All posts by hfhplanning

From Warren Buffet via AAII

Please note the bold italic portion toward the bottom.  It is so important to not fall into that mindset.

Charlie [Warren Buffett’s partner] Sand I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated. 

We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions—even serious ones—are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation—whether the money is slated for acquisitions or share repurchases—is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan (JPM); I recommend that you read his annual letter.) 

Regarding price performance, Buffett argued that investors are better served if a stock price doesn’t move higher when buybacks are made. Rather, he said that long-term shareholders are better served if the stock price languishes for a period of time. Using IBM (IBM), a stock that Berkshire-Hathaway owns, as an example, Buffet explained his rationale:

If IBM’s stock price averages, say, $200 during the [next five years], the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the disappointing scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1-1/2 billion more than if the high-price repurchase scenario had taken place. 

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. 

Buffett acknowledged that his line of thinking won’t win many investors over. Behavioral scientists are documenting how hard it is for humans to pass on a certain, but smaller, reward now for a potentially bigger, but uncertain reward in the future. Yet, the math shows that the potential is there for Buffett’s approach to work.

Even if you don’t agree with Buffett’s logic, cast a critical eye toward announcements of stock repurchase programs. Question whether they are the best use of the company’s cash. Ask whether the company is trading at a discount to its intrinsic value. Ask why insiders aren’t also buying the stock. Finally, consider that there may be better uses of the corporation’s cash, including instituting or boosting the dividend payment.

Thoughts on another advisor's advice

Suze Orman has been in the news recently and made me think of a number of things that Ms Orman suggests that don’t sound as if they should be put into practice.  Rather, they sound as if they were lobbied for by the banks.

Having an emergency fund is great.  The question is how many months of expenses should be in that bank account.  Six months expenses mighty be the right amount.  Further, if one is an “employee at will” for a company six months might be appropriate.  Who is an “employee at will”?  Someone who may be discharges for any reason or no reason without any recourse.  Of course that is not most people.  If one will receive a sum of money when they are fired (laid off, downsized, etc.) the amount of money that they will receive should reduce the six month figure.  So, if you will get two weeks notice you need five and one half months savings.  If you’ve been with the company for 10 years and will get one months salary for every year you’ve been there you need no money in the emergency fund.

Another bad idea is the savings account when you have debt.  When I was teaching a continuing ed course at NYU one of the first things I asked was how many of you have credit card debt.  A number of people raised their hands.  I then asked those who had hands up to keep them up if they had money in the bank.  A good percentage did.  When I asked why, they told me they were told to do that in case of an emergency.  So my next question was, “if you reduced the debt by the amount in the bank and you had an emergency couldn’t you the charge the money to the card?”  In the meantime they would not be paying 15 or 20 % on the debt and getting 1% minus taxes on that income.  WOW.

As long as we’re discussing her recommendations there is one I totally agree with.  If you need life insurance buy Term.  Insurance is risk transference.  If you do not have enough in wealth to permit those who depend on you to continue living in the lifestyle you have been providing they need extra money to invest to continue the lifestyle.  Term life insurance is the vehicle. Other types of life insurance are there to make the insurance company richer.

What/Whom to Listen to for Financial Advice

The November 19/20 weekend had three articles. Peggy Noonan quoting Steve Jobs on why decline in companies happens, Jason Zweig re 401k investments, and The New York Times opinion by Edward Glaeser about the dentist who is not able to retire because of her investment program may not seem to be connected, but I think they are—all three illustrate the pitfalls of making financial decisions based on gut feelings.

Trusting your gut may be appropriate when selecting a mate, but choosing how to invest your money requires a detached analysis of information about investment opportunities, something which historical fact tells us most individuals are not willing to do. It is, therefore, necessary to choose a financial advisor.

While a good financial advisor can’t help you choose a mate, he or she can give sound advice on investing money to accomplish your goals. Choosing a financial advisor is also a decision that requires information and analysis and should not be left to your gut.

First, and probably most important, the individual should be a fiduciary. That means that the decisions that he or she makes put your interest first. A way to insure that is to make sure your advisor is a Certified Financial Planner™.

