. as it deleverages and the eventual graduation of China and other emerging markets from stage three to stage four. Because the U.S. is so rich and China is so big, chances are China will not catch up to the U.S.' average income during this process. The U.S. is not going to turn into a banana republic, either.

The deleveraging phase can be quite graceful, in fact. The U.K. was even more indebted after World War II than the U.S. is today. The British borrowed massively to fund nonproductive (but necessary) goods: guns, boats, tanks, and airplanes to fight the Nazis with. Its total debt/income ratio reached over 400%. How did they pay everything back? They didn't. The U.K. devalued its currency, suppressed real interest rates, and let inflation run a bit. It didn't liquidate its debt with a hyperinflationary bang, but rather let economic growth outpace debt growth over several decades.

I expect the same from the U.S. Not a big bang, but a long slog of low real interest rates and slow debt growth. Investors scared of the debt worry too much about the wrong things: vivid, hyperinflationary scenarios, in which the government's machinations ruin the economy. We have to account for the incentives and the knowledge of our policymakers. Our central bankers do not benefit by driving the economy into the ground. They also know that the debt problem can be slowly defaulted on without throwing the economy into turmoil, so that's likely the policy they'll continue to pursue.

Investment Implications
Intriguingly, it turns out that a deleveraging country's stocks can do quite well. Bridgewater notes British equities returned 13.3% annualized from 1947 to 1959, a period of "beautiful" deleveraging.[1] On the other hand, Japan's equity markets struggled for over two decades since their bubble popped and they entered an "ugly" deleveraging, which they haven't exited yet (though this may be changing with Shinzo Abe's shock-and-awe campaign of fiscal and monetary stimulus coupled with structural reform).

And even with low yields, bonds can do well. If you can leverage up bonds to match the volatility of stocks, you would have received midteens returns in both ugly and beautiful deleveragings because of capital gains from rolling down the yield curve and deflationary surprises[1]. This analysis was why Bridgewater was bullish on Treasuries after the financial crisis, a time when everyone else thought yields would rise. However, if you can't leverage up bonds, they don't offer much return.

Finally, regardless of the type of deleveraging, gold did well against the deleveraging country's currency. Unsurprisingly, Dalio is a big fan of gold. He argues it's a form of money. Many rich-world central bankers don't agree, but, according to data from the World Gold Council, Russia has been a net buyer of gold every quarter since 2007, and both China and India dramatically increased their gold reserves in 2009.

*** [2/16/14]

In many respects, Dalio is the anti-Warren Buffett. Buffett makes big bets on a handful of companies. Dalio makes many small bets on currency pairs, commodities, bonds, and, to a much lesser extent, equities. Buffett grants his subordinates plenty of autonomy and lets them figure out their own way. Dalio imposes a set of principles that his subordinates are to live by and heavily monitors them. Buffett doesn't give much thought to economic cycles. Dalio's investing style is based on identifying and navigating them. Buffett doesn't like gold. Dalio thinks everyone should own a little bit of it.

*** [8/13/14]

Some  billionaires hold onto the secrets to their money-making success with a tight fist. But Ray Dalio is worth $14 billion and is more than happy to share.

Although he isn't a household name, he should be, as he's revealed the secrets to his success in a 123 page paper simply entitled Principles, that is chalked full of great investment advice. And there are five things we should remember when making our own investment decisions.

*** [9/24/14 Grahamites]

One of my all-time favorite readings is “Principles” by Ray Dalio (Trades, Portfolio). I think everyone should read it, whether or not you are an investor. Mr. Dalio stated in the forward that he wanted us to think for ourselves – to decide 1) what you want, 2) what is true and 3) what to do about it.

Among all the principles Dalio generously shared, the principle truth – “more precisely, an accurate understanding of reality” is the one that has the most impact on me. In this article, I’d like to share with the readers a few quotes I jogged down while reading this principle.

Among all the principles Dalio generously shared, the principle truth – “more precisely, an accurate understanding of reality” is the one that has the most impact on me. In this article, I’d like to share with the readers a few quotes I jogged down while reading this principle.

