I’m all about living on the bleeding edge. Gotsta have the newest toys. So, I downloaded the beta version of Windows 7 and also downloaded a trial copy of VMWare’s Fusion. The idea here is that I will run the beta of the new Windows on a virtual partition on my MacBook. If things blow up, I just delete the whole knotted mass. And if things work out, hey, I’ve got a shiny new toy.

So here’s what I did.

Download the beta of Windows 7. Put the .iso file on the MacBook Desktop. (Or some place you’ll know where it is.)

Download and install the Trial of Fusion. During the install, choose to install without the DVD and instead point to the .iso file. I went ahead and let Fusion think it was installing Windows Vista. I’ve seen some people say they tell it to use Windows Server 2008. Nah.

The whole installation process was just magical. Like watching a David Blaine stunt. I remember having to use hex editors on .dll files to get this kind of stuff to work years ago. This time the setup went marching quickly forward and **poof** it was booted and running. I was browsing the web with IE8 looking for ways to enhance the video driver. See, I can’t give up.

I’ve been doing a lot of reading about various backup strategies. It is one of my 2009 New Year’s Resolutions, remember? Here are my requirements:

1. OS Agnostic. Don’t want it to be tied to Mac or Windows. Want it to be able to do anything.
2. Yet, I want it to be Apple Time Machine compatible to take advantage of its ease of use.
3. Must be automatic. Don’t want to think about it.
4. Don’t want large recurring costs, no large monthly fees. $5 a month at most.
5. Must be large enough to hold everything.
6. Want to be able to access resources from any computer on the home network and store stuff on it not just backups.
7. Failsafe!

• External USB or Firewire hard drives, both with A/C plugs and those with only USB power
• Mirrored hard drives
• Drobo backup system
• Online web backups like Mozy.com, Backblaze.com, GetDropBox.com, Mesh.com, etc. (Must encrypt the contents)
• Network Attached Storage systems

The one solution I am attracted to at the moment is the new HP MediaSmart Server. It just won the MacWorldMagazine Best of Show award. The attractiveness of this device is that it can solve items 1, 2, 3, 4, 5, 6, and hopefully 7 above. I do not know how failsafe it is. I think that is a key feature of Drobo: you can actually remove one of the hard drives in the thing and your data is still there. I don’t think the HP does that, instead I think it allows you to do mirroring. 

But, you can also sync the MediaSmart server with an online backup solution, such as Amazon S3. So you have both network attached access to your data as well as an offsite backup. Having worked in information security, I appreciate these things. I am looking at the EX487 model which starts with 1.5TB of capacity in two hard drives. I think I can probably find one for about $725. Another neat thing about it is that supposedly I can move my iTunes music (and podcasts?) to it and access it from any PC on our home network.

A show or two ago, I mentioned using the Microsoft Live.com CashBack program to get 25% off a Buy-It-Now purchase from eBay. It seems to have worked. If you are buying an expensive item from eBay, definitely look into this program.

Bob Barr is also running for president of the US as the Libertarian party candidate. Here’s a 10-minute interview with Judy Woodruff. I like his answers to her questions. I would love to see him debate against BO or JM. But more than that, I would love to see BO and JM absorb his philosophy of individual freedom and tiny government.

Here are some good things I listened to or read today in trying to prepare for show 129 and trying to figure out how to survive if a collapse really does happen:

• NPR Planet Money Podcast 9/26/2008: The Week America’s Economy Almost Died (audio program). This explains what the credit lockup means and why everyone was scared last week.
• Sound Investing Special Report Coping With the Wall Street Crisis (audio program) How to remain calm and invest.
• Gary North: Blaming the Victim: The Free Market. Excellent article on why it wasn’t the free market’s fault, it was the gobmint’s fault.
• Pat Buchanan: Day of Reckoning. Rather pessimistic?
• Everything else at LewRockwell.com and LewRockwell.com/blog I’m addicted to reading this site.
• And just for good measure read SurvivalBlog.com before it’s too late. Here’s a list of lists to get you started.

Not subscribed to the Lew Rockwell podcast yet? Have a listen to this one at least. Then subscribe to all 34 of the previous ones.

To subscribe using iTunes, copy this link:

http://www.lewrockwell.com/podcast/feed.xml

and then in iTunes click Advanced -> Subscribe to Podcast and paste the link in there and click OK.

Episode 35 is a little different, instead of Lew interviewing someone else, he is being interviewed on the Michael Reagan show. He is talking about the current bailout scheme.

I just listened to an hour long podcast from This American Life that explains the current credit crisis by talking to some of the guys in the chain of the crisis. From the guy with No Income No Assets taking out a half million dollar mortgage, to the guy selling it, to the guy buying it, to where they are today. From $1000 bottles of champagne to asking daddy for money.

