PCs: Not Dead Yet (nor irrelevant, obsolete, toast, etc.)

If you've seen Monty Python's Holy Grail, you probably remember the "not dead, yet" scene. If you haven't, picture Medieval England, the plague, dirty dead and dying people laying inside and outside mud huts. Along comes a man with a cart of bodies calling out, "Bring out yer dead!" A peasant brings a body toward the cart, slung over his shoulder, but the body says, "I'm not dead, yet." To which the carrier argues that he is dead or soon will be, so it's the same thing.

The PC industry reminds me of that poor wretch slung over the shoulder of technology and investing commentators--it's being called dead, though it is clearly still alive.

What exactly, is the PC industry? It's the desktop and laptop computer industry, along with the supporting parts and software that make PCs possible. The industry will sell around 350 million units this year, a decline that has many commentators calling for its imminent demise. The PC industry is dead--we are told--because tablets and smartphones are replacing laptops and desktops. I disagree.

The PC market is complex in that computers are used for so many different things. One way to categorize the PC market is by where PCs are used: 1) consumers (computers at home) and 2) enterprises (computers at work). Another way, which I find more helpful, is to categorize PCs into how PCs are used: 1) content consumption and 2) content creation. 

On the content consumption side, computers are used for surfing the web, reading and writing email, playing games, looking at and taking photos, listening to music, playing fantasy football, keeping up with sports news, viewing and writing Facebook posts, Tweeting, writing short blogs, reading the news and other articles/periodicals, checking the weather, shopping, etc. People who use computers in these and similar ways find tablets and smartphones do all those things as easily, but more conveniently, than desktop or laptop computers. There is little or no doubt that the PC industry is and will lose many of those who use computers solely for such consumption.

On the content creation side, computers can be used for creating computer programs, storing and analyzing data, writing articles/long blogs/books, creating presentations, generating and maintaining databases, doing research, crunching numbers, creating complex models and simulations, designing buildings, creating 3D renderings, etc. People who use computers in these ways will probably find tablets and smartphones don't really work. Such users are likely to continue using PCs because they are better designed for content creation. I think this means the PC industry will temporarily shrink as content consumers switch devices (and emerging markets adopt PCs, tablets and smartphones in varying degrees), but will then resume growth along with the still-thriving, worldwide content creation market.

The above examples may highlight why the "at home" versus "at work" distinction has pretty blurry lines. A high-schooler writing a 20 page report with graphs and pictures may work "at home," but is more likely to find a PC works better than a tablet or smartphone for the task. In contrast, an office worker doing research on the road is "at work," but a light-weight, long battery life tablet or smartphone will work quite well for reading articles, displaying presentations, etc. The issue is less about location than about what the user is doing with the PC/tablet/smartphone.

Added to this, there are very good reasons to have all 3 devices. I don't really want to lug around a PC or tablet all day when I'm in London, but I would like to be able to check the weather or read a short article in the news, and a smartphone is best for that. In contrast, if I see a need to do trades in clients' accounts, I must have a laptop PC to toggle between making trades online, keeping track of trades in my trade log, and figuring out what and how much to trade with spreadsheets. Finally, as I'm flying to London, a tablet is really the best way to read articles, play games and even watch movies, because my laptop battery doesn't last that long and a smartphone screen is too small for long term use.

My point is that, in my kitchen, I have an oven, stove-top, toaster, and toaster-oven because each tool works best for certain tasks and poorly for others. Is it possible that I might want a smartphone, tablet and PC depending on my purpose and preferences? If that's the case, then why all the talk about PC obsolescence?

This is a fundamental point: products designed for content consumption are likely to become different than those designed for production. Think about "automobiles" as the broad category of all automotive form factors. Train engines, Mack trucks, RVs, Vans, Pick-up trucks, Lexus sedans, Dodge Caravans, Sports cars, Motorcycles, and ATVs all exist because there are so many uses an "automobile" can be put to. Did the innovation of any of those categories, generally or specifically, make the others obsolete, toast, dead, R.I.P.? Then why would the PC be dead just because similar, but not the same, capabilities now exist with different form factors?

