How to Win at Investing

Below are links to short clips of a fantastic documentary called "How to Win the Losers Game." The documentary, produced by Sensible Investing, basically tells you the nasty truths about investing, but also tells you the very best way to go about investing.  Much of the documentary is focused on the United Kingdom, but most of the data and statistics hold true here in the United States as well the rest of the world.  

Regardless of where you live and invest, regardless of your age, EVERYONE should watch these video clips.  
In a nutshell, the lowest cost investment strategy will always beat a more expensive strategy.  So, you should index everything and ignore the so-called "experts" that chatter endlessly about the ups and downs of the markets, and always stay the course.  

Part 1  (6:02)
Part 2  (7:38)
Part 3 (10:41)
Part 4 (12:08)
Part 5  (8:37)
Part 6 (13:16)
Part 7  (8:14)
Part 8  (9:49)
Part 9  (8:55)
Part 10 (10.01)

If you are on Twitter, @InvestSensibly is well worth following.  (I'm on Twitter too @relmbo). 

The Self-Employed Should Open a Solo 401(k)

I ran some calculations on a self-employed retirement calculator, and as the chart below clearly shows, the Solo 401(k) is a superior retirement plan for the self-employed regardless of income level.  The Solo 401(k) allows self-employed individuals to put more money into a tax-advantaged account while reducing taxable income better than any other retirement vehicle.  

The one advantage the SEP IRA has, is that it can be opened AFTER the tax year has ended.  A SEP IRA can be created as late as April 15th (or as late as October 15th if you extend your tax return) for the previous tax year.  Thus, while the Solo 401(k) is the best way to go, you must open the 401(k) account before the end of your tax year (December 31st). 

Being self-employed means you are both the employee and employer when it comes to retirement plans.  You must create the solo 401(k) account before December 31st and make the employee contribution also before December 31st.  However, the employer contribution can be made as late as April 15th the following year (or October 15th if you extend your tax return).

Self-employed individuals can contribute up to 100% of their compensation to a maximum of $17,500 (plus an additional $5,500 if aged 50+) for their employee portion and up to 25% of net income for the employer contribution up to $34,500 for a grand total combined maximum contribution of $52,000 for 2014 ($57,500 if aged 50+). 

Finance Clippings: Fantastic investigative report into alternatives i...

Finance Clippings: Fantastic investigative report into alternatives i...: Investigative reporting at its best, done by Tom Bullock of WFAE 90.7 - public radio in Charlotte. It's in two parts.  Well worth listening to.

Bravo NC Treasurer Cowell! (Yeah, I said it.)

     I was hopeful when the State Employees Association of North Carolina (SEANC) turned up the heat on North Carolina State Treasurer Janet Cowell to make changes to the North Carolina Retirement System (NCRS) pension investment operations and reporting by hiring professional pension investigator Ted Siedle and his firm Benchmark Alert.  I was hopeful when Treasurer Cowell announced the formation of the Investment Fiduciary Governance Commission to evaluate the State Treasurer's management of the NCRS.  I was hopeful when Treasurer Cowell's Governance Commission issued recommended changes that addressed many of Mr. Siedle's concerns and echoed many of my suggestions.  Hopeful, but skeptical.  

Jon Stewart holds his own with Tim Geithner

If you are a student of the 2008 financial crisis, this extended interview debate between Jon Stewart and Tim Geithner is worth a watch. Stewart surprised me - he really knows quite a lot about the crisis.

SEC: 50% of Private Equity Firms Steal from their Clients

Andrew Bowden, the Director of Compliance Inspections and Examinations recently gave a speech entitled, "Spreading Sunshine on Private Equity."  If you click on the link and read the transcript from Bowden's speech, you would have to wonder why anyone would ever give their money to a private equity fund ever again.  Bowden's speech should be required reading for all pension fund managers.  What follows is a quote from Bowden's speech:

"When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.  This is a remarkable statistic."

The SEC has found in their audits of private equity firms that more than 50% of them:

1.  over charge their clients for fees, and 
2.  improperly reimburse themselves for their expenses from the companies they acquire.  

Both maneuvers essentially mean they take money that is rightfully their clients money.  In other words, they are thieves.

Another astonishing quote from Bowden's speech:

"The private equity model is very different [from publicly traded stock portfolios].  A private equity adviser typically uses client funds to obtain a controlling interest in a non-publicly traded company.  With this control and the relative paucity of disclosure required of privately held companies, a private equity adviser is faced with temptations and conflicts with which most other advisers do not contend.  For example, the private equity adviser can instruct a portfolio company it controls to hire the adviser, or an affiliate, or a preferred third party, to provide certain services and to set the terms of the engagement, including the price to be paid for the services ... or to instruct the company to pay certain of the adviser’s bills or to reimburse the adviser for certain expenses incurred in managing its investment in the company ... or to instruct the company to add to its payroll all of the adviser’s employees who manage the investment." 

