Mad Money Machine

I Want My Bailout Money

Hey MMM’ers, just got back from a ski vacation at Snowshoe and saw this I wanted to share with you.

Probably won’t play it on the show, but it is worth watching to see the lyrics.

One Million Million Dollars

The amount of money being thrown around these days is not just staggering but also bewildering. How many times have you heard someone confuse one million with one billion for example? And others use phrases like, "That’s billion with a ‘b’" to distinguish between the relatively paltry million.

These days though we are hearing the word "trillion" a lot more. Million. Billion. Trillion. They all basically sound the same. Like dime, nickel, quarter. Are they really that much different? It is amazing that they are indeed very much different. In fact, in order to get a billion of something you have to have a thousand million of them. Then to get a trillion of them you need a thousand billion.

More remarkable is how many millions of something you need to get a trillion of them. Let’s supposed that in addition to paper money in denominations of ones, tens, twentys, and one hundreds that the FED just happened to print up for convenience a one million dollar bill. It would have printed on each corner, "1,000,000" and below would be "ONE MILLION DOLLARS." (Oh hey, I just realized, there is no "$" symbol on US money. Hmmmmm.)

If you could get a legitimate one, would you like to have a ONE MILLION DOLLAR bill? I suspect you would. It would pay for a lot of things. In fact, for most people it would completely pay off all their loans and would also carry them through tough times in case they had to leave their job. A million dollars is a lot of money to a person. Yes, a ONE MILLION DOLLAR bill is a lot of money.

So with these one million dollar bills, how many of them would you need to have $1 Trillion? It is astonishing to realize that you would need ONE MILLION ONE MILLION DOLLAR bills to reach $1 Trillion. A million times a million. To write all that out is $1,000,000,000,000. I learned today that Zimbabwe is now printing a one trillion dollar bill (correction: a $100 trillion! ). It is worth something like $30 or $300 US dolllars because of their currency’s hyperinflation.

But I keep hearing how the TARP, the government stimulus, the unfunded liabilities, and all that stuff are putting the US somewhere between $1,200,000,000,000 and $65,000,000,000,000 in debt. Literally mind-numbing numbers for most people. So let’s average the two and round it to 30 trillion. With 6 billion people on the planet, that works out to be $30,000,000,000,000 divided by 6,000,000,000. To simplify by getting rid of excess zeros say $30,0000/6 which is equal to $5,000 of debt for every man, woman, and baby on the planet.

I’m hoping that this is the peak. I’m hoping that we will not have to start using the word quadrillion. But what can I do about it?

MMM-142: WWFM redux

WWFM? Mute computer. Windows 7. Inauguration talk. Lazy? Harry Browne. Bernie. TOOL. Get out of Treasuries? S&P at 600? Uncertainty vs. Prices.

I ENCOURAGE you to Download this show thru iTunes! But, if you just cannot deal with that then go ahead and Play the new show right now

MMM-142: WWFM redux [ 32:56 ] Play Now | Play in Popup | Download

The Mad Money Machine is proud to advertise Index Funds Advisors at ifa.com

Topics in this week’s show include:

• Computer is sick again!
• Windows 7 on Fusion
• Reagan’s Inauguration
• Stock pickers blast the Lazy Portfolios
• GURU: Harry Browne. Hear his radio show talking about the four economic cycles and investments to own. (Thanks CrawlingRoad.com)
• Bernie Madoff: Who do you trust? IFA not like him.
• TOOL: NYTimes Graphic: Calculate Your Financial Comeback
• Barrons says get out of treasuries
• Mish says S&P earnings are going lower , P/E ratio of 15 would mean S&P of 600 or less.
• LEARNING EARNING: IFA Investment Principles #3: Free markets match prices to current levels of uncertainty, so that buyers can earn a risk-appropriate return .
• Calls regarding where did the extra $10 come from on a $100 loan at 10%?
• Subscribe in iTunes to "Index Funds Advisors " podcast!

Music from music.podshow.com:
Runaway Train – Under Feather

Email me: feedback at Mad Money Machine dot com or call the Mad Money Machine voicemail line 206-734-4763

Moving from Skype to GrandCentral Voicemail

So Skype emails me and wants another $60 for my phone number for a year. Bah! The way I figure it, this is not just the "Information Age" but the "Free Information Age." I mentioned on show 141 that I was probably not going to pay. Well, leave it to a listener to remind me of a better (free) way. RalfX called on Skype (actually a Skype-to-Skype call too, so I didn’t need the incoming phone number) to say that he wrote a blog post on five ways to get a free phone number . I read it and was reminded that a long time ago I set up a GrandCentral number. I never used it because I already had too many phone numbers in my life. Well, now that I have one fewer number, I can add this one back in. 571-366-7121. Call it and leave a voicemail.