• Truth is the essential foundation for producing good outcomes.
• I have found that observing how nature works offers innumerable lessons that can help us understand the realities that affect us. For example, I have found that by looking at what is rewarded and punished and why, universally – i.e., in nature as well as in humanity – I have been able to learn more about what is “good” and “bad” than by listening to most people’s views about good and bad.
• I believe that we all get rewarded and punished according to whether we operate in harmony or in conflict with nature’s laws, and that all societies will succeed or fail in the degrees that they operate consistently with these laws.
• Understanding what is good is obtained by looking at the way the world works and figuring out how to operate in harmony with it to help it (and yourself) evolve. What is bad and most punished are those things that don’t work because they are at odds with the laws of the universe and they impede evolution.
• I believe that the desire to evolve, i.e., to get better, is probably humanity’s most pervasive driving force. Enjoying your job, a craft, or your favorite sport comes from the innate satisfaction of getting better. Though most people typically think they are striving to get things (e.g., toys, better houses, money, status, etc.) that will make them happy, that is usually not the case. Instead, when we get the things we are striving for, we rarely remain satisfied. It is natural for us to seek other things to seek to make the things we have better. In the process of seeking, we continue to evolve and we contribute to be evolution of all that we have contact with. The things we are striving for are just the bait to get us to chase after them in order to make us evolve, and it is the evolution and not the reward itself that matters to us and those around us.
• Self-interest and society’s interests are generally symbiotic: more than anything else, it is pursuit of self-interest that motivates people to push themselves to do the difficult things that benefit them and that contribute to society. In return, society rewards those who give it what it wants. That is why how much money have earned is a rough measure of how much they gave society what it wanted – NOT how much they desired to make money. Look at what caused people to make a lot of money and you will see that usually it is in proportion to their production of what the society wanted and largely unrelated to their desire to make money. There are many people who have made a lot of money who never made making a lot of money their primary goal. Instead, they simply engage in the work that they were doing, produced what society wanted, and got rich into it. And there are many people who really wanted to make a lot of money but never produced what the society wanted and they didn’t make a lot of money. In other words, there is an excellent correlation between giving society what it wants and making money, and almost no correlation between the desire to make a lot of money and how much money one makes. I know this is true for me – I never worked to make a lot of money, and if I had I would have stopped ages ago because of the law of diminishing returns. I know that the same is true for all the successful, healthy people I know.
• Some of the most successful people are typically those who see the changing landscape and identify how to best adapt to it.
• It is extremely important to one’s happiness and success to know oneself – most importantly to understand one’s own values and abilities – and then to find the right fits. We all have things that we value that we want and we all have strengths and weaknesses that affect our paths for getting them. The most important quality that differentiates successful people from unsuccessful people is our capacity to learn and adapt to these things.
• However, typically defensive, emotional reactions – i.e., ego barriers – stand in the way of this progress. These reactions take place in the part of the brain called the amygdala. As a result of them, most people don’t like reflecting on their weaknesses even though recognizing them is an essential step toward preventing them from causing them problems. Most people especially dislike others exploring their weaknesses because it makes them feel attacked, which produces fight for flight reactions; however, having others help one find one’s weaknesses is essential because it’s very difficult to identify one’s own. Most people don’t like helping others explore their weaknesses, even though they are willing to talk about them behind their backs. For these reasons most people don’t do a good job of understanding themselves and adapting in order to get what they want most out of life. In my opinion, that is the biggest single problem of mankind because it, more than anything else, impedes people’s abilities to address all other problems and it is probably the greatest source of pain for most people.
• Aristotle defined tragedy as a bad outcome for a person because of a fatal flaw that he can’t get around. So it is tragic when people let ego barriers lead them to experience bad outcomes.

printing money?

The government really doesn’t “print money” in any meaningful sense.  Most of the money in our monetary system exists because banks created it through the loan creation process.  The only money the government really creates is due to the process of notes and coin creation.  These forms of money, however, exist to facilitate the use of bank accounts.  That is, they’re not issued directly to consumers, but rather are distributed through the banking system as bank customers need these forms of money.  The entire concept of the government “printing money” is generally a misportrayal  by the mainstream media.

[I don't get it.  So what this about hyperinflation and precious metals?]

So to "create" money, the government buys bonds (from banks?).  So the government gives cash to banks in exchange for a promise to pay it back with interest.  So where does the cash come from?  Haven't they run out of cash yet to buy bonds with?

So how does inflation occur?  I always thought it was because there was more and more money in circulation, causing the value of money to go down (so prices go up).

I guess not.  But I don't really understand these explanations.  And another one.

payback in 2014?

After a great year for equity markets in 2013, investors are looking to next year and wondering whether there will be a "payback" coming, as described in the Schwab Market Perspective. 

We expect the US market to experience a decent pullback at some point during 2014, but still believe stocks will end the year higher. 

Despite the strong returns in 2013, according to our friends at ISI Research, there have been 11 years since 1950 that the S&P 500 has posted 25% plus gains, and with the exception of two recession years, the S&P posted positive results in the following year.

Giving with purpose

OMAHA, Neb. (AP) — A free online course that starts Monday will offer students the chance to learn about giving from Warren Buffett and help decide how to spend more than $100,000 of his sister's money.

More than 4,000 people have already signed up for the course that will also feature philanthropic advice from baseball legend Cal Ripken Jr. and the founders of Ben & Jerry's ice cream, Ben Cohen and Jerry Greenfield. Boston Red Sox Chairman Tom Werner and journalist Soledad O'Brien are other featured guests. The amount being given away could grow if more students sign up.

