Thursday, December 22, 2011

Measuring Investor Risk

I have used FinaMetrica's investor risk profile for several years to attempt to assess clients' ability to accept risk. FinaMetrica's found, Geoff Davey, was recently featured in an online interview I viewed. Davey identified three distinct forms of risk that investors confront.

Required risk measures the extent to which investors must expose themselves to market volatility and losses in effort to receive the returns they need to achieve their goals. We can use standard deviation as a means of measuring this risk.

Risk capacity refers to the investors' ability to accept losses. If an investor has a $10 million portfolio, a $50,000 loss is not a big deal. The loss is just ½ of 1%. An investor with a $500,000 portfolio would have lost 10%. A very big deal.

Risk tolerance is a psychological construct. It's a personality trait. It's what FinaMetrica measures with their profile.

When I write an investment policy statement for a client, I refer to all three kinds or risk.

Sunday, December 18, 2011

Fund Stars Plummet

I am always looking for evidence to support my belief that it is very difficult, probably impossible, to find mutual fund managers who will outperform their benchmark. It is not difficult to find managers who have beat the market in the past. That information is readily available through Morningstar.

The investment industry and the financial media will often celebrate fund managers who have outperformed the market for an extended period. So, I found it noteworthy that The Oregonian identified five mutual fund managers who have come upon hard times. As of the December 6, 2011, the date of the article:

Bruce Berkowitz was Morningstar's Domestic Fund Manager of the Year, 2009, and Stock Fund Manager of the Decade (2000-2009). His Fairholme Fund is down 29%. The Standard & Poor's 500 index is down 1%.

Michael Hasenstab was the Morningstar Fixed Income Manager of the Year in 2010. His Templeton Global Bond fund has lost 2.4% this year.

Bill Gross was the Morningstar Fixed Income Manager of the Decade (2000-2009). Gross runs the largest mutual fund in the world, the Pimco Total Return fund. The fund has gained 2% this year, but trails 91% of its peers.

David Herro was Morningstar's the International Stock Fund Manger of the Decade (2000-2009). His Oakmark International fund is down nearly 13% this year and is in the bottom 25% of its category.

Even the most accomplished fund investors can get derailed. Most eventually do.

Wednesday, December 7, 2011

The Financial Truth

Today marks the 70th anniversary of the bombing of Pearl Harbor. It was a day that, as President Roosevelt said, would live in infamy. The attack drew the United States into World War II. The war brought out the best in this country. We were galvanized, emboldened and determined to preserve the values upon which this nation was founded.

We are facing yet another great challenge, although not one that will be fought in battle fields, in the skies or on the seas. It is a struggle in which the majority of Americans are finding themselves in trouble financially. Some are in truly desperate financial straits. This short video conveys the seriousness of the matter more powerfully than I can.

Financial Truth

Please watch it and then encourage those around you to save more, spend less and borrow less.

Thursday, November 24, 2011

90, the new 70

I read recently that, according to the Census Bureau and the National Institute of Aging, the number of people in the US who are age 90 or older has nearly tripled since 1980. This is pretty remarkable. At the turn of the last century, life expectancy in this country was 47 years. While that figure is skewed by much higher infant mortality, people were living much shorter lives than they are today.

Keep in mind that life expectancy is the average. Half of the people will reach that age. The other half won't make it. If you are in good health, eat well, exercise and avoid smoking and heavy drinking, you are likely to live beyond life expectancy.

If you are curious about how long you will live, you might try the calculator at Living to 100 http://www.livingto100.com/. I did and I learned that I better plan to live to 100. (All of my grandparents lived to age 90. One lived to 95 and another lived to 98. So, I have a decent shot at making 100.)

When I give clients a retirement planning questionnaire, they often put down an age for life expectancy that they relate to their parents and/or grandparents. The problem is that they are likely to live longer than the generations that preceded them.

A good financial planner will model at least 5-10 years beyond current life expectancy. If the your goal is to live comfortably for as long as you live (i.e. to not run out of money), then you should make sure you have a safety margin for those extra years.

Happy Thanksgiving!

Thursday, November 10, 2011

This Time is Different

If you are interested in placing the current global economic crisis in perspective, I recommend reading This Time is Different by Ken Roggoff and Carmen Reinhart. I read it while I was in Nepal and it helped me understand the history of these crises. We've been careening from crisis to crisis for literally hundreds of years. The current crisis is rather acute and we will not emerge from it any time soon.

I watched the republican presidential debate last night. I was not inspired. I would really like to see our leaders, in both parties, begin having a candid conversation with the American people about how we can solve our economic problems ... unemployment, national debt, budget deficit.

The solution is really pretty straightforward. But it is not easy and not appealing. So, no one really wants to talk about it. The solution is really pretty straightforward. But it is not easy and not appealing. So, no one really wants to talk about it. I'm sure they calculate that, if they tell us the truth, they won't stand a chance of getting elected.

Here's what has to happen:

1. We need reduce our expenses AND

2. We need to increase our revenue.

3. We may need to sell some of our assets to pay down our debt

Simple. This is what I advise clients to do if they are struggling with debt or negative cash flow. Our government is no different.

By the way, the title of the book is a tease. This time is not different.

Wednesday, November 2, 2011

Confidence has its Limits

A prospective client sent me an article that ran in The New York Times on October 19, 2011.

It was written by Daniel Kahneman who is an emeritus professor at Princeton and winner of the 2002 Nobel Prize in Economics. He is a leader in the area of behavior economics.

The article, "Don't Blink! The Hazards of Confidence" is quite interesting.

Investors who believe they are able to beat the market would benefit from considering Kahneman's message.

Sunday, October 30, 2011

Mutual Fund Fees

I have been either very busy serving clients or out of the country for the past several weeks. So, for those of you who read my blog, that explains my absence.

I read an article in this weekend's Wall Street Journal titled, "Why Fund Fees Barely Budge." You can find it here: http://online.wsj.com/article/SB10001424052970203911804576651512398417294.html?KEYWORDS=fund+fees

The article notes that actively managed mutual funds charge an average expense ratio of 1.45%. In contrast, my firm's model portfolios have an expense ratio that averages about 0.25%.

But this is not the only expense incurred by mutual fund investors. Funds pay brokerage expenses and bid-ask spreads when they buy and sell for the fund. The article notes that actively managed mutual funds incur an average of 1.44% of trading costs annually.