I noticed one feature that GrandCentral has that Skype does not: the ability to DOWNLOAD the audio file! No longer do I have to go through hoops rigging up some audio hijack software to play and record the Skype message. Nice. I also like the fact that I get emailed immediately upon receiving a voicemail. I don’t have to have an application running on my computer to get the voice message too.

Maybe someday I will merge all my numbers to this one number, once I really get my contacts put in there correctly. It supposedly allows you to allow calls through from people you know while routing others to voicemail.

Defending Lazy Portfolios Even in Bad Times

I see that Andrew Horowitz over at the Disciplined Investor has taken a look at our Lazy Portfolio Smackdown and thinks that it is idiotic. He says, "How can anyone, even in the best of times, believe that simply throwing money into a few funds and forgetting about them is prudent?" Perhaps even more telling is his lead statement, "Lazy Portfolios has to be one of the most ridiculous investment strategies that has ever been invented."

So let me outline a few points that need to be understood in order to discuss this rationally.

The Lazy Portfolio Smackdown was set up to compare the return vs. risk characteristics within index investing. We did not compare index investing vs. other strategies. However, in 2006 we did run a comparison against a stock-picking strategy. We compared Jim Cramer’s buy buy buy stocks against two lazy portfolios, one with ETFs and one called the IFA Index Portfolio 100 . The lazy portfolios gained over 20% that year and the stock-picking portfolio was -0.2%. But that’s just me, not a scientific study. Let’s move on.

He asks, "what is the point of standard deviation in this table?" Yes, it is shown over one year here. The context is that we are comparing the volatility of an investment vs. the return it generates. After all, risk is the source of returns. Why use standard deviation? It helps us compares apples to apples. It is a good way to compare the performance of a 100% equity allocation against a 60/40 equity/bond allocation, for example. The 100% equity is expected to have a higher risk than the 60/40 split. But what if both portfolios had the same return? Obviously the 60/40 would have been a better choice. Said another way, there must be something wrong with the composition of the all equity portfolio.

But I do caution that looking at portfolios over just a one year period is not sufficient. We really need to look at much longer time frames to statistically capture the correlation of return to risk. But this is also the escape hatch of active managers. If they are lucky one year, they tout their "out performance" as proof they know something. Why do we never hear from the "under-performers?" Very few of active managers have long term records of performance. And of those that do, fewer still have outperformed the market. In fact, I don’t know of any who have. Remember Bill Miller of the Legg Mason Value Trust fund (LMVTX) who was the only manager to outperform the S&P 500 for 15 consecutive years? Have a look at a chart of LMVTX for 2008. His long-term returns are completely wiped out.

Let me answer another way. The standard deviation is used to calculate the Sharpe Ratio of the portfolio. The simplest definition of this ratio is that it measures "top-leftedness" of a portfolio when plotted on a chart of return vs. risk. As return goes higher on the y axis and risk gets larger going right on the x axis we want our portfolio to be top left as far as possible. High returns at low risk is the ideal.

Here is a return vs. risk chart of some of the Lazy portfolios in 2008:

Source: Foliodex.com (when it works) You can see a pretty tight correlation between risk and return.

Remember that risk also measures the potential losses in a portfolio as well as the potential gains. The higher the risk, the higher the potential magnitude of both losses and gains. Sure the Lazy Portfolios had large losses in 2008. But compared to what? Freddie Mac? GE? AIG? GOOG? Or how about these gems from one of Andrew’s posts at the beginning of 2008. He says, "It is a good time to look for deep value…" while cautioning not to chase yield.

I skipped some of the banks in his "screen" just to save time. What would these stock picks look like plotted on the chart above? Pretty much bottom right. Some would be completely off the chart both bottom and right.

But let’s say you were an absolute genius and picked the five best of these and invested your portfolio there. With 20% in each of LEG, PFE, EQR, PGN, WIN I calculate a 2008 return of -14.9% with a risk of 23%. Looking that up on the chart, it would indeed have been better than most. So, what are the chances you would have been a genius and picked the absolute five best? And when should you sell? You have to be right twice, remember? What if, instead, you picked a couple of the worst stocks?

I mentioned that risk is the source of returns above. But keep in mind that there are various types of risk: unsystematic and systematic are two. Systematic risk refers to the risks of the entire market as opposed to the unsystematic risks specific to one stock. Unsystematic risk is not rewarded. Investing in the stock of a single company adds only risk but not return. Better to invest in a market portfolio which minimizes the unsystematic risk of any one particular company. Take a look at this reward vs. risk chart over a period of 20 years. It compares a market-based approach vs. picking individual stocks. Remember that you want to be top-left. Sure, MSFT had higher returns, but would you have been able to put your entire net worth in that one stock and ride its volatility? Even the entire Dow Jones underperformed portfolios 50 thru 100.