Let me give some more examples to really drive my point home. If your employer thought a couch were the most productive sitting device, do you think they'd buy desks and chairs? Think about all the things that differ between content creation and consumption:

• Pixar workstation/movie theater
• Book writing/publishing/reading--each is done with very different form factors
• Presentation creation/presentation viewing 
• House design/building/living
• Investment research and analysis/trading/reporting
• Airplane design/manufacturing/usage--can you imagine designing or manufacturing an airplane sitting in the same chair the pilot uses? 
• Computer game creation/playing
• Banking database/ATM/statements
• Auto design/manufacturing/driving

The examples are truly endless. The devices for creating, building and use are seldom the same as each other--each being designed uniquely for its specific purpose. Is it possible that tablets and smartphones don't need to be permanent, all-encompassing replacements for PCs?

None other than Steve Jobs, the father of the iPad, made this point when he talked about the much vaunted post-PC era: 

"When we were an agrarian nation, all cars were trucks because that's what you needed on the farms. But as people moved more towards urban centers, people started to get into cars."

This didn't mean that trucks died, became irrelevant, or obsolete. The truck market continued to grow and grows to this very day. Truck market growth wasn't as fast as car market growth, initially, but it did still grow along with the economy. I don't think slower growth, or even decline, is the same as death. People stop physically growing in their 20's, and yet we don't consider them dead. People in their 60's may be in decline in their mental and physical faculties, and yet that doesn't mean we consider them dead, irrelevant, toast.

Rapid or slow growth isn't the only consideration, so is specialization, which isn't a bad, but a good thing. Designing things that specialize in content consumption versus production will make people happier and more productive. So was it ever. A good argument can be made that specialization of design leads to greater, better, more productive usage, not death, decay, R.I.P.

Did farm trucks built to be specialized trucks make farmers more productive? You bet! Did urbanites prefer driving cars instead of half-breed car-trucks? Certainly. Did this lead either market to die, or did both grow and thrive? You be the judge. Did the specialization of trucks and cars compliment each others' growth such that both thrived because of specialization? Yes.

And this brings me to the PC companies themselves, where I must admit I'm biased (my clients and I own shares of Microsoft, HP and Dell). My argument above is that the PC market isn't dead because content consumption and production make for logically different products and markets. PCs will still be the major tool used for content creation until some better option comes along, and tablets and smartphones don't seem to fit that bill (talk to people who do any of the content creation tasks I referred to above, and find out how many of them do it exclusively or even most of the time with their tablet or smartphone).

For the PC companies to die, they would have to make computers and software for content consumption only, and no other products, and then everyone who uses computers that way (or a sufficient majority) would have to switch to tablets and smartphones.

First, do HP, Dell and Microsoft make products and services solely for content consumption? Here, the facts speak for themselves. 70% of HP isn't in the desktop and laptop business. 50% of Dell isn't. Microsoft doesn't report the numbers explicitly, but I can infer from public filings that they are like HP: at around 70%. 

So, if 30% of HP, 50% of Dell and 30% of Microsoft are in the desktop and laptop business, how much of this side of their business makes products for content consumption versus production? Once again, the facts speak for themselves. HP's consumer business is only about 1/3 of it's desktop and laptop business, only 35% of Dell's, and Microsoft's is probably around the same 1/3 as HP. That means, of the total business that HP, Dell and Microsoft do (these figures are estimates), less than 10% of HP's business is PC content consumption, 18% of Dell's, and less than 10% of Microsoft's.

Added to this, desktops and laptops for content consumption are the least profitable businesses for each company, with razor-thin margins right now. The result is that HP, Dell and Microsoft are making little or no money off their content consumption desktops and laptops right now, so losing this business--if, indeed, that happens at all--would not be the end of the world for them.

What, then, is the other side of each business--the non-desktop/-laptop for consuming content side? One part is content production desktops and laptops. That side may see some erosion in units and margins from tablets and smartphones, but it seems a bit of a stretch to say Rest In Peace to a huge, vital business that seems more likely to be complimented by tablets and smartphones than replaced by them (can a Boeing engineer really effectively and efficiently design a jetliner on his couch with his smartphone and tablet?).  

What about the other 70% of HP and Microsoft and 50% of Dell that isn't desktops and laptops at all? That side makes servers, networking and storage equipment, data center/productivity/back-office software, and consulting and services for enterprises. In other words, all the pictures, videos, databases, music, and equipment we utilize when we access content with our tablets and smartphones is made possible by the software and hardware made by companies such as HP, Dell and Microsoft.