Investors should keep these expenses in mind when they think about investing in actively managed funds. The active fund manager has to generate returns in excess of these fees in order for investors to experience returns that are better than the market itself.

Sunday, September 4, 2011

Yet Another Reason to Invest Internationally

Do you know what percent of the global stock market is comprised of companies based in the United States? Depending on the data you review, it somewhere between 35% and 40%. How much of your portfolio is made up of US stocks? I would anticipate that it's in excess of 50%.

Most investors are prone to domestic bias. This means that the percent of stocks they own is over weighted to their home country. If you live in Japan, you are tilted toward Japanese stocks. If you live in Germany, you own more German stocks. If you live in the United States, you own more American stocks.

Investors who want to own stocks based on global market capitalization should own no more than 35%-40% of stocks based in the U.S.

The Federal Reserve Bank of San Francisco has given investors a compelling reason to diversify away from U.S. stocks. Fed adviser Zheng Liu and researcher Mark Spiegel suggest in a recent paper that aging baby boomer will dampen U.S. stock values for the next few decades as they sell their investments to finance retirement. (Source: Bloomberg New)

“U.S. equity values have been closely related to demographic trends in the past half century. In the context of the impending retirement of baby boomers over the next two decades, this correlation portends poorly for equity values.”

So, consider shifting the equity portion of your portfolio away from U.S. stocks to international stocks.

Wednesday, August 17, 2011

The Mutual Fund Industry Wealth Transfer

David Swensen, the chief investment officer at Yale University and the author of "Unconventional Success: A Fundamental Approach to Personal Investment," wrote an opinion piece on the mutual fund industry that appeared in The New York Times over the weekend. It's quite an indictment of an industry that offers products that are used by millions of investors.

In the article Swensen makes several important points:

  • The mutual fund industry has failed to deliver on its promises of market beating returns. Very few actively managed funds outperform the market itself.
  • Mutual funds are for-profit enterprises which means that there is an inherent conflict between their incentive to generate revenue and the investors desire to earn returns.Virtually every dollar earned by a mutual fund comes directly from its shareholders. This is a zero sum game.
  • Investors are lured into buying funds that have achieved high praise by mutual fund industry monitors such as Morningstar and Lipper. Unfortunately, such recognition is for historical results. It has nothing to do with what the fund will do in the future. Academic research tells that those funds that have performed well in the past may well underperform in the future. The phenomenon is known as "reversion to the mean."
  • Investors are prone to investing in hot funds only to find that they soon lag their peers. Many investors grow disillusioned, sell the once stellar fund and move on to the next hot fund. It turns out that funds often experience cycles of both superior and inferior performance. They follow each other (imagine the sine curve). Investors buy high and sell low and thus lock in results that are actually far worse than the funds they own. Dalbar has provided research on this for many years. It tells us that mutual fund investors do not come close to earning market returns. It also tells us that investors keep their funds for just over 3 years. Hardly a long term strategy.
  • Swensen tells us to "invest in a well-diversified portfolio of low-cost index funds." He points out that if investors had held their funds for 10 years, their results would have improved by 1.6% per year. This is a dramatic improvement in an industry that measures performance in basis points. (There are 100 basis points in one percent.)
  • Swensen also calls on the Securities and Exchange Commission to do more to regulate the mutual fund industry and protect investors.

Here's the link to the article:

The Mutual Fund Merry-G0-Round

I encourage you to read the article. I suspect those who do will find the case for Intelligent Investing - low-cost, passive investing - even more compelling.

Tuesday, August 9, 2011

Yesterday financial markets across the globe reacted negatively today to Standard & Poor's downgrade of long term debt issued by the United States. Last Friday S&P lowered the rated from AAA to AA+ noting that the recent budget agreement failed to address the government's debt situation. Asian markets opened down and were followed by markets in Europe and the United States.

Despite the unprecedented downgrade, the United States is far from alone in its need to address its excessive national debt levels. The European Union has several members, including Ireland, Greece, Portugal, Italy and Spain that are struggling with debt levels that are unhealthy relative to the size of their economies.

To some extent today's stock market's reaction reflects investors' dissatisfaction with the general state of the US economy. The nation is burdened with an unsustainably large debt and its elected leaders have not demonstrated an ability craft an agreement that will result in a long term solution to the problem. At the same time, economic growth is waning, unemployment remains persistently high, and inflation is creeping into the broader economy.

The stock market is a place in which investors sometimes overreact to news out of fear, panic, and desperation. Yesterday was a good example. The broad market, measured by the Standard & Poor's 500 index, dropped by over 6%. Does that mean that the stocks which comprise this index were suddenly worth less than they were last Friday? No. It means that sellers overran buyers and drove the prices of these large companies down.

Cascade Wealth Management remains committed to the time-tested long term strategies of proper asset allocation, diversification and maintaining low costs. Our clients' portfolios, while down over the past few weeks, have not suffered the temporary losses that the selloff in the U.S. stock market would imply.

What should investors do in the midst of all of this volatility? I would suggest following the advice of Burton G. Malkiel in his opinion piece in yesterday's Wall Street Journal, "Don't Panic About the Stock Market." Malkiel, professor emeritus of economics at Princeton University is co-author of The Elements of Investing, a book I highly recommend. He encourages the investors to "stay the course." So do I.

Thursday, August 4, 2011

Today the global financial markets dropped rather dramatically. The Dow Jones Industrial Average fell by 513 points. The Standard & Poor's 500 index was down 4.8%

I received the following email from another investment advisory firm:

"The financial markets have been experiencing considerable volatility in the last two weeks. We have made changes to our models because we believed this could happen. We are continuing to monitor your portfolios in light of the recent economic and political events and believe the strategy we put in place is appropriate. We will continue to provide you with updates as we study the information available to us."

They believed this could happen? Well, we all know this could happen. Moreover, it happens with some regularity over the long cycles of the stock market.

The strategy we put in place is appropriate? I'd love to know what that strategy is.

Let's not forget the following:

  1. The financial markets are prone to volatility. This has been the case for 200 years in this country.
  2. No one knows what will happen tomorrow, next week or next year in the stock market. If someone tells you they know what is going to occur in the stock market, run in the opposite direction.
  3. The stock market generally prices securities in an efficient manner. This means that identify mispriced securities is very difficult.
  4. Given that the stock market is an efficient marketplace, waste no time trying to find the underpriced or overpriced security. Instead build a well allocated and properly diversified portfolio.
  5. In times of market volatility, manage your emotions and not your portfolio.

