The credit crunch has the possibility to expand, so suggests Reuters:

The problem with using credit cards — with their high interest rates — to stave off default brought on by “reset” adjustable mortgage interest is that it merely postpones an inevitable crisis, said Gregary Brown, social policy director at Metropolitan Family Services in Chicago.

“Our biggest concern right now is that there are lot of people who will face a choice between bankruptcy or foreclosure,” he said. “Either way, it’s going to suck.”

There’s no doubt that the general population has a tendency to offset problems to a later date. I just worry we might see an implosion in the credit card market with increasing delinquency rates. This may lead to credit lenders tightening the reins, and the profit margin, which could mean less discounts and award schemes for consumers.   I hope not, because wise credit card use is a great way to recover losses in fees from financial institutions.

 The subject of aid in the mainstream seems to me to be very uniform; almost everyone supports aid to Africa. Among economists, however, the debate rages on. The problem with aid isn’t so much the theory, it’s more the tendency for the money to fall into the wrong hands. Many UN reports have shown over the years, only a small percentage of aid actually gets to where its needed, the general populations. Worse still, most of this money ultimately ends up in the hands of corrupt government officials, whom represent authoritarian regimes, and instead use the money to further their own agenda; one which is delivers sad irony to both the donators and the intended beneficiaries.

I’ve always believed its the little things that will save Africa. Microloans is one of my favourites, encouraging entrepreneurship and responsibility, all rolled into one. Today I read of another great idea for fighting poverty; Eleni Gabre-Madhin wants to set up a commodities market in her home country of Ethopia.  I think this is a fantastic idea. Its often understated how important the markets were to the development of Western countries. Although they created some perilous times as well (namely the 1929 stock market crash, and subsequent depression), overall they’ve been an important cornerstone for our economic achievements.

Money quote:

Gabre-Madhin left her earlier job, as a World Bank senior economist in Washington, DC, in part because she was disturbed by the 2002 famine in Ethiopia — after a bumper crop of maize the year before. With prices depressed, many farmers simply left their grain in the field in 2001. But when the rains failed in 2002, a famine of 1984 proportions threatened the country. Her dream: to build a market that protects the African farmer, who is too often living at the mercy of forces beyond his or her control.

I wish her the best of luck. Its about time we gave this continent something tangible that doesn’t need to be re-loaded.

John Dvorak has no idea why Microsoft bought itself a 1.6% stake in Facebook, valuing the company at $15 billion US. As a regular Facebook user, all I can say is, its a very well designed site, extremely useful, and light years ahead of Myspace, whom was purchased by Rupert Murdoch’s News Ltd some 2 years ago. John is right, us social network website users always flock to the latest and greatest thing. The great part about Facebook though, is the ability to add custom user apps to your user profile. At the moment, I’m in a football tipping competition, I can monitor where my friends are traveling too, and best of all, draw stupid picture messages of assorted penis’s and boobs, and post them on my friends profile.

One of my favourite bloggers, Pmarca, is in the start up phase of his social networking website, Ning. Although I’ve never spoken to him, if Pmarca is as shrewd at business development as he is at posting fantastic ideas on his blog, he may someday make Microsoft look very very foolish over this announcement…. He also points out the hilarity in Microsoft’s change of heart.

Comedy gold.

Reading the Byrne’s Eye View blog today, I stumbled across an interest notion of cross-ownership of companies (i.e, both companies owning a piece of each other). His thoughts are based on the news that Citic, China’s largest investment bank, and Bear Stearns, one of the largest US investment banks, are planning on swapping ownership stakes. I’m thinking of this in terms of a half merger; these companies don’t quite want to merge, but they’d still like to have some formal connection as they move into the future.  Byrne made an interesting point:

 This was apparently one of the problems with Japanese equity markets in the 80’s. If A, B, C, and D were connected in a chain of cross-ownership, A’s good quarter (in operations) could show up on B’s P&L thanks to trading, which would boost C’s results, which, in turn, would give D’s balance sheet enough heft for it to issue more debt, which it would lend to A, which would…

I’d love to see if any Australian companies have some kind of cross-ownership going. It’d make for interesting analysis. And when I say interesting, I of course, mean nerdy.

