Buy things on sale

It seems that all the pundits have piled on the “bash the US” bus over the past two or three years.

Unquestionably America has, in the words of Warren Buffet, experienced the economic version of Pearl Harbor. It has been hit hard.

The profligate spending of consumers and government is going to take several years to unwind. While business indicators are generally trending positively, Jane and John Doe are feeling poorer. It’s no surprise given the erosion of paper wealth created when the housing bubble popped.

For those of you who know me you know me to be a resolute fan of the US. Yes, everyone is excited about China and its prospects. I am under no illusion about the positive impact China’s growth with have on the world’s prosperity. I am excited about the possibilities of more than a billion middle class consumers looking for things like toasters, DVD players and microwave ovens.

But I believe that the entrepreneurial spirit, free enterprise system, rule of law, stable democracy and the protection of intellectual and real property rights will always keep America on the leading edge.

Warren Buffet spends fifty minutes with Charlie Rose talking about business, the economy, the US, China, Berkshire Hathaway, succession and the role of government.

I highly recommend watching the interview. But in case you don’t have time then I’ve summarized his main points under the YouTube box below.

(1) People must have confidence that their government can work. This confidence comes from avoiding promises that cannot be kept and by making realistic and achievable plans.

(2) McGraw Hill owns S&P, it’s likely that McGraw has a lot of its money in US T-bills. The US can and will always pay its bills. The downgrade shouldn’t have happened.

(3) China’s criticism of the US is self interested. It owns more than $1 trillion in USD and gets worried about that investment being devalued (through printing more money).

(4) The economy is improving. Across Berkshire’s 70 businesses almost all of them have been growing. Only those related to the housing sector are struggling.

(5) The US has to work off the excess housing created during the binge last decade. It is happening. It will take time because growth in population is baked into the system (people have kids and people immigrate).

(6) In 1779 the population of China was 290 million, Europe 50 million and the US 4 million.  Americans weren’t smarter, they didn’t work harder and they didn’t have better natural resources. They had a system that worked. Chinese were smart back then too, but now they’re learning and employing the system that works.

(7) The world economy is not a zero sum game. It is good for everyone if countries like China and the US prosper. One does not necessarily do it at the expense of the other.

(8) Approximately 19% of revenue comes from taxes and the government can spend 21% if the economy and country continues to grow. What can’t happen is for that 2% deficit (of GDP) to grow as a percentage of income or growth.

(9) A bit tongue-in-cheek, but a good way to get the attention of legislators is to require that unless the deficit is reduced to 3% of GDP (now 10% of GDP) then they are not eligible for reelection.

(10) It’s nonsensical that 60 million people live in households that earn less than $21,000. But through entitlements people like Warren Buffet get a $32,000 per year social security benefit. Entitlements are a problem.

(11) The market system works. Incentives and equality of opportunity being key. The lucky ones prosper disproportionately. A rich society like the US should think about those 60 million people and how to help them.

(12) Two things are needed to keep the financial system from going crazy: (a) limits on leverage and (b) proper incentives for people at the top of important financial institutions.

(13) Buy things on sale. Berkshire spent more money buying stock this past Monday than any other day in 2011. Berkshire has spent $7 billion on capital investment almost all of which is in the US. This is $1 billion more than at any other time in its history.

(14) Seventeen countries joined the European economic union and in so doing gave up their right to print money. The US doesn’t have this problem.

Gold

One can never time the market – investors either buy/sell too soon or too late.

Barring a catastrophe along the lines of North Korea bombing its southern neighbour, indications are that the public is confident the recovery has taken hold. I am not yet sold on this, but the data point to improving economic performance all around.

Separately, it’s been proven over and again that as soon as the mainstream media start dedicating their front pages to a specific asset class it is time to sell that asset class.

Today’s National Post and a recent Globe and Mail feature on gold tell me that maybe that asset class is near its peak.

John Dobson

This is a great five video series of an interview with John Dobson, one of Canada’s great investors.

He provides wise insights into investing, the American equities markets, SOX and university based entrepreneurship.  If you’re interested in investing or entrepreneurship I think you’ll enjoy this vignette.