Wednesday, August 3, 2011

Variable Annuities - Expenses Drag Performance

With the economy weakening and the stock market faltering, investors are moving out of the stock market and seeking refuge inside annuities. Morningstar reports that investors withdrew $50 billion from stock mutual funds in the 12 months through April of this year. LIMRA reported that sales of variable annuities in the United States increased to $39.8 billion in the first quarter compared to $32.2 billion in the same period in 2010.

The problem is that investors generally have no idea how much they are paying for these insurance products. According to Morningstar the average fees for variable annuities are 2.51%. Many buy a rider that offers guaranteed minimum payments. These riders cost 1.03% on average. So, investors who buy these products can end up paying more than 3.5% in expenses.

These expenses are a significant drag on the performance of variable annuities. If the sub accounts inside the annuity earned an average of 8%, the return after fees would be 5.5%. In addition, income received from an annuity is taxed as ordinary income.

Some investors would benefit from including a variable annuity in their portfolios. But the fees make them unattractive investments for most investors.

Tuesday, July 26, 2011

The Debt Ceiling

Several clients have contacted me in the past few weeks expressing concern about the approaching deadline to raise the nation's debt limit.

The Treasury Department has indicated the limit must be increased by next Tuesday, August 2, or the country may default on its obligations. Unfortunately, as of today, with one week to go, our elected leaders have still not been able to craft an agreement that will increase the debt limit.

Analysts have been speculating about the impact a default could have on the financial markets. No one really knows, because the United States has never defaulted. But clearly the effect would be negative and perhaps severely so.

I would not be surprised if the stock and bonds markets both dropped fairly dramatically, if it were to become clear that Congress and the Obama administration will not reach a deal.

However, as has been the case with our other events that have shaken the market -- remember when the markets opened after the September 11, 2001 attacks or when Congress voted down the Troubled Asset Relief Program in September of 2008? -- I expect the markets would recover and in a relatively short period of time.

I have read that some investors have decided to get out of the markets until this situation clears up. This approach assumes that we will actually know when things are stable again and when it's safe to re-enter the market. I know I do not have the ability to see into the future.

Moreover, the nation's financial predicament involves much more than another increase in its debt ceiling. (There have been 74 increases since March of 1962.) The government spends considerably more than it receives in revenue. We have a national debt that is nearing the total annual productivity of the country and, if not soon addressed, will simply dominate the nation's budget. Congress and the administration have to address this imbalance or the nation will be facing the kind of austerity measures that are currently being implemented throughout the Europe Union.

I have recently read three books on the history of crashes and depressions in financial markets. I was struck by how often these events occur and by how quickly the markets recover. While we cannot predict market events, we know they will occur and we know that eventually the markets heal.

Intelligent, long term investors need to remain disciplined and resolute in the face of these events. I realize this is not particularly comforting. But I know there is no better approach.

Friday, July 15, 2011

Dimensional Fund Advisors

My blog seems like a good place to announce that Cascade Wealth Management will begin offering funds from Dimensional Fund Advisors in the very near future. I am very excited about this, as I believe DFA offers funds built on the finest academic research in the investment community.

DFA Funds are not directly available to retail investors. Investors can access them through a Registered Investment Advisor (e.g. CWM) which has been authorized by DFA to offer their funds.

DFA has several key principles:

Markets Work. DFA believes that the Efficient Markets Hypothesis (EMH) is valid. The EMH suggests that securities are generally properly priced and that it is very difficult, essentially impossible, to consistently identify securities that are mispriced. Consequently, it is misguided to attempt to outperform the overall market through active management strategies such as individual security selection and timing strategies.

Risk and Return are Related. The idea is that investors are rewarded for taking risk. The amount of the reward (i.e. return) is directly related to the amount of risk. However, the founders of DFA, Eugene Fama and Kenneth French, have developed a multifactor model which is the basis for DFA funds. I will come back to this model in a future blog.

Diversification is Essential. Portfolios should be structured to provide comprehensive diversification within and across global asset classes. Portfolio risk is composed of diversifiable or non-systematic risk and non-diversifiable, systematic or market risk (all interchangeable terms). Investors are only compensated for taking market risk. Investors must diversify sufficiently to eliminate non-systematic risk.

Structure Determines Performance. Asset allocation explains most of the variation of portfolio returns. DFA posits that over 96% of the variation in return is due to risk factor exposure. Thus, investors must get asset allocation right in order to be successful.

Look for more information about DFA funds in subsequent postings.

Wednesday, July 6, 2011

So what are you?

I thought I might offer my take on the differences between savers, investors, speculators and gamblers.

Saver: A saver is someone who consistently sets aside some portion of her income for use in the future. The saver delays the gratification that comes from spending today and instead reduces current consumption below what her total income would allow her to spend.

The saver puts the money that is not spent in some kind of an account that will be secure and grow modestly in value. The saver's primary objective is to preserve the monies saved. Therefore, she will likely put her funds in an account that is guaranteed by the federal government. The money might be invested in a bank product like a savings account, interest-bearing checking account, a bank money market account or a certificate of deposit. All of these bank products are eligible for Federal Deposit Insurance (FDIC) up to a legal limit of $250,000.

The smart saver will seek to put enough into "safe" investments, so that emergencies can be met from these funds. A rough rule of thumb suggests that three to six times monthly expenses should be set aside in an emergency fund. The saver can tap this fund if her car needs repairs, an appliance must be replaced, or to get through a brief period of unemployment.

Investor: An investor is someone who is willing to accept investment risk with the expectation of receiving a return proportionate to the risk. The greater the risk of loss of principal, the greater the expected return.

Savers become investors once their emergency funds are fully funded. Savers should not "invest" funds that belong in their emergency funds. However, once the emergency fund has been fully funded, the investor should become an investor as well.

The investor will consider a wide universe of investments such as individual securities (e.g. stocks and bonds), mutual funds, exchange traded funds, limited partnerships or investment trusts. In fact, there are many kinds of investment that may appeal to the investor.

Speculator: A speculator is someone who is willing to accept a very high level of risk with the hope that she will be rewarded with a very high return. The speculator accepts a very high probability that she may lose some, or all, of her investment. The risk of loss with speculation is greater than it is with investing.