Buffett and his older sister, Doris Buffett, will be featured in the first class to talk about their motivation for philanthropy. Warren Buffett is gradually giving away all of his $58 billion Berkshire Hathaway stock while Doris Buffett has already given more than $150 million away en route to her goal of redistributing all her wealth before she dies.

"The trick is not to have her give it away faster than I make it," Warren Buffett joked because his family's wealth is tied to the Berkshire Hathaway conglomerate he runs.

Each one of the big-name givers will be featured in videos at the end of each of the six class sessions discussing an aspect of philanthropy.

But everyone involved with the course agrees that the fact students get a chance to give away real money may be more important than the famous speakers because it makes the lessons more powerful.

"It's an experience that gives profound insight into deciding how we meet the needs of our society," said Rebecca Riccio, the Northeastern University professor who will teach the course.

The Giving With Purpose online course is modeled after a class that has been taught at more than 30 universities that allows students to give away $10,000 after evaluating several nonprofits and learning about effective giving. This online offering allowed Doris Buffett's Sunshine Lady foundation to expand the classes without adding staff to manage the program.

"Giving With Purpose allows us to extend the classroom walls to include any individual passionate about philanthropy," Doris Buffett said in a statement. "There are thousands of people with the energy and ideas to make a difference."

simple financial tips to follow (30 years ago)

Sadly, we can't turn back the clock and do things right. We can, however, teach the younger generation to avoid making our mistakes.

Here is a handy, one-page financial checklist that will allow everyone to build their wealth over the long term. If you follow this simple advice, you'll be on the road to financial freedom.

1.  pay yourself first
3.  create a portfolio for all seasons

market valuation

What a great year it was! The market was up 30%, the best year since the go-go years of 1990s.The good news is that our account balance is higher, investors are more bullish. The bad news is that we will see lower future returns.

So where are we with the market valuation and the expected return starting 2014?

The ratio of Total Market Cap over GNP, Warren Buffett’s “the best single measure of where valuations stand at any given moment,” is standing at 115%. This ratio is already higher than the pre financial crisis peak of 107% and is higher than any time except for the go-go years of late 1990s, when it reached 141%. Its historical mean is around 85%.

Shiller P/E, the cycle adjusted P/E ratio, is now at 25.6, 55.2% higher than the historical mean of 16.5.

If we assume that the ratio of total market cap over GNP (Buffett’s indicator) and Shiller P/E will reverse to their mean over time, which they always did in the past, the future market returns do not look good. Using 8 years as time the market will reverse to its mean, both Buffett’s indicator and Shiller P/E suggest that the stock market will average 1% a year (2% dividends contribution included) over the next 8 years. At 1% of total market return, the market indices will be lower than they are now after 8 years.


Howard Marks, one of the smartest investors from Oaktree Capital, describes the three stages of a bull market:

· the first, when a few forward-looking people begin to believe things will get better
· the second, when most investors realize improvement is actually underway, and
· the third, when everyone’s sure things will get better forever

He also wrote the three stages of a bear market:

· the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
· the second, when most investors recognize things are deteriorating, and
· the third, when everyone’s convinced things can only get worse

In May 2012, he thought we were at the first stages of bull market: a few forward-looking people begin to believe things will get better. In May 2013, he thought that we were somewhere in the first part of stage two.

After a gain of 30% in 2013, investors are more bullish. We don’t know which stage of bull market Howard Marks thinks we are now, but we believe that we are either at late second stage or early third stage.

is the secular bear over?

Here's an interesting video from Kevin Cook at Zacks.

Doing a search, it looks like Kevin is rehashing Doug Short's article.

The first chart is interesting.  It identifies five secular bull markets and four secular bear markets since 1877.

1877-1906 bull (334%)
1906-1921 bear (-69%)
1921-1929 bull (396%)
1929-1932 bear (-81%)
1932-1937 bull (266%) [I call this a bull even though the line is still red on the chart]
1937-1949 bear (-54%)
1949-1968 bull (413%)
1968-1982 bear (-63%)
1982-2000 bull (666%)
2000-2009 bear (-59%)
2009-present (115%)

[from the color on the chart, apparently there was no bull market in 1932-1937 and a secular bear from 1929-1949]

The question seems to be whether we are presently still in a bear market or whether it'll be like 1937 when the market rallied 266%, then pulled back 54%.

The next chart adds a regression line.  The previous bottoms were 33%, 59%, 67%, 59%, 55% below the trend line.  The previous tops were 85%, 81%, 12%, 55%, 151% above.

The 2009 bottom was only 11% below trend and we are presently 77% above.  The bear case is that there is more room to fall since the previous bears fell much further than 11% below trend.

But even if we're still in a secular bear (like 1929-1949), the market went 266% from the bottom, so we could have more room to run too.