What portfolio of stocks can you pick that go further top left than in that chart? And at what effort? If being lazy yields such great reward vs. risk characteristics, why waste time, energy, bid/ask spreads, commissions, tax consequences, and other expenses doing anything else?

Why would someone be so antagonistic towards lazy portfolios when it can be shown they have the best return to risk ratio over the long term? Let’s look at the economic incentives of holding different positions on investing. If someone wants to make money in the investing business, would they try to come up with a unique angle and give their clients the impression they know something that everyone else does not? Or would they follow a scientific approach that most everyone else already knows? Most try the former, thinking it appeals to clients who are seeking answers.

If one were to make commissions from trading stocks, would that person advocate trading or not trading? If one were to make a fee from assets under management, would that person ask you to invest with them or would they say you can do it yourself? Sure, some people don’t want to do it themselves. In that case they need an advisor that can assess their risk capacity and place their investments in a portfolio of index funds.

If one were to write a book on investing, would they try to come up with unique strategies to outperform the market or would they simply tell people to invest in the market? You know there have been studies of active managers showing that the odds of them beating the market over the long term are about 1 in 38, the same odds of picking one number on a roulette wheel? But of course your manager is the one that beats the market, right? Hey, maybe he actually did beat the market last year. Everyone floods into his fund or firm. Like Bill Miller’s or Bernie Madoff’s. It is what happens next that sickens.

When one takes a rational look at Lazy Portfolios, one can hardly call them "idiotic." Unless of course one is in the business of making money trading stocks on behalf of others.

Shifting to Mac Hastened

Remember that new Dell XPS I bought off eBay to help rescue my previous DELL XPS that failed? And remember that it worked, right, I got my data off the hard disks. Whew, that was nice.

Now guess what? The sound is gone. No audio. Mute. I have tried everything that is reasonable including replacing the sound card from my old XPS onto this one, downloading new audio card driver software, and switching things around. No joy. It just ain’t fun watching YouTube videos with no sound.

But the biggest problem is that I can no longer use Adobe Audition on the PC to record and edit my shows. Sure, I’ve recorded and edited shows on the MacBook in GarageBand. But Audition is the super-ultra-supremo-king of audio editing. I’ve got all the keyboard shortcuts down and can whiz through a show faster than real time now. Not so in GarageBand.

And from what I’m reading on the net, nothing on a Mac is as good as Audition. Some say that Soundtrack Pro from the Final Cut Studio 2 is pretty good, but guess how much that want for that sucker? $400? Nope. $800? Nope. Try north of $1500! Yikes. Can I get a TARP for that?

So I hang my head and commit to GarageBand. Hey, I even tried running Audition under Windows 7 under VMWare Fusion on the MacBook. Hardee har har har on that one. Sounds like this, “a. et. ip. o. ot.” Seems to get about every 1/2 second of sound out.

So Mac here we come full force. I have a countdown list of PC-only applications that I’m trying to figure out how to migrate from. Luckily, none of them require sound. So I can still run them for a while until I figure it out. They are: Fidelity Active Trader Pro (don’t chastise ME!), Microsoft Expression Web, Microsoft Excel, Natara Bonsai outliner, and of course my iTunes library. I’ll let you know how it goes.

NYTimes has great interactive graphic on getting back to even

Check this out. NYTimes, with its unlimited budget (ha) has gone and done my pitiful "Table of What it Takes to Get Back to Even " several times better. Theirs is an interactive graphic (in Flash no less) where you can enter what you once HAD, what you now HAVE, and your expected return rate (ha again!). It will tell you how long you’ll have to wait to see that same amount of money again.

http://www.nytimes.com/interactive/2009/01/06/business/20090106-comeback-graphic.html

What’s neat is that if you put in a negative inflation rate, say -3%, you can get your money back in a few years even at 0% Annual return!

Run Windows 7 on a MacBook

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.

Gift Cards

We have a stack of gift cards. Literally, a stack. I used to carry them around in my wallet so that in the event we were out and about and happened to stop at one of those stores, I’d have the card with me. But my wallet got so thick with these things that it became difficult to fit into my back pocket. So I moved them to the glove compartment. Today we had an opportunity to use a couple of them. First, dinner at Panera Bread. I actually had *two* cards for them. So I asked the cashier how much was on each. The first one had about three dollars. The other one was filled up with $25. Our order came to only $19 though, so I am still stuck with a card with nine bucks on it. Next up a visit to Trader Joe’s grocery store. I figured that the card for them was also $25 so I wanted to go in and pick up about $25 worth of stuff. As it turned out, we loaded up the cart with over $75 worth of stuff and I ended up having to pay to get out of the place.