There are many ways to speculate. One can purchase an interest in a wildcat oil exploration project, raw land subject to future development, a start-up company with no revenue and in many other ventures. The speculator reviews information related to an opportunity that requires funds, evaluates the risks and potential returns and decides to participate or not based on her own assessment

Gambler: A gambler is a different kind of risk taker. The gambler has no ability to assess risk. He is willing to part with money for the hope that he may receive a large sum in return. Gambling is based on random outcomes and, as a result, the gambler has no influence over the outcome. People who part with their money in casinos are gamblers.

Gamblers seem to gain satisfaction from entertaining the possibility that they may receive a large "reward" for participating in the gamble.

So, what are you?

Friday, July 1, 2011

GAO's Advice for Retirees

The General Accounting Office (GAO) released (June 2011) a study "Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices." I read the key findings and scanned the study. Here's what the GAO has to say to those approaching retirement.

Consider delaying the receipt of Social Security benefits until reaching at least full retirement age. The Social Security Administration permits recipients to start payments as early as age 62. Many Americans begin receiving benefits at this age. However, their payments would be higher by waiting to full retirement. Nearly three quarters of current beneficiaries took payouts before age 65. Those who wait to age 70 increase their benefits 32% compared to taking them at age 66.

Waiting to start Social Security has other benefits. The applicant continues to work and, hopefully, save. The period of retirement is reduced and, as a result, so is the amount of money required to fund living expenses during retirement.

The study suggests retirees may take withdrawals from their retirement savings at a rate of 3%-6%. This is a pretty widely accepted rule of them in the financial planning community.

For many this draw down rate will not produce sufficient income. The GAO suggests retirees consider the purchase of an immediate annuity which guarantees income for the life of the annuitant.

I find fee only advisors reluctant to suggest clients consider using annuities to fund retirement. Fee only advisors (and their clients) find annuities overly complex and expensive. They are often reluctant to have their clients transfer assets they may be managing to an insurance company. Further, the rates credited by insurance companies to annuities are quite low in the current investment environment rendering the effective return on annuities uninspiring.

I believe there is a place for an immediate annuity in many retirement plans. When I include immediate annuities in client retirement models, I see the model's performance improve.

The GAO study warns that many Americans are in jeopardy of living in poverty in retirement. The office calls for greater financial literacy and making annuities available in defined contribution retirement plans (e.g. 401(k) or 403(b)).

Thursday, June 23, 2011

Investors have Lousy Timing

The June/July issue of Morningstar Advisor (a trade publication for independent advisors) contains an article about how poorly investors time their purchases of mutual funds.

The article points out that, through most of 2009 and 2010, investors moved money from equity funds to bonds. The problem is that the stock market hit a low in March of 2009 and then proceeded to mount a rather aggressive recovery.

Investors who were moving from stocks to bond were heading in the wrong direction. They sold stocks when the market was low and moved into bonds after the bond market's very long rally.

Why do investors do this? Because they are driven by emotion. In the depths of the economic crisis, investors were panicked and fearful. What do people do when they feel this way? They run away. This reaction is instinctual. Taking flight is a helpful and appropriate reaction if you are being chased by a saber tooth tiger. In fact, it could save your life. It is not helpful if you are a long term investor trying to grow your wealth.

Tuesday, June 14, 2011

Stock Pickers Beaten Badly

Three of the most highly regarded fund managers have recently lagged behind their peers and the market itself.

Investment News reports (Berkowitz, Heebner and Miller in tight battle — for last place) that Bruce Berkowitz, Kenneth Heebner and Bill Miller have posted results are all well behind the Standard & Poor's Index through June 9, 2011.

Mr. Berkowitz was Morningstar's fun manager of the decade. Mr. Miller beat the S&P 500 index 15 straight years through 2005. Mr. Heebner was manager of the best-performing diversified US stock fund over a 10-year period.

Here's the scorecard:

Manager - Fund - Return

Bruce Berkowitz - Fairholme Fund - 12%

Kenneth Heebner - CGM Focus Fund - 12%

Bill Miller - Legg Mason Capital Opportunity Fund - 11%

S&P 500 Index + 3.4%

Data source: Morningstar

What can we learn from the fall of these stock picking stars? We have more information that suggests that stock pickers are unable to beat the market indefinitely. Certainly some managers beat the market. We would expect some to beat the market and others to underperform the market. The problem is differentiating one from the other.

Moreover, we do not know whether managers who beat the market do so because of skill or luck. Certainly successful fund managers claim that their superior investing skills underlie their performance. But we also routinely hear from underperforming managers that bad luck has derailed their funds. So, is it skill or luck?

Some might suggest that the savvy investors should ride the stars as long as possible and then jump off when they start to falter. There are three challenges that must the investor must overcome to pull this off. First, the investor must be able to identify and invest with the stock picking star BEFORE he starts his winning streak. Second, the investor must have the conviction to stay invested with the star if/when a more compelling investing opportunity appears. Third, the investor must know when to fold 'em and move out of the fund BEFORE it becomes a losing fund.

We know that investors are rarely able to move in and out of mutual funds successfully. Dalbar's research shows that shareholders in mutual funds earn returns that are consistently lower than those of the funds in which they invest.

The lesson for intelligent investors: Waste no time searching for the next hot fund manager. Instead invest across asset classes and capture the returns of those asset classes using low cost, passive funds.

Tuesday, June 7, 2011

Investors Hunkered Down

Prudential Financial recently conducted an online survey of investors, "The Next Chapter: Meeting Investment & Retirement Challenges."

http://news.prudential.com/images/20026/2011TLConsumerStudyFINAL.pdf

The study yielded some interesting data.
  • 44% of the participants said they are not likely to ever put money in the stock market.
This is rather alarming, because it means a substantial portion of Americans are forsaking the asset class (stocks) with the greatest long term returns when compared to bonds, real estate and cash instruments (CDs, bank accounts, money market accounts).

  • 61% believe the principles of investment diversification and asset allocation have changed.
The principles of successful investing have not changed. We know that markets are fickle. Asset allocation and diversification cannot and do not provide a shield from extreme market volatility. However, over long periods, no other strategy provides better results.

  • 66% are concerned that they will miss out on the stock market recover based on their current portfolio mix.
Many investors bailed out of equities at or near the bottom of the recent stock market swoon. Since March of 2009, the low point, the stock market is up well over 100%. Investors who were not properly invested in equities lost out on this opportunity. Moreover, the opportunity will not present itself again until we have yet another economic crisis.

