Wise Money Decisions

This Investors Business Daily article entitled “Too Much Diversification Can Hurt You” is a good example of the kind of “throw away article” that the mainstream financial media churns out on a daily basis. 

The premise is that too much diversification can hurt you because you might pick a bunch of bad stocks.  The article gives this helpful little bit of advice:

“Research shows it’s better to own several high-quality stocks than dozens of stocks.”

Now there’s some enlightenment I can take to the bank!

For some unknown reason the article doesn’t quite come out and say it, but the implied reasoning is that you will pick bad stocks if you “diversify” and you will pick good stocks if you don’t “diversify.” 

That’s an assumption that is silly at best and harmful at worst. If you are able to pick good stocks, then you should be able to pick them whether you “diversify” or not.  Picking good stocks and diversifying are not mutually exclusive.

There may be something redeeming further down in the article. I don’t know.  I didn’t make it that far.

I find it comical that these short, silly little articles do away with decades of research into the benefits of diversification with a simple swat of their proverbial hand.

So why do these silly/harmful articles get written?  I’ll give you some options:

A) To share helpful knowledge

B) To teach people how to make money in the stock market

C) Because a journalist has a deadline and has to come up with something or he’ll lose his job

If you don’t know the answer, follow the advice I got from a friend as I walked in to take the ACT many years ago:  “Always guess C.”

Of all the skills that our government leaders should have, a basic understanding of economics is high on the list.  Too often I see politicians say or do things that betray basic misunderstandings of how the world works.

Here’s the latest example. From this AP Yahoo article about the Greek debt crisis, we have the Swedish finance minister Andres Borg saying:

“We now see herd behaviors in the markets that are really pack behaviors, wolf pack behaviors,” he said. If unchecked, “they will tear the weaker countries apart. So it is very important that we now make progress.” 

Does Mr. Borg really believe that Greece’s problems are a result of investors knowingly banding together to bring Greece down?   Really?  

Could decades of Greek financial and social mismanagement have something to do with it?

Borg’s misunderstanding is, alas, a common one.  My sense is that most people (politicians and non-politicians, and even some economists) don’t appreciate the “information aggregation” aspect of markets.  Market prices are a source of information that can help us understand what’s going on in the world. Market prices are the messenger.

For example, when the cost of milk goes up, something is causing it.  It may be a result of bad weather, mad cow disease, increased government regulation, higher consumption, or other factors.  The higher price is an effect, not a cause.  It is a message that something is going on, not necessarily that there are sinister forces conspiring to increase the price of milk (which could be a cause, but should not be the de facto explanation for any price whose level we think is too high).  If government believes that something should be done to lower the price, it should begin from the premise that the high price is telling us something.  It should figure out what that something is.

If the price of assets with Greek exposure is going down, the right conclusion to draw is that their value is low, not that speculators have banded together to punish Greece by selling assets at artificially low prices. 

By the way, if Mr. Borg’s explanation is correct, then these unidentified speculators have found a great way to lose lots and lots of money. After all they are selling at below fair price.  I only hope Mr. Borg is smart enough to take advantage of this supposed fire sale by dumping his entire net worth into Greek government bonds.

Fortunately there is another European finance minister that seems to have a better understanding:

“I’m against putting all the blame on speculation,” said Austrian Finance Minister Josef Proell. “Speculation is only successful against countries that have mismanaged their finances for years.” 

Update: Over at Seeking Alpha, Kid Dynamite offers another explanation for Greece’s problems.

Big news today in the antivirus software world.  A McAfee antivirus update has caused widespread havoc by causing computers to continually reboot:

“The computer problem forced about a third of the hospitals in Rhode Island to postpone elective surgeries and stop treating patients without traumas in emergency rooms.”

This particular outage appears to have affected corporate clients only, not individual consumer clients. 

The article concludes with this ominous note:

“It’s not uncommon for antivirus programs to misidentify legitimate files as viruses. Last month, antivirus software from Bitdefender locked up PCs running several different versions of Windows.” 

I didn’t realize it was “not uncommon.”  Before today I figured companies life McAfee would run so many redundant tests that they would never have this type of problem. Not so.

I never set automatic updates for any of my software. Not antivirus, not antispam, nor windows, nor anything else, except when the software doesn’t allow me to change the setting (curse you Google toolbar, I can’t live without you!).  I want to control, and know, what my computer is doing and when.  Perhaps I’m too much of a control freak.  But I’m a control freak with a working computer.

The IRS is still working through the UBS tax evader cases, and now they’ve got another insider from another bank feeding them information on tax evaders.

I don’t know anything about Rudolf Elmer except what I read in the New York Times article Swiss Banker Blows Whistle on Tax Evasion. He’s not a character that’s going to generate much sympathy from the public. But he is helping the IRS and other tax agencies chase down wealthy clients of his former employer, Swiss bank Julius Baer, that allegedly evaded taxes.

In my work as a tax lawyer I have represented taxpayers on both sides of the line. Some were clearly victims of government overreaching, and others were clearly on the wrong side of the law.  My hunch is that many of the Julius Baer taxpayers whose names are turned over to the IRS will fall closer toward the latter than the former.

On the other hand the informant may really be the scumbag that Julius Baer wants us to believe he is, and the whole affair may be more about getting even with his former employer and less about exposing taxpayers that merit IRS investigation.

We shall see.

In any event, if you have been hiding income with Julius Baer, now is a good time to call a tax lawyer and figure out your options. 

A statement by IRS Commissioner Douglas Shulman got some attention today.

On C-Span Shulman talked about using a tax preparer:

“I’ve used one for years. I find it convenient. I find the tax code complex so I use a preparer.”