The episode is 355: The Giant Pool of Money and if you’ve got an hour, I definitely recommend it. You can either listen on your computer or thru iTunes. 

Yes, You Can Supercharge Your Portfolio! 2008 by Ben Stein and Phil DeMuth

I admit an initial bias against wanting to like this book. After all, these are the guys who wrote Yes, You Can Time the Market! And I’ve come to the view that you can time the market about as well as you can time the roulette wheel. You have to be right twice each time you try to time the market, both when to leave and when to return. I didn’t read that book, but I think it is wrong anyway whatever it says. Therefore I viewed this latest book by these guys skeptically. So to keep my hands clean and my bookshelf guilt-free, I borrowed it from the library instead of buying a copy.

My skepticism turned quickly to excitement once I got inside. These guys are talking my current passion, Lazy Portfolios and buying the best basket of index funds you can assemble. They are talking return-to-risk ratios. They are talking standard deviations. They are talking uncorrelated asset classes. These guys are going to give me the answer to my question, "What is the Perfect Portfolio?" I flipped pages quickly, impatient to get the answer. Hey, I thought, I may want to actually buy a copy of this book. I want to keep a permanent record of the answer.

I got an answer alright. But it wasn’t what you might expect. But let’s start at the beginning and set the stage before I give you the answer. The authors lay this portfolio supercharging process out in what they subtitle as Six Steps for Investing Success in the 21st Century. The first few steps start typically. Know what you are buying. Diversify. Know your risk. Diversify. And so forth. Some nuggets embedded within are particularly appropriate to lazy portfolio investing. Such as the notion of dividing the annualized historic return by the annualized standard deviation resulting in the return-to-risk ratio. On my Lazy Portfolio graphs, those portfolios with a high return-to-risk ratio would be plotted at the top left of the chart just where you want to be.

What the authors never told me though is that there is another well-known return-to-risk ratio measurement called the Sharpe Ratio. And they never told me that the Sharpe Ratio can be easily found at finance.yahoo.com for most any mutual fund ticker you can type, such as for VGPMX for example. Instead, they told me to go and buy a program called Quantext Portfolio Planner (QPP) and calculate some funny things myself. I’ll get to this in a second. Let’s return to my excitement.

You’ve seen that I’ve been tracking a number of Lazy Portfolios by professional investing gurus. So naturally when I saw Table 4.3 listing the Couch Potato, Margarita, Six Ways from Sunday, Diehard, Coward, and Coffeehouse portfolios, I knew it would be a late night staying up with this book to get to the answer. And this table confirmed what I have also witnessed, that the Six Ways from Sunday portfolio developed by Scott Burns has outperformed all others and by a nice margin. How exciting it was to see that in the very next chapter the authors take this Six Ways portfolio and Supercharge it using a Monte Carlo simulator. Wow, do even better than the best portfolio? Let me call my broker just as soon as I get the answer.

How can we do better? They assert that we can find higher return-to-risk portfolios by adding in investments that are non-correlated and that themselves have high return-to-risk ratios. So when you’ve run out of non-correlating, high return, low risk index funds, where do you turn? Shockingly, the authors suggest that we turn to individual stocks. So help me Cramer that’s what they said. But first we need tools. Tools will help us get the answer.

Right. So after detailing the benefits of diversification and non-correlated asset classes, the authors take us into the land of the Monte Carlo simulation. (How appropriate that in the real Monte Carlo they have roulette tables.) This is the point where the authors introduce us to the QPP Monte Carlo simulator which is basically an Excel spreadsheet for $85 per year that pulls historical fund quotes from Yahoo! Finance and runs some stats and simulations against them. Hey, haven’t I heard of something like this before? Oh yeah, the Stock Market Functions Add-In and the RCHGetYahooHistory function that I use to calculate annualized standard deviations on portfolios in Excel. But of course their tool does much more than standard deviations — they do Monte Carlo simulations! Which are what, exactly? The authors say a Monte Carlo simulator:

uses a computer’s random number generator to construct sample sequences of future returns. After spawning thousands of possible scenarios for a given portfolio, the shape of its financial future begins to take form.

Most important, Monte Carlo simulation can put different portfolios through the same set of paces, letting us make head-to-head comparisons… It’s an effective tool to sharpen investment decisions.

Basically, the simulator looks at the range of past results for each fund and then rolls a matching set of dice thousands of times to see the range of possibilities that could happen to the whole portfolio in the future. It’s magical! I guess, since the authors don’t show any supporting facts that having run Monte Carlo simulations in the past have actually resulted in good things happening in the future. Let’s just believe that we can run this QPP and get a better idea of success than by just simply looking at past Sharpe Ratios, OK?