  • 72% of Americans agree that they need to think differently about saving and planning for retirement.
The economic crisis, stock market crash and housing collapse may yield some long term benefit, if Americans actually begin reducing personal debt and saving more. Very few Americans are on track for a financially secure retirement.

  • 69% believe few financial service firms are trustworthy.
The banks, wire houses, insurance companies, and credit unions have largely failed investors. In general, they have not served their customers in a fiduciary capacity. They have not engaged their customers in comprehensive planning. Instead they have offered complex and confusing products that have essentially transferred billions of savings from investors to large financial institutions.

Many Americans need to make a major change in their approach to retirement. If they do not, they run the risk of finding that the last decades of their lives will be something far less than golden. Among other findings, the Prudential survey suggests that the need for greater financial and investment literacy is great.

Friday, June 3, 2011

The Erosive Effect of Fees

I often wonder if investors realize how important fees are to their long term investing results. My sense is that they really don't get it. If they did, they would embrace low cost, passive investing and avoid active management and high priced investment advisors.

The Department of Labor reports that for every 1% increase in fees, an investor's portfolio erodes by 28% over 35 years. So, if an investor would have had $1 million at the end of 35 years, instead she would have $650,000. This is an enormous difference.

Investors have no control over the performance of their market based investments. However, they do have the ability to work with advisors who charge low fees and invest in funds that have low internal costs. Intelligent investors realize that low cost, passive investing is the most reliable path to successful investing.

Wednesday, May 25, 2011

CDs - Investing in Reverse

Investors in certificates of deposit (CD) continue to lose ground. Market Rates Insight reports that the interest investors earn on the highest paying CDs is now lower than the rate of inflation.

The rate on 5 year, callable CDs hit 2.4% in April, while the annual inflation rate ticked up to 3.16%. The result is a negative yield of 0.76%.

This drop in the real rate of return for CDs is not surprising. Shorter term CDs have carried negative inflation adjusted yields since late 2009.

CDs are often held by older and very conservative investors. They are perceived to be less risky than market-based investments.

It is true that there is little, if any, risk that investors in CDs will not receive their money back at the maturity of the CD. However, CDs do carry risk. The risk is that the investor will not be able to maintain purchasing power in the face of rising inflation.

Intelligent investors realize that risk comes in many forms. They also understand that there is no truly risk-free investment.

Tuesday, May 10, 2011

The Mystery of Hedge Funds

The Wall Street Journal ran article on the front page a few weeks ago about how investors our pouring money into hedge funds. The Journal reported that hedge funds are managing nearly $2 trillion and are approaching the high point they reached in early 2008 before the economic crisis.

The recovery of the hedge fund industry is baffling. This industry claims to provide investors with returns that are better than those that can be achieved though such pedestrian vehicles as mutual funds. Hedge funds market themselves as sophisticated, exclusive, and elitist. They cater to the affluent investor who must meet the accredited investor standard. (According to the Securities and Exchange Commission, these investors must have an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year. Alternatively, the investor must have a net worth that exceeds $1 million.)

Apparently many accredited investors are not particularly intelligent investors. If they were, they would realize that hedge funds have generally failed to live up to their claims. In 2008, hedge funds suffered their worst year on record with the average fund losing 19% according to Hedge Fund Research Inc.

As a result of losses and withdrawals the hedge fund industry shrank by a quarter. But the industry has rebounded and attracted $55.5 billion in net new money in 2010.

Now the average hedge fund earned 20% in 2009 and 10.3% in 2010. The Standard & Poor's 500 index increased 26.5% and 15.1% in those same periods. In the first quarter of this year, the average hedge fund rose 1.6% in the first quarter of this year compared to 5.4% for the S&P 500 index.

One has to wonder about investors who pour billions in to vehicles that routinely underperform the market. It's even more perplexing to consider that most of these hedge funds use strategies that carry risk that is far greater than the risk of the market itself. So, investors take on more risk than the market and are rewarded with lower returns than the market.

It does not end there. Hedge funds typically charge their investors a 2% management fee and they take 20% of the profits. I don't know how Hedge Fund Research reports their data. It could be before or after fees. If it's before fees, then hedge funds are even less appealing.

Intelligent investors don't accept the hype surrounding hedge funds. They are smart enough to ask serious questions before investing in anything, including hedge funds. Questions like:
How much risk is involved in this investment?
What is your performance benchmark?
How have you performed against that benchmark?
What fees will I be paying?



Sources: The Wall Street Journal, Hedge Fund Research

Saturday, May 7, 2011

Got a POLST?

Imagine you are involved in a serious accident. You are brought to the hospital and placed in intensive care. The ER docs are not sure you're going to make it.

You are unable to communicate. What do you want to happen? Are the docs supposed to take every measure to keep you alive? Are they supposed to make you comfortable and let nature takes it course?

Are your intentions written down? If so, where is that document? Who has copies?

According to the University of California, San Francisco, three quarters of us will be unable to make some or all of the decisions at the end of our lives. As a result, inappropriate care may be given and family members may be placed in very difficult emotional situations.

You can prevent this from happening by implementing a Physician Order for Life-Sustaining Treatment, or POLST. This document, which you and your personal physician sign, specifies the kind of care you would like to receive.

Oregon is one of 14 states that have a POLST program. The POLST is an official medical record that is stored in a state registry. You complete this document with your physician.

If you are interested in learning more about POLST, you can visit this page at the Oregon Health Science University (OHSU) web site, http://www.ohsu.edu/polst/.

Consider bringing the subject up with your doctor, the next time you're in for a visit.

Tuesday, April 26, 2011

Asset Location

If you have been reading my blog for any length of time, you know how important asset allocation is to long term investment performance. Numerous academic articles and white papers have established that the manner in which funds are allocated into different asset classes is more important than any other factor which influences portfolio returns. Several sources suggest that as much as 90% of portfolio results are driven by asset allocation.

Today I would like to draw your attention to another factor which can significantly affect the returns you experience. I call it "asset location." It is the process of placing asset classes inside investment vehicles based on their tax characteristics.

Let's imagine an investor with a $1 million portfolio. This portfolio consists of three investment vehicles - $300,000 in a 401(k), $250,000 in an IRA and $450,000 in taxable account. Our investor earns $100,000. He's 50 years old and plans to retire in 10 years.