Next, you should choose a financial planner who works on an hourly basis, one who does not charge fees as a percentage of assets under management. Make sure the advisor will recommend both the asset allocation and the investment. For example, your advisor should be able recommend the extent to which your long-term needs require rapid growth and the amount of risk your financial situation can tolerate. Your advisor should also be able to recommend individual funds to satisfy the allocation. Finally, you should choose an advisor who will monitor your account at least quarterly.

As you have select an advisor, discuss the allocation the advisor recommends. Ask the reasons for the advisor’s recommendations and what the alternatives are. A good advisor will answer your questions and will not leave you feeling “talked into” his or her recommendations. When you agree to the allocation, your advisor should explain why it is in your financial interest to remain committed to that allocation unless you have a life change–for example, a new child, a divorce, a change in employment, or a major illness.

You should also discuss the funds the advisor recommends. Ask the advisor to explain how the performance of individual funds may be affected by market forces and may in turn affect the balance of the asset allocation. The advisor should also explain that changes in investments may be necessary to correct any imbalances and get back to the original allocation. How often reallocations are necessary will depend on the market forces and the size of your portfolio.

Your advisor should assist you in understanding the statements you will receive. When you receive them it is your responsibility to examine them to make sure there are no unauthorized transactions or other inaccuracies.

Finally, if your advisor performs these tasks, you should be confident that he or she is pro-actively looking out for your financial interests throughout the inevitable fluctuations in the economy and the “market”. You will not need to turn to television, computer, or newspapers for news about investments. In fact, to do so is counterproductive—it will only tempt you to buy or sell investments based on your gut. This,in spite of the fact that such reactive moves are financially unwise. One should always be pro-active, not reactive. Your financial advisor, and not your gut, has the proven ability to provide the best long-term protection of your financial assets in a way that will make your goals attainable.

Fallacy in Generic Thinking

There’s an adage that says you can never be too rich or too skinny. The fact is that it depends on how you try to get there. We’re pretty much all in agreement that bulimia and anorexia (an eating disorder characterized by refusal to maintain a healthy body weight and an obsessive fear of gaining weight) are notable exceptions to the latter.
Those in the Hedge fund business, on the other hand work hard at making themselves more wealthy. These people use their expertise to bring in returns that are in excess of what the general individual can find. I’m not about to suggest that being bad. Of course, even they have losses. But not losses that forces the individual into bankruptcy.
However, along comes the story of the professional football player who chooses to use his wealth by investing in areas that he knows little or nothing about to create wealth that he REALLY doesn’t need. Maybe like the anorexic. If the quarterback had invested in a diversified portfolio, similar to what we encourage people to do, he would be able to live out his entire life ( to whatever age that turns out to be) spending at the same level he did during his career, without concern about running out of funds and be able to leave money to heirs.
So where was the financial advisor? Thinking about assets under management or getting great commissions?

"Wall Street" Is Not Doing Its Job

The article in today’s Wall Street Journal about a pioneer in computer trading assailing the practices that are now being employed by “Wall Street” to make profits for the firm and the wealthy who can afford to take advantage of these transactions is the fuse for this blog.
There was a time, not too long ago when “Wall Street” served the function of lending to start-up firms. Nurturing them, and then taking them public. Not only creating wealth for the owners of the business, but, permitting the businesses to grow and create jobs. No more.
The roll of lending to new businesses has transitioned to private equity firms. That is neither good nor bad, except they are not really interested in the company that will not bring a new technology to market or in some other way be a bonanza.
What it does it to leave the manufacturer of a better chair, stove, appliance, etc out in the cold.
What does that mean for the country? It means no job growth.
What does it mean for the “Wall Street” firms?
It means they are looking in the universities for the brightest computer engineers to design programs to make money for themselves and their wealthiest clients. Doing nothing for the country or for the economy.