But what if your range of historical past results is too short? For example, let’s say you are trying to figure out the range of possible values of five dice rolled together by rolling them many times. These guys effectively rolled the five dice just 36 times. Dudes, you’re going to need a lot more than that to predict the future possibilities. That is one flaw in what the authors are showing here. They used only three years of historic data to show returns and standard deviations for assets. And even worse, the three years they chose were from 2003 to 2006, a major bull market in stocks. Any monkey would make money by buying stocks in 2003, so come on.

A further flaw: they don’t elaborate on exactly what percentage of risk, what standard deviation of a portfolio, that one should buy into. They do say that "risk is not psychological" and that we should not be talking about risk tolerance, we should be talking about "running out of money tolerance." But that is basically where they leave it. For listeners to my show and readers of this blog, you’ll know that the first step is to take the Risk Capacity Survey at IFA.com. It will give you a better idea of what risk level you should seek. Then Index Funds Advisors can help you build a portfolio to match that risk level.

But the biggest flaw of all is in back-testing individual stocks to try to find ones that will do better than the market. They think that by adding 10% individual stock picks you can make your portfolio have a higher return with a lower risk. Keep dreaming guys. I’d guess that of the folks that try this, that 45% will beat the market and that would be just by sheer chance alone.  Kind of the same success rate of picking Red to win on the roulette wheel, wouldn’t you say? And that margin of "beating the market" is so slim that it would have been a much wiser use of one’s time to sell one’s old junk on Ebay or something.

But oh what a price to pay to try to achieve that slim margin. First, you have to buy their book. Second, you have to buy this spreadsheet tool. Then get it working. (I obtained a trial copy. It did not work immediately. It did not work after I tried a couple of things. I did not pursue it further. It must work for someone because the authors report its results extensively.) Third, you have to spend time guessing which stocks to pick. Then you have to buy the stocks. Then you have to monitor the stocks. Then you panic and wish you had bought different stocks.

Finally you come to the realization that just sticking purely with index funds is the right way to go. Which brings us to the answer: No, you cannot supercharge your portfolio! 

Here are some other relevant quotes to consider when deciding whether to use 3 years of data to create a Monte Carlo simulation:

"Statisticians will tell you that you need 20 years worth of data — that’s right, two full decades — to draw statistically meaningful conclusions [about mutual funds]. Anything less, they say, and you have little to hang your hat on. But here’s the problem for fund investors: After 20 successful years of managing a mutual fund, most managers are ready to retire. In fact, only 22 U.S. stock funds have had the same manager on board for at least two decades–and I wouldn’t call all the managers in that bunch skilled. "
by Susan Dziubinski, University editor with Morningstar.com
Note: Index Funds are the only source of reliable 20 year risk and return data.

And since picking individual stocks essentially turns you into a portfolio manager:

"Studies show either that most managers cannot outperform passive strategies, or that if there is a margin of superiority, it is small." p. 372-b.

"It will take Joe Dart’s entire working career [calculated to be 32 years] to get to the point where statistics will confirm his true ability." p. 821 -  c.

"In the end, it is likely that the margin of superiority that any professional manager can add is so slight that the statistician will not easily be able to detect it. " p. 374

Zvi Bodie, Alex Kane, Alan J. Marcus, Investments, Fifth Edition, McGraw-Hill (Thanks Mark Hebner for the quotes.)

I feel the sudden urge to write a book entitled, The Quest for the Perfect Portfolio in which I will compare all of the Lazy Portfolios and try to construct THE ONE portfolio appropriate for everyone by simply adjusting the percentage of bonds vs. stocks. Oh, wait a minute, Mark Hebner has already done that: Index Funds: The 12-Step Program for Active Investors.

Feel free to read comments at the blog.

An article in the NYTimes quotes Steve Jobs from Apple talking about the Amazon Kindle eBook reader:

Yet, when Mr. Jobs was asked two weeks ago at the Macworld Expo what he thought of the Kindle, he heaped scorn on the book industry. “It doesn’t matter how good or bad the product is; the fact is that people don’t read anymore,” he said. “Forty percent of the people in the U.S. read one book or less last year.”

Here’s your chance to prove him wrong. You can read TWO books this year. And if you haven’t already purchased your Amazon Kindle eBook reader, do so now because I have some more neat things to say about it on upcoming shows.

Two good books I’m reading on it right now are Jim Rogers’ A Bull in China available from Amazon and Human Action: A Treatise on Economics by Ludwig von Mises, which is freely available!