I'm not arguing that Dell, HP and Microsoft will or can win back content consumers with new products and services--even though that is clearly possible--to avoid becoming dead, irrelevant or obsolete. I'm arguing that part of the PC market--the content creation side--will continue to thrive, and that the more profitable and growing sides of Microsoft, Dell and HP creates the back-office equipment necessary for tablets and smartphones to exist, much less thrive.

PCs aren't dead any more than trucks died 3 years after the first car, any more than airplanes eliminated the need for cars, any more than word-processing eliminated the need for paper, any more than railroads were irrelevant after trucks were first created. Not every new invention is a substitute. I would argue that tablets and cellphones will substitute as content consumption devices, but not as content production devices.

Is the PC market rapidly changing? Yes. Will there be winners and losers? Definitely. Will content consumption and production devices continue to rapidly change and evolve into more specialized equipment? Almost certainly. Will all the back-office equipment and software made by Dell, HP and Microsoft be necessary for content consumers to gain access on their tablets and smartphones? Yes. 

Will current PC companies die? Perhaps, if other, new businesses become better at profitably making the specialized content consumption/content production devices. Perhaps, if they fail to compete in their markets outside of desktops and laptops. Perhaps if they make strategic errors to enter markets they can't compete in, or pay too much for acquisitions, or create a culture that snuffs out innovation. But, that's a lot of "perhaps." The future is uncertain, especially for highly competitive markets with little or no barriers to entry. Competitive markets are not, by definition, dead, but quite the opposite. You'll know its dead when there is no more competition, and no one cares, and commentators aren't trying to convince you it's dead.

Perhaps the talking, breathing, huge, dynamic PC industry isn't quite dead, yet. Perhaps we should monitor the patient objectively before chucking it into the dead-body cart.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

What do you do when price goes down?

When you buy a new car and drive it off the lot, the price others would pay for it goes down that instant. In fact, on average, the market price of a new car declines 20% in the first year. How do you react to that?

Did you make a mistake in buying? Did you think about that price drop ahead of time? Would you feel better or worse if you had daily, monthly, quarterly or annual price quotes on  your purchase?

These questions are not idle chatter, because any investment you make will decline in market price at some point in time. If you respond rationally to that decline, you'll get very satisfactory results over time. If you don't, you'll be your own worst enemy.

Every investment rises and falls in price over time. Go ahead and accept that right now. Cash fluctuates with inflation and deflation; bonds fluctuate with interest rates; commodities fluctuate with supply and demand; stocks fluctuate with all the above and more. It's a fact of life.

If you expect fluctuations to occur, you can react prudently to market price--benefiting from volatility. If you hope your investments will only go up in price, you'll panic and sell at the wrong time. That will lead to lousy results.

Acknowledge it right now: whatever you buy will fall in price at some point in time. You should be prepared, specifically, to see any stock you buy both drop by half and double over time. How can you possibly sleep at night or react prudently to such an acknowledgement? By clearly understanding the difference between market price and underlying value.

As Warren Buffett put it, price is what you pay and value is what you get. Let me modify that statement a little: market price is the amount you'd pay or receive if you had to buy or sell RIGHT NOW! If you don't have to buy or sell right now, market price should not be your main focus.

Market price is the intersection of the price a seller is willing to sell and the price a buyer is willing to buy. If the seller is panicking, they are likely to take a lower price. If the seller is euphoric, they're likely to want a higher price. When sellers and buyers agree to make a transaction, that's market price.

But, what if particular buyers and sellers aren't knowledgeable or rational. What if they are panicking like they did in early 2009, or overly euphoric about technology stocks like they were in early 2000? In those cases, market price may not be a very good indication of underlying value.

Market price tends to depend on who is doing the selling and buying at any point in time. If the people you are selling to or buying from are sober-minded, intelligent, knowledgeable, then market price and value are likely very similar. If not, then not.

Underlying value is the value to someone sober-minded, intelligent, knowledgeable. Think about someone who has been in an industry for 30 years, who knows and understands suppliers and buyers, who grasps the full context of where the industry has been and is going, who knows growth rates, input prices, distributors, shipping costs, financing rates, the competition, etc.