Let me summarize that paragraph.  Bowden is saying that private equity managers use their client's money to buy businesses. Once they control the business, they proceed to rob it.  What an incredible business model!  Use someone else's money to buy businesses so that you can rape and pillage the business for your own benefit.

Lastly, Borden points out that Bruce Karpati of the SEC's Enforcement Division has found that many private equity funds lie to their clients about the valuation of their investments.  This also boosts fees which is another way to steal from their clients.

"Last year at this conference, Bruce Karpati, then of the SEC’s Enforcement Division, addressed this debate, noting the importance of valuations in fund marketing.  Academic studies have supported this thesis, showing that some advisers inflate valuations during periods of fundraising...A common valuation issue we have seen is advisers using a valuation methodology that is different from the one that has been disclosed to investors....."

One would have to wonder how any pension fund manager could possible ponder investing in private equity funds without inherently violating their fiduciary duty to their pensioners?

Finance Clippings: How much does the NC Pension Fund pay hedge fund a...

Finance Clippings: How much does the NC Pension Fund pay hedge fund a...: The answer is hard to figure out.  While the pension fund will disclose (reluctantly) the fees paid directly to managers - in many cases tho...

Politics Already at Play Within North Carolina Pension

What follows was my letter to the editor of the Raleigh News & Observer that was published on page 2 of the Work & Money Section of Sunday's paper on 2/2/2014.  My letter was a response to Andrew Silton's column from the prior Sunday's News & Observer. 

Mr. Silton’s Jan. 26^th column, “Keep politics out of pensions” was sparse on facts.  I’d like to add some.

The last annual report issued by Treasurer Cowell shows the state pension funding status to have fallen from 112.8% in 2000 to just 94% now.  That is to say, it is 6% UNDER-funded.  That’s roughly a $4 billion shortfall.  But, Treasurer Cowell knows the government pension accounting standards are flawed and about to change.  A Buck Consultants report says the pension will be just 86% funded under the new rules.  That’s 14% under-funded, or roughly $8 billion.  However, the nation’s leading expert on public pension funding, Stanford Professor Joshua Rauh, argues that public pensions should calculate funding status in the manner corporate pensions are required. Professor Rauh estimates North Carolina is $38 billion under-funded.  That is roughly the equivalent of two years of North Carolina tax receipts. Professor Rauh will lecture at NC State University on April 16.  I suggest Mr. Silton and Treasurer Cowell both attend.

As of 6/30/13, the annualized 10-year investment performance of the state pension of 6.6% lagged the median public pension return of 7.4%.  The underperformance of 0.8% per year for 10 years for the $83 billion pension fund translates into lost returns of $6 billion.  And, that is the cost of not being merely average.  Plus, the average pension fund underperformed a simple portfolio of index mutual funds.

The primary cause of the state pension’s poor investment performance

A Suggestion for the new NCRS Investment Fiduciary Governance Commission

To the North Carolina Retirement System (NCRS) Investment Fiduciary Governance Committee:

I applaud Treasurer Cowell in creating your committee and look forward to hearing your recommendations.  I wanted to share my thoughts.  I see no reason to start from scratch, but perhaps it might be best to essentially copy another state plan that seems to perform well with great transparency. 

The Minnesota State Retirement System (MSRS) and the Minnesota State Board of Investments (MSBI) could serve as a model for what North Carolina Retirement System should aspire to emulate.  Minnesota's pension is one of the largest in the country and has produced the best 3-year returns among state pension funds and second best for 10-year returns. NCRS pension returns have lagged behind the median pension significantly for these same periods and ranked 5th from last and 4th from last among states reporting for the 10-year and 3-year returns, respectively.

Not only has MSBI produced great returns, but they have also won awards for their excellent and timely financial reporting.  MSBI actually produces a Comprehensive Annual Financial Report (CAFR) that focuses ONLY on the state pension (North Carolina does not).  The MSBI CAFR actually includes real financial statements with detailed expense accounting and asset reporting (North Carolina does not).  The CAFR includes an audit opinion from the Minnesota Office of the Legislative Auditor.  MSBI has achieved all of this with an investment staff of just 22.

With an investment staff of 26, the NCRS poor relative investment performance compared to other state funds will not be solved by adding staff.  MSBI's good returns are due to a healthy 60% allocation to equities and less than 15% alternative investments (including real estate) and a focus on expense control (less than 30 bps of assets vs. NCRS over 50 bps).

The MSBI pension is slightly lower funded than North Carolina, but don't let that fool you.  It appears Minnesota employees only contribute 5% of their pay (up from just 4.25% a few years ago) and a full employer actuarial required contribution has not been made in the last 10 years. Meanwhile, NCRS participants contribute 6% (or more) of their pay to the pension, and our general assembly has been much better than Minnesota at making annual required actuarial contributions.  So, while MSBI is not as well "funded" as NCRS, I believe you will find it is much better "managed" and has better reporting transparency.