In this simplified scenario, the investor will have a portfolio consisting of 50% in equities and 50% in bonds. How should we allocate the $1 million across these two broad asset classes (equities and bonds) and across the three investment vehicles?

We know that bonds generally create income. Ordinary incomes taxes are 10%-35%. Our investor is in the 28% marginal tax bracket.

Equities can kick off dividends and capital gains. Qualified dividend income is taxed at 0%-15%. Our investor is in the 15% tax bracket. Short term capital gains are taxed as ordinary income. Long term capital gains are taxed at 0%-15%. Our investor is in the 15% tax bracket.

So, where do we place the $450,000 in bonds? These funds will go into either the 401(k) or the IRA. Why? Because the income coming from the bond funds we select will not be taxed inside these accounts. If we placed the bond funds in the taxable account, the income they create would be subject to a tax of 25%.

What about the equities? We should put these funds inside the taxable account. They may create some dividend income. If the dividends are qualified, the tax will be 15%. If the dividends are not qualified, the tax will be the ordinary income tax rate of 28%. Capital gains will be subject to tax at 15%. If we use exchange traded funds (ETFs), realized capital gains will not likely occur until the investor sells the ETFs.

Some investors might not think the asset location for tax efficiency makes much difference.

In this example, let's assume the equity return is 8% (2% dividends, 5.5% unrealized gain, 0% short term gains, and 0.5% long-term capital gains) and the return on the bonds is 3%. We'll assume the bonds are taxable, rather than municipal bonds.

If we locate the bonds in the non-taxable accounts (401(k) and IRA) and the equities into the taxable account (individual), in 20 years the investor will have $270,000 more than if we placed the bonds in the taxable account and the equities in the non-taxable accounts. This is an enormous difference and should serve to illustrate how important "asset location" is to Intelligent Investing.

Tuesday, April 19, 2011

A Distinction about Diversification

I was on a webinar today that included Jason Zweig, a journalist for The Wall Street Journal, on its panel. I respect Jason. He is a voice of reason for investors.

Jason made a comment about diversification that we should all bear in mind. He said, "Diversification works over time. It does not work all of the time."

This is an important distinction. Investors who believe diversification does not work should review the academic research on the role of diversification in investment performance. The data indicates that risk is lowered and returns are enhanced through proper diversification. Modern Portfolio Theory proves this to be true.

Investors have their own proof that diversification does not work at all times. During the market crash of late 2008 through the spring of 2009 investors saw that even a well diversified portfolio can suffer sign cant losses. In times of crisis, virtually all asset classes tend to move downward.

Many investors (and far too many advisors) have made the claim that "diversification is dead." This is not true.

Investors who remained invested through the full cycle of market crash to recovery have generally fully recovered their losses. The losses they experienced were temporary.

Investors who divested during the market crash converted what would have likely been a temporary loss of value into a permanent, realized loss.

I have recently read two books on market crises, bubbles, manias, depression, crashes, etc. We know that these market events happen fairly routinely. In fact, they tend to happen every 10 years or so. This has been true for about 400 years.

Intelligent Investors will not be surprised when the next market swoon occurs. They will buckle their seat belts and ride it out. For doing so, they will be rewarded on the other side.

Friday, April 15, 2011

Let's Make a Plan

The CERTIFIED FINANCIAL PLANNER Board of Standards is rolling out a $37 million awareness campaign. Based on market research, the board found that consumers who represent the typical CFP's target audience are generally unaware of the credential or the benefits of working with a CFP. Further, when they learned about the value of comprehensive financial planning and the role of a CFP in that process, they were more likely to seek the services of a CFP.

The board commissioned a leading marketing agency, Arnold-DC, to place print ads (The Wall Street Journal’s Money & Investing section, SmartMoney, Kiplinger’s, Money and Barron’s), run commercials on cable news networks (CNN, MSNBC and the Fox News Channel)and lifestyle cable networks (The History Channel, HGTV and ESPN) and position banners on select web sites (LinkedIn, Morningstar.com, Bloomberg and Forbes). The campaign is called "Let's Make a Plan." The position statement is "If you need your whole financial life pulled together, a CFP professional is uniquely qualified to help.”

It is no wonder that the CFP credential is not well known. There are dozens of credentials in the financial services industry. A small industry creates credentials, develops curriculum for them and then markets them to insurance agents, stockbrokers, and financial advisors. It is literally a business with some of these mills producing several credentials in areas that range from life insurance to long term care insurance to mutual funds. Almost all of them can be obtained by satisfying very weak requirements.

The strongest credentials are Certified Public Account, Chartered Financial Analyst and CERTIFIED FINANCIAL PLANNER. The CPA, CFA and CFP are also held to a fiduciary level of care when working with clients.

I hope that the CFP Board's campaign is successful. But I suspect it will take regulatory action to actually clean up the industry and provide consumers more information about the true nature of the credentials that advisors use to promote themselves.

Sunday, April 10, 2011

Relying on Social Security

The Associated Press and the LifeGoesStrong lifestyle website reported last week that nearly two thirds of Baby Boomers surveyed said Social Security will be either an "extremely" or "very" important source of income when they retire.

Most of those surveyed reported that their retirement accounts lost significant value during the economic crisis. Many indicated they plan to work longer than they anticipated. Few have saved nearly enough for retirement.

Social Security was never intended to be the primary, much less sole, source of income for retirees. It was conceived to complement the pension income employees receive through their employers and workers' savings.

Unfortunately, few employers offer formal defined benefit pension plans. Most companies have instead opted for a deferred compensation plan, such as a 401(k).

This would not be so bad if employees actually picked up the slack and saved more. However, they have generally not saved enough either through their plans at work or on their own.

The result is a generation that is headed toward retirement with very little in savings. While Social Security will surely remain a source of income for retirees, it will not provide nearly enough income to maintain the lifestyle that most Americans consider reasonable.

Sunday, April 3, 2011

The Important will soon become Urgent

Considerable research indicates that very few Americans are on track to save enough for retirement. Most are so far off course that they will likely face rather sobering choices when they reach the traditional age of retirement. Why is this?

Do Americans not care about their future? Surely this is not true. No one wants to spend the last decades of their life worrying about how to pay for basics like rent, food, and utilities.

Are Americans simply not able to save any money? We know that most American workers earn enough income to be able to save at least 10% of their gross income. There are many stories about how even those with low wage paying jobs are able to squirrel money away over their working lives.