When that expert looks at a business, they don't think about market price, they think about dividends, returns on investment, cash needs, industry dynamics, and they think about it over the long term. When an expert comes up with what a business is worth, that assessment is based all the relevant information available at the time, and will much more accurately reflect the long range value of the business. Unlike Wall Street analysts and most investors, an expert isn't thinking about market price in 6 months or 6 seconds, they are thinking about customers, buildings, factories, raw materials, long term contracts.

To successfully invest, you need to focus on underlying value instead of market price. Market price then becomes your servant instead of your master. If buyers and sellers are scared, you may want to buy from them. If they are euphoric, you may want to sell to them. At all other times, you look at their price quotes like a disinterested shopper. You aren't forced to buy or sell and aren't swayed by the crowd's frequent price quotes and dramatically shifting opinions.

This is the key to successful investing. If you need to buy and sell right away, market price is your guide, and you're likely get a poor deal. If you don't need to buy and sell, then you should feel free to focus on underlying value first and market price second.

In this way, you benefit from swings in the market. If you focus on what the expert does: long term cash flows, industry dynamics, underlying asset values, etc., you can easily take or leave market prices. Then you can buy assets cheap and sell them expensive, and you'll get very nice returns.

But, if you focus primarily on market prices, you'll panic when price drops and sell at the bottom, or become euphoric as prices climb and buy at the top. That's what most people do in the stock market, and that's why they get lousy results.

Next time the price of something you own drops, ask yourself if you are focused on market price or underlying value. If the truth is that you don't know anything about the underlying value of what you own, you shouldn't be investing your own money. If you are focused on underlying value, ask yourself if you would be panicking if you owned the whole business. It is, after all, a portion of the business that you own. 

Yes, the future may not look as good as the past. Yes, competitors or the economic cycle may be making things difficult, but did the value of your buildings, factories, inventory, cash and future cash flows really drop by 30% just because reported earnings missed Wall Street's forecast by 5%? 

If no, then it's probably time to buy more of the business. If yes, then take a week or month to think about and review all the relevant data, and wait until your emotions have simmered down. In the cold light of full analysis, you may decide the business isn't as bad off as others think. Or, you may decide it really is doomed and you should sell. Wait until you're sober-minded to do so.

Make market price your servant, not your master. Focus on underlying value. Your net worth will reflect this choice over time.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Breaking up the banks?

Sandy Weill, the big banker most associated with breaking down the government barrier between investment and commercial banking to form Citigroup, now says that big banks should be broken up to protect taxpayers.  

Richard Kovacevich, the former CEO of Wells Fargo (full disclosure: my clients and I own shares of Wells Fargo), says banks are safer as big banks.

Who's right?  Who should voters, legislators, regulators, the Federal Reserve, the executive branch, the press, etc. listen to?

Let's look at their respective records.

Citigroup was formed by the merger of Travelers group--run by Weill--with Citigroup in 1998.  Citigroup's split-adjusted stock price was over $300 per share in April 1998, the month its merger occurred. Weill was chairman of Citigroup until he retired as CEO in 2003 (Citigroup: $474 per share) and chairman in 2006 ($500 per share).  Weill hired as his successor Chuck Prince, who later became famous for excusing Citigroup's participation in the sub-prime meltdown by saying, "as long as the music is playing, you've got to get up and dance." Prince chose to enter early retirement in November 2007 after Citigroup blew up.  Citigroup gladly took $45 billion in assets from the government's Troubled Asset Relief Program (TARP) in 2008 and 2009 and has paid back only 44% ($20 billion). Citigroup also received $306 billion in asset guarantees as part of the TARP program. Citigroup's stock price crashed to $15 per share in 2009 (down 97% from May 2007), and is currently around $28 (down 91% since the Citigroup merger, and 94% since Weill retired as CEO and chairman).  

Wells Fargo was formed by the merger of Norwest Corp.--run by Kovacevich--with Wells Fargo in 1998.  Wells Fargo's split-adjusted stock price was $18 in November 1998, the month its merger occurred. Kovacevich stepped down as CEO in 2007 ($35) and chairman in 2009 ($27). Kovacevich's successor, John Stump, is still CEO and chairman of Wells Fargo.  Wells Fargo was forced (Kovacevich has been quite vocal in his criticisms of TARP and how he pounded the table--literally--trying not to be forced to take the funds) to take $25 billion in TARP funds and repaid them in full as soon as the government would allow it. Wells Fargo received no asset guarantees as part of TARP. Wells Fargo was strong enough during the financial crisis of 2008 to buy out distressed Wachovia (snatched from Citigroup's clutches because Citigroup required government loss guarantees to buy Wachovia). Wells Fargo's stock price fell to $12 per share in 2009 (down 67% from May 2007), and is currently $34 (up 89% since the Wells Fargo merger, and down 3% and up 26% since Kovacevich retired as CEO and chairman, respectively).