The inflation figures are out, and it doesn’t look good for Howard Inc, with inflation numbers staying the course of the last few years. This quarter, it was at 1.9%, which is on the lower scale of past inflation figures. The trouble is, past inflation figures have led to rate rises, and unfortunately for our lovable Liberals, if the Reserve Bank wants to be consistent, an interest rate hike is close to a certainty. This is the peril in running a campaign based on a mechanism you have little control over. The RBA is embodied with powers that are separate from our politicians, and with good reason. Can you imagine the abuse that could occur, in situations just like this one? Using interest rates as a political tool is very dangerous. Hence why the current system stands; independent, highly experienced board members meet, talk about figures, and make a decision without having to worry about so much as a text message from Costello (although he probably has tried).

Costello makes one glaring mistake, at least from my eyes. He talks as if the sole goal of the reserve bank; yes, all those highly paid egg heads with mountains of experience, is to keep the inflation rate between 2-3 percent.

PETER COSTELLO: Well, as I said yesterday …take out volatile items, and the other statistical measures showed that inflation was towards the upper level of the band, around three per cent.

CHRIS UHLMANN: Forcing the Reserve Bank to move?

PETER COSTELLO: Well, I don’t think that’s the right understanding of monetary policy. The monetary policy which I have set with the Reserve Bank governor is to keep consumer price inflation between two and three per cent over the course of the cycle.

So why do we need a reserve bank then, Pete? All decision making on interest rate cuts or rises could be made automatically, using a simple equation. Surely a conservative government could recognise the need to cut the fat. Why do we even need an RBA? We have the treasurer setting targets, why the need for experienced men to talk about possible future financial conditions? What’s the point in debating various macro-economic scenarios, and how changes could effect all participants, as a whole? Of course, by talking this way, I sound like a moron, because the answer is pretty obvious. Especially to Mr Costello. There in lies his problem. He knows the truth, and he knows if the RBA makes the financially sensible move, his re-election chances take a huge hit. Politics and money rarely mix well.

Could the credit crisis not be about liquidity, instead about something even scarier, like exposure to risk? Telos reports:

“Since the month of August, economists have been trying to understand why something that was supposed to be positive for global growth, namely the diversification of risk through securitization, had turned out to be the source of the recent crisis. The first reaction was to characterize this as a liquidity crisis…. More than a month, and many billions of dollars of extra liquidity injections, later the situation in money and credit markets has not improved. Central banks have added liquidity to a situation of already “excess liquidity” to tackle an apparent liquidity crunch, and yet nothing has got better. Perhaps it was not about liquidity, after all.

What we are experiencing is a combination of reduction in the value of global collateral, deleveraging, reintermediation, and risk aversion.”

To me, this is very scary and raises the idea that maybe the underlying theory behind practices such as securitisation, to be perfectly blunt, are majorly flawed as a growth mechanism. When loans get repackaged, bundled and sold off as AAA credit ratings, it’s not unlike a manufacturer selling a flawed product inside some very pretty packaging. These tactics in the consumer world aren’t as huge a crime, because eventually consumers figure out the products are not as advertised, but flawed, and simply ‘bad value’. But what if every consumer took it as gospel that each boxed good was exactly what the box said: a low risk, high quality mechanism, and no one ever questioned it? Then you’ve got some problems. Liquidity is still the problem, but that’s in the medium term. In the short term, risk is the true
problem.

Advice in newspapers leaves a lot to be desired. Most of it is fore-casted on a ‘best case scenario’, using a sample period of usually ten years or less. The trouble is, it’s difficult for multiple market cycles to exist within such a short space in time, giving off certain illusions. When a statistician collecting data for the government needs to survey growth and demographic trends, at least 50 years of careful data analysis is needed to determine the direction of the trend. More importantly than the direction, however, is the volatility that occurs within the sample. By identifying the standard deviation of the mean, someone well-versed in statistics could determine a system that smoothes out shutters in the data, providing the end user of the data with a clear picture on what kind of changes to expect. In other words, proper statistical collection can arm the end user with likely outcomes, allowing them to make logical decisions about future projects.

Although the above paragraph was probably a little heavy for most readers, I still believe it’s necessary to make an important point. Understanding the importance of long term statistical deviation is the key to identifying whether someone was ‘lucky’ or ‘unlucky’. In the end, that’s the one thorn in our decision making. Bad luck, or even temporary good luck, may skew our views, or give us false pretenses to believe our system of investing in a strong long term prospect.