Do Americans believe that Social Security will provide enough income to meet their needs? This is rather unlikely, given that it is common knowledge that Social Security is underfunded and will require significant revision to prevent it from collapse.

Are Americans relying on an inheritance to make up for what they have not saved? They had better not. Most Americans will receive no inheritance and those who do will rarely receive enough to make a significant difference in their financial condition.

My theory is that, while almost all Americans believe having sufficient savings in retirement is very important, is not an urgent matter. As we march through the decades of our lives, retirement is always far removed from reality. It is 40 years out, then 30 years out, then 20 years out.

We act upon that which is urgent. If your hand is cut, you stop the bleeding. If your house is on fire, you call the fire department. If the kettle is boiling, you pull it off the stove.

We may or may not act upon that which is important. If we feel it is important to brush our teeth, we do it. If we believe going to church is important, we go. If we feel getting an education is important, we go to school.

Then again most Americans would agree that exercise is important. But most Americans do not exercise. Most Americans feel it's important to maintain a balanced, nutritious diet. But most Americans do not. Most Americans believe charity is important. However, very few Americans give much of their time or money.

Americans know planning for retirement is important. But it's not urgent. So, they put it off. Only when it becomes urgent do most Americans act. Unfortunately, at this point, it is very difficult to do much to improve their prospects for comfortable retirement.

Sunday, March 27, 2011

Saving Adds Up

Most Americans will work for 40 or more years before retiring. Hopefully, they save enough money along the way, so that they can maintain their lifestyle for the remainder of their lives.

If a person started off earning $40,000, had 3% annual salary increases, saved 10% per year, and earned 8% on the amount saved, she would have just over $1.5 million at retirement. Her salary at retirement would be $130,000.

If she then retired and drew 4% per year from pool of savings, she would be able to received distributions of $60,000. These withdrawals could be increased for inflation and she would never run out of money.

You might note that $60,000 is less than half of her final salary. She would have Social Security. She might have a pension.

Sunday, March 20, 2011

Planning for a Long Trip

The Employee Benefit Research Institute's Retirement Confidence Survey was released last week. It found that more than half of those surveyed are "not at all confident" or "not too confident" that they will be able to afford the retirement they want.

Only 42% have tried to calculate how much money they'll need for retirement. Imagine getting on a plane for a long trip. If you were the pilot would you want to know how much fuel will be required to reach your destination? Would you want to make certain the plane had that much fuel and perhaps an emergency reserve in case you needed it?

Americans enter retirement for a journey that will typically last 20-40 years. Most of them don't bother to determine how much money will be required to make sure that the journey will be pleasant. Some of these people will eventually realize that they will have to work longer, save more and spend less. Others will not wake up to the reality of their financial situation until they have run out of money and are forced to make radical changes in their lives.

It is too bad our education system does not teach financial literacy. Too many people enter their working lives with little understanding of how much money is required to maintain a standard of living over several decades. If our schools taught this, more Americans would enjoy the retirement they envision.

Sunday, March 13, 2011

CWM Model Portfolios

I recently reviewed all of CWM's model portfolios. I started by looking at all of the asset class I thought might be appropriate for our portfolios. I considered 30 distinct asset classes:

ultra short bond fund
short term gov bond
short term bond
inter term gov bond
inter term bond
multi sector bond
world bond
emerging markets bond
inflat protected bond - short
inflat protected bond
intl inflat protected bond
large cap growth
large cap value
large cap blend
small cap growth
small cap value
small cap blend
micro cap
foreign large growth
foreign large value
foreign large blend
foreign small cap growth
foreign small cap value
foreign small cap blend
emerging markets large
emerging market small-mid
frontier markets
REIT - US
REIT - Foreign
commodities
Cash

I then searched for the no load mutual funds and exchange traded funds that are currently available for each of these asset classes. One asset class had no options. Other asset classes had several to choose from. I select 2-3 funds for each asset class and added them to my preferred list. My selections were based on the size of the fund, the cost of the fund, and the composition of the fund.

Next I reviewed the broad weighting of each of CWM model portfolios. I tweaked the level of stocks, bonds, and cash in each model. I broke down the amount of domestic and international exposure for both equities and fixed income.

Finally, I allocated specific weightings to each of the funds I placed in each of the asset classes. I ended up with 18-25 funds in each model portfolio.

I then used Morningstar's data to determine the expected return and risk associated with each portfolio. I also established a benchmark for each of the seven portfolios.

In comparison to the prior version of the CWM models, the revised versions are
• more tilted to international in both equities and fixed income
• include no long term or intermediate term bond funds
• include asset classes for which there were not fund options a few years ago
• no longer contain high yield bonds
• no longer contain preferred stocks

I believe these portfolios are well positioned for the future. When interest rates rise, the impact on these portfolios will be muted. As emerging markets develop, these portfolios will benefit.

Sunday, March 6, 2011

One Star Funds Shine

Morningstar recently found that nine of the top 10 stock funds over the past 24 months are one star rated funds. This is Morningstar's lowest rating in its five star scale. The system considers historical returns and risk.

What are we to make of this? Did the managers of these funds find some new method to dramatically improve their performance? Are there new managers running these funds? Were these funds in sectors that suffered poor performance in past years? Were the fund managers, among the thousands of funds tracked by Morningstar, just lucky after a stretch of bad luck?

There is probably no way to know for sure. But my first thought is of "reversion to the mean." This is the theory that performance eventually moves back to the mean or average. These top stock funds had performed well below the mean for several years. Perhaps they were simply due for a correction back to the mean.

We have recently seen this phenomenon with one highly acclaimed fund manager. Legg Mason's Bill Miller bet aggressively on financial stocks during the recent economic crisis. Unfortunately, the financial sector suffered massive losses and Miller's fund took a beating. As a result, his overall performance went from stellar to dismal. Recently, however, Miller's fund has recovered and is among the strongest performers in the past 2 years.

Again, I ask , is it luck or is it skill?

Sunday, February 27, 2011

Finding Winning Active Managers

I read an interesting article in the current issue of Morningstar's monthly magazine for advisors. The article compared the results of actively and passively managed mutual funds. The author asserts that a review of performance across all mutual funds does not support one approach over the other. He noted that there are more passive funds that produce performance around the overall average for comparable funds. (This is what we would expect.) Further active funds are more prone to performance both well below and well above the average for comparable funds.