Gold

I host a monthly investment discussion group.  It’s composed of a group of professionals who have invested assets outside of their primary home, take an interest in their investments and make decisions related to them.  We range in age from our early thirties to our late forties.

Last evening we discussed gold, the gold standard, fiat currency, the recent run up in gold prices and, most importantly, given how gold is priced and where we think it goes from here.

What influences the price of gold?  Supply and demand.

Supply comes from mines, government sales and old gold scrap (people selling jewelry etc.).  Demand comes from jewelry purchases, industrial and dental, bar, coin and retail investment and investment vehicles like exchange traded funds.

From Q1 2008 to Q3 2009 total supply increased by 17% and total demand decreased by -8%.  All other things being equal, this should mean that the price of gold will go down.

What is the case for an increase in the price of gold?

Big countries like China and India purchasing gold from the IMF.  While this doesn’t increase the supply of gold, it does increase demand and Joe Retail Investor may run into gold thinking that this move will cause a jump in gold prices.  Trying to time the market (which is impossible in my view) and buy on the recent dip in prices.  Worries about Obama’s massive fiscal deficits and the impact on the US dollar with the inevitable run up in inflation.

What is the case for gold going down?

Interest rates remaining unchanged until 2011 will reduce the potential for big inflation in 2010 and reduce demand for gold as a hedge against inflation.  The slow recovery of the US economy will reduce demand for gold as the ultimate safe haven and will stabilize the US dollar (gold prices run inversely to the greenback).

More generally, although gold has had an exceptional run over 2009, historically it provides pretty dismal returns.  From 1983 to its peak in 2009 gold returned 180% where US Treasuries return 1089% and the S&P 500 returned 2182%.

Our group predicted where we think gold prices will be when we meet again this time next month: $1300, $1050, $1300, $1100 and $1240.

Maria Bartiromo or Jim Kramer won’t pay for my losses

I am not a regular watcher of Jon Stewart’s show. In fact, I don’t think I have ever watched more than five minutes at a time. However, the following vignette was sent to me last night by a friend who is an investment advisor with a major firm. I enjoyed it and thought you might too.

http://tinyurl.com/bd5soh

Using his own dry humour and some clips from business media over the last eighteen months (including notables like Kramer and Bartiromo) he illustrates the folly of taking business talking heads as being experts with their fingers on the pulse of all investment matters.

About eight years ago I decided to take on responsibility for management of my investment portfolio. This doesn’t necessarily mean managing an account and executing trades, as I do. But it does mean not acceding an understanding of what one owns and why.

There are lots of suspect investment managers and brokers who, frankly, don’t know anything more than how to sell. But there are also lots of investment advisors who know what they are talking about and always work toward their clients’ best interests.

This topic of understanding one’s portfolio and choosing their advisors is of some interest to me. I will write more on it in the future.

BRK.B

There is not much good news being published in the stock and bond markets these days.  While I have no idea when the current economic malaise will subside, I do have hope that we are closer to the bottom than the top (although I don’t believe I am able to time the market, so I don’t try).  

As a class B shareholder of Berkshire Hathaway stock I haven’t been been totally insulated from market meltdown.  I was pleased, though, to see that while the S&P 500 was down 37% in 2008, Berkshire was down “only” 9.6% for a difference of 27.4%.  

Since 1966 there are only five years where the S&P has come out ahead of Mr. Buffett.  Let’s hope Berkshire keeps up this trend even when the Oracle retires.

Hand on hot stove = pain

In the interest of full disclosure, I do believe that government has a role in society.  Protecting property rights, enforcing the law and keeping our borders secure are some of the most important functions.  However, manipulating the economy, owning businesses or running businesses are not functions government is equipped to do well.

I have been very disappointed that over the course of this economic unwinding the press (some of it well respected) and so-called “free market” economists have jumped on the Keynesian bandwagon with such great fervour.  It seems that everywhere I turn there has been a newspaper or an economist arguing for a big stimulus and a fast stimulus.  