You can understand why this book was written, can’t you? It’s like a shampoo brand that demands you use it in conjunction with their conditioner. Yet the more you wash and condition, the greasier your hair feels. So you gotta wash again. Jim Cramer’s Stay Mad for Life: Get Rich, Stay Rich (Make Your Kids Even Richer) promotes the TV show. The TV show promotes the book. ‘Round and ’round. Slap down 261 pages of stream-of-consciousness stock talk, put Jim’s bald head on the cover with his mouth open and hands in the air, and include the word "Mad" in the title. Reach an Amazon rank of 15 or so. Jim works himself into a lather. We rinse. He repeats next Christmas. But it’s a bad hair day.

We already have a Cramer book telling us to beat the market by picking stocks (Jim Cramer’s Real Money) and a book telling how to watch his TV show (Jim Cramer’s Mad Money). So what’s left for this Christmas season? Jim telling us that we need to save money. Jim telling us to make a budget. Jim telling us to invest in our 401(k). Jim telling us to buy bonds. Jim telling us to get a good mortgage. Jim telling us to buy stock for our children! 

Jim states up front the distinction between discretionary vs. retirement money. And while there are no charts anywhere in the book, he should have put a pie chart in that looks something like this:

And then go on to say that on his TV show and in his previous books he was focusing on that tiny slice of Discretionary money or "Mad Money" that is exciting, thrilling, fun (and lucrative for those who sell their ideas about which stocks to gamble upon). In the first few chapters he tells us that we should save, budget, and invest in a 401K to take care of most of the pie. And then in later chapters he gets back into his shtick of picking out the winning stocks and actively managed mutual funds for the tiny slice.

In many places his advice is confusing, such as when he takes both sides of an argument. Are index funds good or bad? Page 104:

Then there’s the index funds crowd that still believes in owning stocks, but not picking them. Their attitude is just another example of sour grapes… You can still read columns by people who think something like this: Only a tiny minority of mutual funds consistently beat the indexes, and if the pros can’t do it, it’s no wonder I screwed up, so you’ll screw up too! These types know that stocks are winners, but don’t believe anyone can consistently tell good stocks from bad, so they give up and smugly buy an index fund. Then they act like those of us who pick stocks are dopes for even trying. They can call us dopes all the way to the bank.

Then on page 126:

With very few exceptions, I’m a strong advocate of owning index funds. I think John Bogle, the man who created the first modern index fund and opened up indexing to nonprofessionals, is both a genius and, from what I saw when I brought him on my old TV show Kudlow & Cramer, a really good guy. Even if Bogle were a jerk, he’d still be right about index funds. If you really cannot or will not spare the time and energy to research and own stocks, index funds are a great way for you to get exposure to pretty much everything you need….

In any case, index funds are terrific.

Whew, my shampooed and conditioned head is spinning!

After getting all the Suze Orman-like material out of the way in the first few chapters, he goes into his tried and true collection of sure-fire rules for better investing. Similar to Real Money‘s twenty-five rules, this time he presents twenty rules. Some are repeats familiar: "Never turn an investment into a trade."  (like "Never turn a trade into an investment") Some appear to contradict previous rules: "If you buy a position to fill a need in a portfolio, don’t jettison it because it’s not working" replaces this rule from Real Money: "Your first loss is your best loss." If you are looking to invest by cracking open fortune cookies, here’s the book for you.

He continues with "Ten Things Pros Do Right but Amateurs Get Wrong."  Number 9: "Pros know that cuffing it without doing homework can reduce you to–well, no offense–an amateur!" This is Jim’s catch-all safety net any time someone complains that the stock or mutual fund they bought upon his recommendation didn’t work out: You didn’t do your homework!

The final two chapters give us twenty specific stocks and a dozen or so specific mutual funds.  They seem to focus on US stocks. What about the international or emerging markets Jim? He does mention that we should get into US stocks that have good international exposure so that "regardless of what’s happening in the domestic economy, regardless of all that chatter you hear endlessly about what the Federal Reserve might do or what the growth of the nation is or what the next quarters look like, these bull markets will hold up on their own." Yes but they are all still denominated in dollars. How about diversifying into stocks denominated in their local foreign currency?

Nonetheless, Jim’s specific recommendations are going to be fun indeed to watch over the long term and see whether they beat or lag a passive investing approach. My prediction is that they won’t beat the indexes and that all the time wasted doing stock picking homework and reading his books and watching his TV show could have been spent on more constructive pursuits. Like washing that man right out of our hair.

So, who wants to win a copy? I’ve got two more to give away. Make a comment here or write something on your blog referencing MadMoneyMachine.com and I’ll enter your name to win on show 90.