I urge the North Carolina Investment Fiduciary Governance Committee to read the MSBI CAFR and compare it to the North Carolina State Treasurer's Annual Report.  The treasurer's annual report includes information about the pension, but also other information that is irrelevant to the pension.  NCRS participants must read the treasurer's annual report, but also must know to look for and find the Government Investment Operations Report to find any expense reporting of the pension.  In addition, NCRS participants must know to look for the Investment Advisory Committee reports and minutes to discover more details on investments and actuarial data.  Finally, an NCRS participant must know they can find further pension details in the State of North Carolina CAFR.  This CAFR is some 300 pages and covers the ENTIRE state of North Carolina.  Of the 300 pages, only a handful pertain to the state pension and these pages are scattered throughout the 300 page document.  NCRS participants and North Carolina tax payers need a single CAFR dedicated to the pension plans that summarizes everything that is currently scattered haphazardly across several reports.  

Even after combining all the above-mentioned reports, you will find North Carolina's reporting woefully inadequate and returns alarmingly lower compared to Minnesota.  The MSBI CAFR also outlines how they structure their functional staff and oversight boards and committees.  The MSBI CAFR can be viewed by clicking here.

Also, South Dakota and North Dakota both have independent CPA firms that audit the retirement system CAFR each year (instead of another government entity). Additionally, while North Dakota's level of expenses and returns are nothing to brag about, their reporting is something to brag about as ND  publicly reports the investment performance of each and every external manager in addition to assets managed and fees paid.  Perhaps copying what works in Minnesota and adding a few tweaks to add more transparency like North and South Dakota could be a good place to start for your committee.

Thank you for your commitment to improving the NCRS pension fund.

More evidence you will be better off if you index your investments

Click here for an article from Bloomberg news that suggests college endowment investment returns fail to beat simple index funds.

(Hat Tip to the Real McCoy)

Bravo! State Employee's Association of North Carolina Hires Pension Investigator

I applaud the State Employee's Association of North Carolina (SEANC) for hiring a pension and legal professional to investigate the North Carolina Retirement System (NCRS). You can read the SEANC press release by clicking here or the Charlotte Observer article by clicking here.  

Slowly but surely, more and more people are beginning to pay attention to one of North Carolina's greatest assets - the $83 Billion pot of money solely controlled by North Carolina's elected State Treasurer.  As the treasurer essentially reports to "the people," the treasurer in practice, reports to no one.  North Carolinian's probably don't realize the immense power the State Treasurer has as the sole-trustee of North Carolina's $83 Billion pension fund.  The sole-trustee set up is rare for this country as North Carolina is one of only 4 states with this structure.  No other elected politician in North Carolina controls this amount of money with virtually no checks and balances.     

While North Carolina has a very competent State Auditor in Beth Wood (a CPA), she has far too much on her plate to be able to give the attention required to fully understand the intricate web of details of a multi-billion dollar pension fund with increasingly complicated investments managed by over 200 external managers scattered globally.  And, does anyone really believe the State Legislature as a body is adequately monitoring the Treasurer's office?  

Historical Asset Class Returns Chart 2013

2013 was a fantastic year for investors unless you mistakenly thought gold was an investment (Buying gold is a speculation, NOT an investment since it pays no dividends or interest. However, it is very pretty!).  Gold fell -28% in 2013 while US stocks rose 32-38%.  Long-term bonds and Treasury Inflation-Protected Securities (TIPS) had one of their worst years on record with each falling -9% in value in 2013.  In addition, tax-free bonds lost roughly -2% while high-yield or junk bonds returned +5%.

Hopefully you were not unfortunate enough to fall for a slick Wall Street pitch to "diversify" by "betting" on the following commodity prices.  However, I know certain prominent investors were burned by these sales pitches. 

2013 Returns
Crude Oil -2%
Heating Oil -3%
Aluminum -10%
Wheat -15%
Gold -28%
Silver -37%
Corn -38%

The chart above shows the last 15 years of investment returns by asset class. On the far right I have calculated the 20-year average for each asset class and pointed out the best and worst annual returns for the past 20 years for each asset class.  I love this chart - which is why I put it on the back cover of every book I have written.  Almost everything you need to know about investing can be learned from this chart:

1. Stocks beat bonds over the long-run.  In the far right columns of the chart you will notice that all 4 of the major stock classes have a higher 20-year average return than all 4 of the major bond classes. You will notice that the various stock classes averaged 9-14% annual returns over 20 years while the various bond classes averaged just 5-7%.  
2. Stocks don't beat bonds EVERY year, but they win about 75-80% of the time.  You will also notice that a stock class claimed the top spot in 11 out of the past 15 years (and 20 out of the past 25 years).