My disappointment has been a bit muted more recently because some pundits are beginning to question the size and effectiveness of the American stimulus package and our more modest “made in Canada” version.  

As we are all now well aware, the American mortgage market got way out of hand with people taking on debt that they had no ability service.  Then these debt obligations were being packaged up, securitized and resold on the basis that, because these sub-prime mortgages were distributed piece-meal through these securities, the risks were mitigated.

You’ll see a previous post of mine (read it here) where I outline, from my perspective, the cause of our current malaise.  History aside, fundamentally we had people borrowing money they couldn’t afford to pay back.  They were banking (pun intended) on their real estate rising in value in perpetuity.   They took risks that were far too big – they were excessive.

Now the aberration of the current stimulus package, with the Troubled Asset Relief Program (“TARP”) leading the way, is that it is ultimately going to promote excessive risk.  The US government has put $45 billion each into Citigroup and Bank of America instead of letting them die.  By propping up these failed enterprises, the US government has sent the loud and clear message that business can take massive risk and reap the rewards (bet big, win big) and, at the very worst, come out even if things go south.  

The government has removed the down side of risk. 

Think about this in terms of a poker game.  If players know that worst case scenario was to come out even then they would always bet huge sums on risky hands.  Without the potential to lose their entire float, there is no incentive for a player to think about the potential reward or loss in light the risk he is taking.  This is the same behaviour we will begin see from private enterprise like US banks and auto makers.

Scarcity and incentives are two tenets of economics.  We all make decisions to invest, save or spend our money.  If we remove incentives created by risk then that it is not hard to see how our decisions will be distorted.  

When kids put their hands on a hot stove there is a repercussion.  Similarly, there must be repercussions for a failing business.  There must be pain.

Our system for household budgeting

Household financial management

I am putting together a financial management system for our household.  In the great words of one of Canada’s most respected think tanks, The Fraser Institute, “if it matters, measure it.”  We’ll be measuring our budget and keeping it simple.

Here is our system.  Use it, plagiarize it, criticize it or tell me what you do. 

(1)    We put together a system of accounts which is on a cash flow basis (both my fiancé and I receive the cash from our incomes several weeks after we earn it)

a.       Revenue which equals our combined income (as opposed to sale of capital assets).

b.      Expenses

1. Cars – including fuel, insurance and maintenance
2. Clothes
3. Dog – all expenses related to our puppy
4. Entertainment – including everything fun except going out to restaurants
5. Groceries – all non-restaurant food items
6. Household – all expenses related to the roof(s) over our heads
7. Miscellaneous
8. Restaurants
9. Savings – in accordance with The Wealthy Barber this should be no less than 10% of your income (I like it to be 10% of gross income, not net)
10.  Tax Provision – our income taxes are not deducted at source, so we need to put aside enough cash to cover our tax liabilities.
11. Travel – personal travel including vacations and trips to visit family

c.       Net cash flow

(2)    Our accounts are listed in an accordion file folder that holds up to sixteen accounts (good for when we add more)

(3)    We collect receipts for everything we purchase whether paid for by credit card or by cash.

(4)    When we come home we each file our receipts under the most appropriate account

(5)    At the end of each month I enter the receipts into our chart of accounts, give my fiancés credit card receipts back to her for reconciling against her credit card bill.  I keep mine for reconciliation.   I throw out (recycle) the cash receipts.

(6)    We measure our actual results against our budgeted results and determine where we need to make changes.

This is a very easy system to follow, only takes a few minutes per month, ensures you know where your money is going and helps to monitor your savings. 

Let me know what you do.

My investment portfolio at the end of 2008

It is not pretty, but I have taken a look at my portfolio and its 2008 performance and thought I would post some details here.

Structure – defensive and ready to buy

I hold a combination of equities directly and through index funds.   I also own bonds through index funds and hold cash in my registered retirement fund (RRSP’s in Canada, roughly equivalent to the US 401K) and in a non-registered trading account.  I trade on my own account through a major Canadian bank’s online brokerage.