Basically, Weill created a Frankenstein's monster of a bank that, not surprisingly, blew up during the financial crisis of 2008. Weill was a deal-maker that used his political influence and bluster to build an unstable house of cards that collapsed with the first real puff of wind. His bank would have gone under without government guarantees that are outstanding to this day. Not only did his bank fail on almost every measure, it destroyed 90% of shareholder value. Why exactly would anyone want to listen to this "expert's" opinion?

Kovacevich, on the other hand, built Wells Fargo slowly and stably over time. His bank was sound enough to handle the worse financial crisis since the Great Depression, so much so that he could afford to bail out another large unstable bank without any government assistance. He did it because he understood banking instead of political influence. Under his stewardship and that of his successor's, Wells Fargo has succeeded on almost every measure and has created value for shareholders. Kovacevich is the type of expert that people should be listening to, and he's not calling to break up the banks.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Illusory Patterns

Some people's investment results would improve from targeted brain damage.

This rather shocking statement is based on an article Jason Zweig wrote in the Wall Street Journal, "Why We're Driven to Trade." Neuroscience research has shown that specific parts of the brain contribute to certain decision making. More narrowly, researchers have found that one part of the brain, the frontopolar cortex, contributes to predicting rewards.

To better understand such decision making, researchers set up an experiment with three groups: two groups without brain damage and one group with damage to their frontopolar cortex. Then, they let the three groups play a series of games where the rewards varied unpredictably. 

What they found was that the two groups without brain damage tended to base their decisions on very recent data--their last two games played--whereas the group with brain damage tended to base their decisions on cumulative data of all the games they'd played. The more effective approach is to use cumulative instead of recent data.

Basically, the frontopolar cortex is a part of the brain that's used to recognize patterns. It works great when there are useful patterns to be recognized, but when no patterns exist (as they don't with random data) it goes right on recognizing illusory patterns that aren't really there. 

The result is that when we run into rewards with unpredictable variability, our brains still tend to react as if it finding patterns (even though there are none). That's why people with a damaged frontopolar cortex have an advantage in dealing with such circumstances: they don't have a part of the brain that would recognize and act on illusory patterns.

This research holds lessons for investors, because investment returns--and you may have guessed this--vary unpredictably just like the game in the experiment. Like the two groups without brain damage, most people base their investing decisions on recent instead of cumulative results. This leads them to trade too frequently, selling something that has done poorly recently and buying something that has done well recently only to find what they bought does poorly and what they sold does well.

The good news is that you don't need to damage your brain to invest better. Investors who base their decisions on long term, cumulative results instead of recent data can do just as well as those with a damaged frontopolar cortex. 

First, don't buy just because a stock goes up or sell because a stock goes down. That's basing your decision on recent data. Second, use long term, cumulative data to make decisions instead of short term, recent data. Third, make sure you have three reasons, outside of stock price movements, for deciding to buy or sell. And, last, keep track of your results so you can generate a cumulative record of what does and doesn't work. This is best done by keeping track of what you sell as well as what you buy.

You don't need brain damage to do better, you just need to create a deliberate decision making process that does an end-run around the part of your brain that sees illusory patterns. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Optimism = poor returns

It's easiest to invest when you feel good about a company or the economy. That feeling reflects good recent results, and a herd of other people who share your good impression. Good feelings cause people to push prices far above underlying value. When the future turns out to be not as rosy as people's inflated expectations, prices move back to value and poor returns result.

Exhibit A is 1999, when almost everyone was so optimistic about technology stocks, right before they dropped 76%.

Exhibit B is 2006, when almost everyone was in love with the real estate market, right before it plunged over 30%.

It's hardest to invest when you feel terrible about a company or the economy. That bad feeling is due to poor recent results, and a herd of other people who agree that prospects are lousy. Bad feelings cause people to sell or not buy, pushing prices far below underlying value. When the future turns out to be not as bleak as most expect, prices move back up to value and better than average returns ensue.