Not to Worry, or better yet, Worry Not

I was reminded again this weekend why asset allocation is such an important aspect of financial planning.
I don’t necessarily mean the allocation between the categories HFH Planning uses to diversify, I mean the allocation between equities, fixed income and cash.
If one is 35 or 40 years old with YEARS to go before you need to withdraw from you accounts, time is on your side. Take advantage of it. No need for money market or fixed income. Your chances of having more loaves of bread in your accounts when you start withdrawing is huge. Yes. I said loaves of bread. Dollars, Pounds, Euros, Yen don’t count. What you want when you start to take money out of the account is buying power. More loaves of bread than when you put the dollar equivalent of a loaf of bread into the account.
What about if you want to buy a “big ticket” item in the not too distant future? Well that money should be in a liquid instrument – Money market, CD, short term mutual fund, etc. You don’t want to come across the “right” apartment or house just when the market dumps and you need X dollars and the investment is now X minus.
As you come closer to retirement the investment in fixed income should grow while the equity portion is lowered. Further, we suggest that if you are retired you take out the percentage you and the planner have agreed upon at the beginning of the year. If you divide the sum into 12 pieces it will be just as if you were receiving your monthly pay check. You’ll budget accordingly. Money that you don’t spend in month one goes to a savings account (just like you used to do) and is available for the vacation, extra purchase, etc.

Bank Fees

Most people who read this blog do not use a bank debit card. For those who do, I implore you to switch your bank to a bank that does not plan to charge a fee for the use of the card. I also encourage you to examine the use of a credit union. There are a number of reasons to do so.
The interest rate on your deposit is generally higher than at banks.
Loans are generally easier to obtain and the charges are, again, generally lower.
Most care about the people they serve.
If you need the name of a credit union to use – email us.

The movement of holdings in the same direction

The following is taken from the AAII newsletter with the comment at the end being mine.


Stock price movements have become highly correlated, with correlations reaching levels not seen since 2008. This is not surprising given historical data and should end up being a temporary occurrence.

Correlation, in financial terms, is a mathematical model that indicates how closely the returns of various assets match each other. Correlations can range from +1.0 (assets have returns that move in lockstep together) to -1.0, (assets have mirror opposite returns). Correlations may be expressed in decimal format (e.g., 0.72) or percentage format (72%).

Over the long-term different types of stocks have varying correlations. Small-cap stocks, for instance, have a long-term correlation of 0.72 with large-cap stocks, according to the Ibbotson SBBI 2011 Classic Yearbook. This means that while small-cap stocks have similar returns to their bigger brethren, they do not always move in the same direction or experience the same magnitude of change. Thus, you get some diversification benefits by combining small- and large-cap stocks in a portfolio. (Mixing in micro-cap, developed foreign market and emerging market stocks into a portfolio provides even more diversification benefits.)

During periods of market duress and volatility, correlations move toward 1.0. This is what is happening right now. Nicholas Colas, the chief market strategist for the ConvergEx Group, calculated that “average correlations between the 10 major sectors of the S&P 500 have reached 97.2%” for the 30-day period ended September 9, 2011. This is the highest correlation since 2008’s financial crisis. Coincidently, Vanguard just issued a research note showing last month’s volatility in the S&P 500 as being the highest since the second half of 2008. Volatility brings higher correlations.

The big reason for the volatility and consequent high correlations are macro factors. Headlines about the U.S. economy, the lack of bipartisanship in Washington, and European sovereign debt problems have shifted the focus of institutional investors to the big picture, and away from individual company stories.

Rising correlations diminish the benefits of diversification.

This rising correlations applies not only to various classes of stocks but to fixed income valuations as well.

AAII Sentiment Survey – August 2011

Individual investor sentiment turned bearish after the holiday weekend. Bullish sentiment declined 8.4 percentage points over the last week. The percentage of individual investors who expect stock prices to rise over the next six months measured 30.2% this week, reversing a four-week trend of steady weekly increases in bullish sentiment. Bullish sentiment is now 8.8 percentage points below its historical average of 39%.

Neutral sentiment, expectations that stock prices will be essentially unchanged over the next six months, increased 0.5 percentage points to 29.5%. Neutral sentiment has been below its historical average of 31% for eight consecutive weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, climbed by 8.0 percentage points to 40.3%. Bearish sentiment has been above its historical average of 30% for eight straight weeks, and it has been above its historical average for 26 out of the last 29 weekly readings.