I am pleased to say that I think my portfolio is fairly defensive with 32% in cash, 42% in equities and 22% in bonds.  At the age of 35 and using the “100 minus my age” rule of thumb I should be 65% equities and the balance in cash and bonds.  Over 2009 I expect do some buying, so the composition of my portfolio will likely change significantly in favour of stocks with some additions to my bond holdings too.

 

Holdings – not sufficiently understood

Admittedly I am bit embarrassed publishing a chart that specifies my holdings.  This embarrassment is not necessarily because I think the holdings are bad, indeed, I would not own them if I thought they were bad. 

I am embarrassed because I have not done nearly enough research on my holdings.  I own index funds and have not dug deeply into each fund’s holdings.  Consequently, I do not really have a handle on whether I am properly diversified.  Additionally, I have not performed the necessary financial analysis to determine whether my equities actually create shareholder value commensurate with their risk profiles or whether they erode it.

 

Performance

What a year.  My non registered account is down a mind numbing -19.21% and my RRSP (the money I plan to retire on!) is down a slightly less unnerving -16.09%. 

The only solace for me is that according to Google Finance, the S&P TSX Composite is down more than -33% and the S&P500 was down almost -37% for the twelve months ended 2008.  So I  am only slightly less unsuccessful than the S&P.  Most certainly nothing to write home about.

 

 

2009 – “You only tell who is fishing naked when the tide goes out.” – Warren Buffett

I have put together an investment discussion club comprised of five friends and myself.   All six of us come from different professional backgrounds (an entrepreneur, an Accenture consultant, the director of fiscal studies of a major Canadian economic think tank, the CFO of a small technology company and a director of business development from a battery supply company) and we range in age from 35 to 47. 

What we share is a keen interest in our investment portfolios.  We will not necessarily invest together and we are not putting any money on the table, so it is not an investment club per se.  What we will do is discuss investing strategies, methods for putting our personal portfolios together, tools for assessing investment opportunities and we will discuss specific investment recommendations.

Our group’s expectation is that we all become better investors and reach financial independence sooner as a result of our learning.

My hope for myself is that the group impresses sufficient discipline on me so that I will properly assess my portfolio, put more structure into its construction and take the time to review the financial performance of current and proposed equities.

Over the course of the year I’ll continue to post my portfolio’s performance.  If I have done my job properly then I should do far better in 2009 (after removing the effect of a far improved market (hope springs eternal, right?)).

This blog in 2009

I am writing this blog because I wish to stimulate conversation and learn from others.  My goal is that through this conversation I will become a better investor and help others become better investors.

While this blog will be primarily about investments and investing, I will also post on administering wills and estates and on politics.  I’ll write about planning and administering estates because I have some experience as an executor.  I’ll write about politics because the ubiquity of governments has caused them to affect most everything in our lives.

1)      Investing and the economy: Managing investments effectively impacts so much in life (retirement, children’s education, independence, bequests).  I have managed my own portfolio for about eight years, have had joint responsibility for a second portfolio and act in an informal advisory capacity for a third portfolio.  I’m not an investment advisor, but have long taken a keen interest.  Through conversations in this blog, I hope we all become better investors (even if you’re Prem Watsa or Warren Buffet you can improve), become financially independent sooner, retire earlier and leave more money to our beneficiaries.

2)      Administering estates: Administering an estate is a tough and sometimes thankless job.  There are the legal and administrative pieces, which are important, but there are also the wishes of the deceased and personalities and emotions of the beneficiaries which must be respected and managed.  I’m going to use my experience as a co-executor for two estates to write about some the challenges and pitfalls and, hopefully, offer some suggestions on how it can “be done right”.

3)      Politics: Whether we like it or not, decisions made by our political leadership can have significant influence on our own personal decision making.  Government policy will affect investment decisions and will affect how estates are structured.  For this reason, I will use this blog to write about politics in Canada, the US (because it directly affects Canadians) and in British Columbia (because I live in BC).

I plan to post regularly and up to three times weekly.  I hope you enjoy it, I hope you contribute to it and I hope you get some benefit from it.