That’s kinda the idea behind gift cards, isn’t it? You are always going to spend an amount in excess of what is on the card. So the next time we want to use up our Panera Bread card with only $9 on it, we will end up paying another $10 out of our pocket.

I personally don’t like these gift cards. I prefer coins or Federal Reserve Notes. Doesn’t matter the denomination. Dimes, quarters, dollars. These are gifts that don’t depend upon any specific store remaining in business. If giving money as a gift is too crass, then a candle will do. Please don’t buy the overpriced Yankee Candles either.

Austrian Investing Means Investing in Capitalism

I was talking with Mark Hebner today about this idea of Black Swan investing. As I mentioned in show 141, I read an article entitled “Is There Such a Thing as Austrian Investing?” by  Sterling T. Terrell. He talks about the differences between passive and active investing. But then he talks about their similarity: they both realize small gains most of the time and large gains very rarely. He says an Austrian approach would embrace the fact that the future is unknowable. He says the way to invest in the unknowable is to do Taleb’s approach of putting most of one’s net worth in low risk assets, perhaps money markets or short term bonds, and then with a small amount invest in options. The idea is that most of the time one would lose a little amount of money but on rare occasions, when there is a shock to the market, the strategy would make a large amount of money.

My comment upon his article is that it needs to be fleshed out more. Simply saying that one would follow this approach because the future is uncertain leaves a lot of arguments untouched. For instance, the article does not show how one would implement it, how it would have performed in the past, and what mathematical basis it has upon reality. Show me how such a strategy would have performed over the last 10 years. 20 years. Rolling periods. What amount of one’s investment would be eaten by fees and bid/ask spreads on these options? Can an individual actually implement such a plan or must one be a hedge fund with millions rolling around?

Wouldn’t investing in capitalism be closer to the Austrian ideal rather than speculating in financial derivatives? And particularly investing in ALL of capitalism and taking out the “controlling” decisions of some fund manager to select which companies may do better than others. This means investing in index funds. This means buying baskets of as many companies as possible, with some rational due diligence hopefully embedded in the process. By this I mean, if a company comes out and says, “We intend to close our business in the next couple of years” then by all means the index manager could have leeway to pull out of that stock.

Perhaps an important aspect of Austrian Investing was something else Terrell mentioned, 

To further explore Austrian investing, one might look at the nature of Austrian Business Cycle Theory: how can the role of the Federal Reserve in setting interest rates, causing shortages and surpluses in the market for loanable funds, the nature of malinvestment, and the inevitable boom and bust that follow, be formulated into a successful investment process?

That’s definitely something to take into consideration. Peter Schiff, Nouriel Roubini, Ron Paul, James Grant, Jim Rogers and many, many others are trying to do this too. Still, applying it to investing is akin to licking one’s finger and sticking it up to the wind. I need something more scientific, more measurable, more definitive so that I can take the belief factor out of the equation and instead invest rationally. In fact, maybe rationality is the real key to Austrian Investing after all.

MMM-141: Austrian Investing?

Austrian Investing? Lazy Portfolio Smackdown winners. Risk vs. Return explained. Geocaching. The mathmatical impossibility of paying off interest. 2008 prediction results.

I ENCOURAGE you to Download this show thru iTunes! But, if you just cannot deal with that then go ahead and Play the new show right now

MMM-141: Austrian Investing? [ 36:08 ] Play Now | Play in Popup | Download

The Mad Money Machine is proud to advertise Index Funds Advisors at ifa.com

Topics isn this week’s show include:

• Computer is running!
• Looking at HP MediaSmart server backup solution.
• TOOL: Google Reader (Subscribe to MadMoneyMachine.com/feed )
• Magnetic sign geocache (Geocaching.com)
• Lazy Portfolio Smackdown Results (And Greg Farber)
• LEARNING EARNING: IFA Investment Principles #2: Risk and return have a positive correlation.
• Where does the interest money come from ?
• Austian Investing ?
• Prediction results from 2008
• Subscribe in iTunes to "Index Funds Advisors " podcast!

Got feedback? Leave it at drop.io/MadMoneyMachine

Music from music.podshow.com:
Runaway Train – Under Feather

Email me: feedback at Mad Money Machine dot com or call the Mad Money Machine voicemail line 206-734-4763