Fairfax’s moneymanager.com.au website is a never-ending source of bad advice (good resource for news and information, however), or at best, good advice with a bad lesson. I was particularly fuming over the article, “many different roads to riches.” I must admit, I like the title, because it’s a very good point; there’s a million ways to make your money work harder. Index funds, investment properties, stock picking, venture capitalism, all share a common characteristic; methods in which to grow your net assets by placing them in areas which will be valued higher in the future. Read that sentence again, carefully, because that’s the crux of the issue. You need to be placing your money in a place where a re-evaluation by the general investing world will see your particular asset valued higher. Not just that, it needs to have an absolute return (I’ll get into relative and absolute returns in another post) which is satisfactory for the market conditions (if stocks are appreciating 20% per year, your 5% per year may be unsatisfactory in the context), and the long running needs of your asset requirement (in other words, how much cash you think you’ll need in the future). That’s it. I just wrote the secret to good researching for an investment, always be keeping the concept of higher valuation in your mind.

Penny Prior is probably not an experienced investor. She no doubt has solid journalism experience, 5 years according to my search. She’s been involved with many finance publishing houses, and seems to know what she’s talking about. In a way, she does. She knows the lingo. She has a solid knowledge of financial history. She likes to explore different ideas, helping the public become acquainted with investing ideas that may give them a greater return. All of these are good things, but one must remember, she’s a journalist, not a finance manager. Her own portfolio probably performs modestly. She
probably earns the standard experienced journalist wage, in other words, not even close to the amount that an experience financial analyst as a large firm would earn. To get to the point, why would her lack of experience and intelligence be an issue for those reading this article? Because she’s prone to misrepresenting the true circumstances of those involved, and drawing irrational conclusion from analogious situations. In other words, she’s giving you bad advice. Allow me to review each case, the advice given, and put a more realistic spin on the situation.

Steven Chang, young options trader.

Steven is a young graduate who trades options on a $100,000 portfolio. First mistake, she identified Mr Chang as having $100 000 in net assets. Mr Chang, as stated in the article, actually has $0 in net assets.

Of his $100 000 portfolio, $50 000 is his own capital and $50 000 is
borrowed.

Nitpicking, but its important because it misrepresents his financial position. Next, she points out that Chang had an annual return of 30%. Good gains over 4 years. Not to poo-poo on Mr Chang’s results, but lest we forget, we have been through one of the strongest bull markets in the ASX’s history. This is what I was referring to when I said “best case scenarios” in the first paragraph. It doesn’t get much better for a growth orientated options strategy then the last 4 years. Once again, no disrespect to Mr Chang, but I’d love to see his 20 year results, although Ms Prior probably won’t be covering that. Either Mr Chang’s results fade, and she’ll scrap his record off her journalistic record, or he’ll go on to huge success, in which case bigger super-journalists will probably cover the story of the wonder kid who struck it rich. Somehow, I doubt we’re going to hear a case of the latter. Why? Because options trading is extremely complex, far more so then any regular stock investing strategy. To cut a long story short, options are worthless at expiry; thus they have a time decay feature that require consistent re-evaluation of the security and the resourcefulness to make a decision on the fly, with the pressure of total capital loss if the wrong decision is made. In other words, options trading is very difficult, and should not be attempted by everyday investors.

Catherine Lezer, property investment.

Perhaps my biggest pet hate for investment ideas are those who peddle a property ‘buy and hold’ strategy as a fail safe, strong relative return, and most importantly, a ‘no brainer’ investment. In this example, Mrs Lezer held a $59 000 property for 10 years, with little appreciation in those years, and when it did go up, she sold it for a tidy profit. Firstly, let’s assume that Mrs Lezer could make 10% on the market over 10 years. This would give her a net capital of $159 715.45. Without knowing exactly how much Mrs Lezer sold the house for, its hard for me to make an assessment as to whether it was a wise decision. I will say this: even if she made double her money back, and including her $110 a week rent (this also assuming no expenses for house fixture problems, 100% tenancy, and self managed with no real estate fees), she’d only just reach my 10% benchmark. But the real problems with her first investment is simple; our simple 10% Rate-of-Return gave us the option of redrawing that money at any point through the 10 years. Although my example may lack a little realism, the point is, she was stuck with her investment for 10 years and if she withdrew at any point before then, she would have suffered a huge loss. In my basic, abstract investment example, my gains are more balanced throughout the years, so any withdrawal in capital will still net me a return relative to the time I invested. In other
words, Mrs Lezer took a huge risk, and was lucky to get a pay off. The risk did not equal the reward. Even if she made double the money back, she still would only have made 10% compounded per year on her initial investment. Total risk, but only an average return. Sign me up!

She then describes how she made insane profits in Australia’s biggest property bull market ever.

“We bought that for $310,000 in 1999 and sold it two years later for $440,000,” she says.