A lot of bloggers and readers are using the statement to argue the tax laws are too complex. 

That’s like saying Conan O’Brien is too juvenile for the Tonight Show. In other words, duh!  Tell us something we didn’t know already!

Nevertheless, it is a good soundbite to hear the Commissioner of the IRS “admit” that he doesn’t (can’t?) prepare his own taxes, whether it’s due to complexity or convenience.

Shulman rightly points out the ball is in Congress’s court, not his.  Bush put together a task force that studied ways to overhaul and simplify the tax laws. The task force released a report in 2005 that included some compelling ideas, but the report was largely ignored.

I’m a tax lawyer, which means the marginal value of my labor rises as the tax laws get more complex because fewer people can handle their own tax affairs.  Despite it being against my own financial interest, I would love nothing more than to see Congress simplify the tax system. 

When I think about how much money we spend to obey the tax laws, through government expenditures for enforcement as well as private expenditures for compliance, and then I realize that none of that money is used to build something or develop something or help somebody, well, it’s a thought I don’t like to dwell on.

If you’d like to know where your stimulus tax dollars are going, check out this report from Pro Publica.

It makes sense that the states with highest unemployment would receive the most stimulus dollars per capita, right? 

Not so fast.  California, Nevada, and Michigan have among the highest unemployment rates. California and Nevada received well less than average dollars, and Michigan received only slightly more than average.

But at least the states with least unemployment should receive the least dollars, right?   

Not so fast.  Check out Alaska. With an unemployment rate well below the national average, it received nearly 3 times as many dollars per capital as the national average. North Dakota received more than 1.5 times the dollars despite its microscopic unemployment rate of 4.2%.

And here’s the most interesting of all.  Which state received the most stimulus dollars per capita?  Here’s a hint: it’s not a state. 

The District of Columbia received more than 6 times the national average.  And it wasn’t even a close race (as if it is supposed to be a race).  D.C. received 2.5 times as many as its closest “competitor,” Alaska.  

D.C. received more than 7.5 times as many dollars as Nevada despite Nevada’a monumental rate of unemployment.

Hmmm, could it be that the people who are making the decisions about where your stimulus dollars go live and work in the District of Columbia?

This map from mint.com shows income by state as well as several other interesting statistics.

For better and for worse, I live near the most expensive rent in the nation. Good because I’m a landlord, bad because I’m also a tenant.

Here is a sobering article about the growing size of government via Yahoo Finance.

In an admittedly non-scientific study of the wealthiest 400 Americans, Forbes reports that a “significant percentage of them had parents with a high aptitude for math.”

“The ability to crunch numbers is typically a key to becoming a billionaire. Often, mathematical prowess is hereditary. Some of the most common professions among the parents of American billionaires for whom we could find that information were engineer, accountant and small-business owner.”

My dad has a graduate degree in math and taught college-level math. I won’t complain if the trend continues and I end up with a billion dollars.

Seriously, I never thought that math would make me rich. And it hasn’t yet, at least not enough to be part of the Forbes study (only a billion more and it will!).

But somehow I always knew it would open doors.

And it has. I was able to receive a graduate engineering degree from a good university because of math. I believe a big reason I was accepted into a good law school is because of math. I use math every day in my business and in countless other ways. 

I don’t know if it was nature or nurture. Probably a combination of the two. But I think it’s fair to say my love for math has affected my life more than anything other than the Three F’s, family, friends, and faith.

It’s important for all parents to help their kids develop a love for math. And if not a love, then at least a working knowledge and an appreciation.

They won’t become billionaires, but they will find more doors opened for them. They might not become rich, but they will avoid the anxiety that many people feel every time they are asked to do a math problem. They might not become a successful entrepreneur, but they will avoid the easy (and sometimes costly) mistakes made by the math illiterate.

This interview of Eugene Fama, who is commonly referred to as the father of the Efficient Market Hypothesis (”EMH”), was conducted in August 2009 by Dimensional Fund Advisors. 

A few highlights:

Responding to critics that the recent volatility has ”killed” the EMH: 

“The market can only know what’s knowable. It can’t resolve uncertainties that are unresolvable. So when there’s a large amount of economic uncertainty out there, there’s going to be a large amount of volatility in prices. As far as I’m concerned that’s exactly what we’d expect an efficient market to look like.”

Paraphrasing other interesting comments:

Most behavioral finance advocates like to point out inefficiencies, but usually conclude that it’s too impractical to take advantage of these inefficiencies and therefore you’re better off to do your risk-return tradeoff.  In other words they conclude that you’re better off to presume the EMH is an accurate description of the way markets work.

The top insiders do better trading on their own company’s stock but interestingly only by about 1%.

The most potent challenge to the EMH is evidence of momentum in stocks that can’t be easily explained. Secondly, movements due to earnings announcements tend to persist longer that expected.  Those are the two biggest challenges. Remember, EMH is a model, not truth. It’s a simplification of the world that does a good job on almost everything, but a few things it doesn’t do a good job on, e.g. insider trading, momentum, and movement from earnings announcement.

The EMH is not a perfect explanation of everything that happens in the market, but it is the best working proposition for use by investors.  Most investors should presume that the only way to reliably affect the expected return from their portfolio is by varying the level of risk they’re prepared to take.  Nothing in the last 12 months has altered that. Some people are claiming the market isn’t efficient, but they aren’t claiming there are easy profit opportunities out there.  It’s one or the other.

Whether you agree or disagree with Fama and EMH, this is a must-see interview in light of the recent volatility in the debate about EMH (ha ha).