I am a bit surprised that nowhere did the author mention the process involved in finding successful fund managers. It is well established that investors are not readily able to identify managers who beat their peers in advance. So, while there will certainly be managers who both underperform and outperform their peers, that is not the issue. Investors only benefit if they can identify these winning active managers beforehand.

Friday, February 18, 2011

Market Doubles

The Standard & Poor's 500 index has now doubled its crisis low of 666.7 which it hit in March of 2009. According to Birinyi Associates, this was the fastest climb of 100% since 1936 when the index took 501 days to jump from 8.06 to 16.15. This time it took 707 days.

The point? Stay in the market.

Thursday, February 10, 2011

Junk is Hot

The Wall Street Journal reported yesterday that the yield on high yield bonds fell below 7% for the first time in more than six years. Investors, fed up with low yields in bank products and bonds, have thrown caution to the wind and added riskier debt to their portfolios.

As a quick refresher, when investors bid up the prices of fixed income securities (e.g. bonds), the yield goes down. A 7% yield is what we would expect from investment grade debt in a more normal interest rate environment. However, the current environment is far from normal.

I find this interesting, because I am responding in a rather different way. I have begun moving all clients out of intermediate term debt. We were never in long term debt, as the risk-return characteristics are unappealing. I am now moving out of intermediate term debt. I am also shifting and even greater percentage of the fixed income portion of client portfolios to higher grade debt. While I rue the low yields in short term, high grade bonds, I am not willing to take the risks associate with longer maturities and lower credit risk.

The Journal reports that high yield or "junk" bonds are up 2.57% this already. They were up 15.2% in 2010 and 57.5% in 2009. The risk premium - the extra yield investors demand to own riskier investments - has fallen to 4.68% over the Treasury yield. The historic risk premium is about 5% above Treasuries.

My self-directed research suggests investors are not adequately compensated for taking the risk associated with junk bonds. Therefore, I do not include them in client portfolios.

Saturday, February 5, 2011

Time in the Market

With very little fanfare, the stock market has roared back from the lows of March 2009. The Dow Jones Industrial Average recently crossed back over 12,000. It is now just 20% away from re-touching the high of 14,400 in October of 2007.

Some investors might point out that it has taken over three years to reach this point and that expecting a 20% return in 2011 is being highly optimistic. True.

But what a recovery we have witnessed. The Dow is up 84%. Most of my clients' portfolios are not far from where they were before the market crashed.

Many investors fled the stock market in the midst of the economic crisis. I am sure that many of these people thought would get back when things looked more stable. Well, do they look stable today? Let' see. We have massive budget deficits at every level of government, a $14 trillion national debt, unemployment that is stubbornly well above 9% and a housing market that is still deeply depressed. Several European countries are in dire financial straits. There is also major unrest in Egypt that threatens to alter the landscape of the Middle East.

I have seen numerous examples of investors who have stood on the sidelines as the market made this dramatic retracement. These people will never be able to capture those gains. They were apportioned only to those who stood in the arena with flames all around and refused to flee.

Successful long term investing has nothing to do with "timing the market." It has a lot to do with "time in the market."

Sunday, January 30, 2011

Malkiel on Beating the Market

"Telling people you cannot beat the market is like telling a six-year-old that Santa Claus doesn't exist. The six-year-old doesn't want to believe it. Neither do people on Wall Street." - Burton Malkiel, Princeton University professor and author of A Random Walk Down Wall Street and The Elements of Investing.

I highly recommend The Elements of Investing. I routinely give this book out to those who are interested in learning more about the keys to successful long term investing.

Thursday, January 20, 2011

Analysts Get it Wrong - Most of the Time

Ever wondered how effective equity analysts are in accurately predicting the prices of the stocks they monitor? Bloomberg reports that the prices of the stocks in the S&P500 that received the most "buy" recommendations from analysts rose 73% on average since March of 2009.

However, the stocks with the fewest "buy" recommendations gained 165%. For perspective, the S&P500 index has gained 88% since hitting a low of 1,271.50 on March 9, 2009.

Bloomberg found that the companies with the most "buy" ratings gained 8.7% in 2010. The stocks with the fewest "buy" ratings rose 20%.

What can we make of this? It is very difficult to predict what will happen with the market, much less individual companies. Analysts know more about the companies they follow than anyone except the senior management of the companies themselves. Even then they are not very good at predicting price movement. In addition, we may wonder about the incentives they may have to issue ratings.

Once again we turn to low-cost passive investing as the most intelligent approach for long term investors.

Sunday, January 16, 2011

Hedge Funds Underperform and Overcharge

I have long been suspicious of hedge funds. These privately managed funds are very lightly regulated. They are typically very secretive and unwilling to explain their investing methodologies. They charge very high fees that are typically 2% of funds under management and 20% of profits.

Hedge Fund Research reported that since the start of 2009, the average performance of hedge funds has trailed the return of the Standard & Poor's 500 index in six out of eight quarters. Hedge funds were up 10.4% on average in 2010 compared with a 15% gain for the Standard & Poor's 500 index, including dividends reinvested. (Source: The Wall Street Journal).

This is only part of the story, however. Most hedge funds pursue strategies that are risky. So, while we don't know for certain, it is very likely that in addition to underperforming the market, most hedge funds carried more risk than the market itself.

Investors should be very wary of hedge funds.

Wednesday, January 5, 2011

The January Effect

The stock market is off to a very nice start in the first few days of the New Year. Some market technicians attribute this to the “January Effect” which describes a phenomenon in which stocks rally in the first few weeks of a new year. The buying is often attributed to investors who redeploy cash that was created from selling losing stocks in December. The selling is done to create tax losses that may be used to offset capital gains.

Given that investors often place the bulk of their savings in qualified retirement plans (IRAs, 401(k)s, 403(b)s, etc), one may wonder about the extent to which this “tax loss harvesting” actually occurs today.

It turns out that small cap stocks seem to benefit from the January Effect more than other stocks. Mark Hulbert, writing for Market Watch, points out that in all Januarys since 1926, small cap stocks have beaten large cap stocks by an average of 7%. The performance of large cap stocks in January is statistically indistinguishable from their performance during the other 11 months of the year.

The January Effect is a “market anomaly” - abnormal performance within the stock market that is contrary to the principles of an “efficient market.” Intelligent investors are very skeptical of such anomalies. If they were persistent, then smart investors would game the system and exploit them. This very action would eliminate the anomaly.