“It then dawned on us how easy it is to make money in property.”

I’ll give her one thing, at least she’s smart enough to cash in on a once-in-a-lifetime opportunity. But once again, her example is littered with half of the facts. What of the land taxes she would have to pay? What was her rental returns? How much in fees did she need to pay to real estate agents? What about the cost of borrowing? Many questions remained unanswered. But this quote is my favourite:

“People may need to cut back on their day-to-day spending and they may even have to buy in a cheaper area.

‘My advice would be to get into property as soon as you can even if it’s not where you want to live,’ Lezer says.”

My perspective is a little broader then Mr Lezer’s. That’s mostly because I’ve studied a whole range of investment strategies, as well as reviewing the historical context of past performances. When I look at today’s property market, and I see people saying “I can’t lose, just make as much sacrifices as you can to save, then buy whatever you can!” I think of Japan in 1989. Japan went through a huge borrowing glut, blowing property prices sky high, creating the biggest property bubble ever seen. In fact, prices still have no recovered, some 18 years later. Most depreciated for up to 12 years after the fact. Granted, Japan’s property woes were divided between both commercial and residential, but the point still stands. Property can go very wrong, very fast, and you can be locked into paying into an asset that will lose value, and there’s no way you can escape it. That’s a scary prospect. And it’s not unprecedented in world property history. Just for the record, I have no objections to people buying property as a means of gathering a return. But when you don’t understand cash flow, property price valuations, tax minimisation, and absolute risk, you probably should purchase a few books and start reading. Too many dim minded people got rich off property, and started handing out dim minded advice to even dimmer people. Don’t get stuck in this cycle, be smart, look beyond the hype for the true opportunities that lie in any market place.

Although I didn’t start this blog as a means of playing media watch to the financial community, I have no qualms in trying to educate readers on common fallacies that arise. If there’s a common theme I see in our mainstream media, it’s that they don’t know jack about what they’re peddling; that goes for any category; politics, sport, even lifestyle. Money managing is no different.

Stock portfolios are tricky concepts. We all know about the need to balance our assets according to various, and very well repeated, practices. Diversification as a risk management concept is one which is often treated as gospel among even those who don’t fully understand it. There’s no doubt that your portfolio needs diversification - mine sure as hell has it. The problem is, most people (and unfortunately, financial planners) don’t understand what proper diversification really is. This can lead to strategies built on totally false ideas. Sector diversification is one I \continually see people using as a way of ‘avoiding a dot com-like meltdown’ in their portfolio. In truth, it doesn’t avoid anything.

James Montier discusses the perils of using sector rotation as a strategy. In short, even if you guess the life cycles perfectly, you still only make around 2% p.a more, assuming some fairy gives you the definitive guide on exactly what each sector is in what position. If anyone meets such a fairy, I would love for her (or his?) number to be forwarded to me so I can profit by selling this report to gullible individuals, not by a meager 2% rise in portfolio worth. Even fund managers, those who are supposed to be in the know, couldn’t use the core values of a sector strategy for their clients, and all end up ‘destroying value for clients’. And they make up around 35% of accounts managed in the US market. The world financial markets constantly reminds me of what a cess pool of bad information and mediocre individuals it really is.

So, what can be done to smarten up your portfolio? Use both overseas and domestic stocks, use bonds so you’re never fully vested, diversify in index funds, and keep everything balanced on paper. This should keep your risk down and your returns normal. “But I want abnormally high gains!” I hear you say. Don’t we all? The good news is, they are obtainable to the right
investor. The bad news is, it requires more complexities, more courage, more restraint, and persistence. And you can’t get it with simplistic approaches, or by reading the latest book written in honor of Warren Buffett.

Retiree’s from university earn up to $1317 more per month than their high school graduate counter parts. It makes perfect sense that a disparity would exist, but what surprises me is how wide the gap is; particularly when unversity graduates don’t get as well compensated as what everyone is led to believe.

Reading further into the article, the real truth is discovered. Moneyquote:

“The fact that those with higher levels of education may have earned more during their working lives is further enhanced by the fact that they are also more likely both to obtain financial advice and to start saving for retirement sooner.” The survey shows 51 per cent of tertiary-educated respondents plan to visit an adviser in the next 12 months, compared with just 24per cent of those with only a secondary education.

People who seek financial advice and plan for the future have more money than those who do not. University graduates trust professionals more than high school graduates. None of this is of any great surprise, however. Perhaps we need more education at the high school level at the benefits of solid financial planning.