Exhibit C is 2003, after the stock market dropped 48% and the second Gulf War started, right as the market started to climb 95% over the next 4 1/2 years.

Exhibit D is 2009, after the stock market dropped 56% and there were rumors the government was going to nationalize the banks, right as the market started to climb 106% over the following 3 years.

My point: optimism leads to poor returns, and pessimism precedes great returns.

The above is easier to grasp than it is to follow. Most people know they should buy low and sell high, but they mistakenly believe that they should wait "until the coast is clear" to invest, and run for cover "when the future looks scary." They know what they should do, but they succumb to optimism or pessimism and don't act.

Warren Buffett is the most successful investor alive because he is "greedy when others are fearful and fearful when others are greedy." Follow his lead:

• If the coast is clear and it looks like everything is coming up roses, that's not the time to double down--expect poor future returns
• If some people are optimistic and others pessimistic, then you can expect average returns
• If people are panicking and running for cover, that's the time to double down--expect high future returns

In other words, don't expect great results if everything looks safe, and don't expect poor results just because everything looks gloomy. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

A little perspective

If you ever want an experiment in what's important, try packing everything you value into two cars with danger at your heels.

I live in the foothills the Rocky Mountains, in Colorado Springs, Colorado. Because of the Waldo Canyon fire, we had to evacuate our home on Tuesday, June 26th.  The fire started on the 23rd, so we had over 3 days to prepare--plenty of time. And yet, it seemed like a somewhat theoretical effort until smoke covered our neighborhood, a bizarre yellow light shown on everything, and ashes were literally falling from the sky.

In hindsight, firefighters stopped the fire 1.8 miles from my home, and 0.6 miles from my in-laws' home. What seemed theoretical and just-in-case at first became starkly real on Tuesday evening when we went from voluntary to mandatory evacuation in about 20 minutes (not including the delay in receiving that information--yikes!).

First: bring what can't be replaced.  Wife, check; daughter, check; cat, check; fish, can't really transport on short notice. Also, bring photo's that aren't digitally backed-up (something to look into...), paperwork like marriage and birth certificates, passports, wills and life insurance documents, business paperwork, computers, other records, memorabilia, heirlooms, old daily planners, etc . If you're a nerd--I am--bring underlined books (the others can be replaced, but the underlining can't).  

Second: bring stuff you'll need to get by for a couple of days like clothes, food and water, sleeping bags and thermarests, so you can sleep anywhere. Be prepared to find out that all hotels are booked and you may need to find someplace else to stay (in a town of 500,000, there aren't 30,000+ hotel rooms, of course).

Third, other people can be amazingly helpful. My father-in-law owns a commercial building with a vacancy, so we had a place to crash that first night. We went to eat at Old Chicago's, and the manager gave us our meal and drinks for free after he found out we had been evacuated (talk about a brilliant loyalty program). Before we even asked, we had 4 offers of places to stay in Colorado Springs, and 3 in Denver. After one night in the commercial building, my mother-in-law's tennis friend, and her husband, gave us their home in Monument, CO while they went on a trip to Chicago to see family. We spent 3 nights there before returning to our home last Saturday (no damage whatsoever--thanks to the firefighters).

Fourth, everyone has a job to do, and I'm endlessly fascinated by the professionalism of people who do good work. From the beginning of the fire through today, I've been watching the intelligence, tireless efforts, and efficacy of firefighters, emergency-responders, police, utility operators, etc. This has been truly inspiring.

I've watched firefighters from the forest and city brief us twice daily, and this has given me a new appreciation and vocabulary (point protection, anchor, dozer line) to describe wildfires and how to fight them. Rich Harvey is the man.

I've also watched aircrews (helicopters and fixed wing) and firefighters fight the fire day and night for the last week and a half. They've had amazing victories (the fire is 55% contained at present), and terrible defeats (346 homes destroyed, 2 lives lost). It could have been much worse if it weren't for the firefighters' dedication and efficacy, but the outcome is still awful nonetheless.

All told, I have a new appreciation for what I own, what's truly irreplaceable, the wonderful people I know, and for the people I don't know, but can truly respect and admire from afar.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Downturn ahead?

With economic data getting worse and markets looking shaky, the question on everyone's mind seems to be: our we heading into another economic and market downturn?

Specifically, economic and market data in the U.S. are rolling over, Europe seems to be in full-out recession, and China is growing more slowly with its manufacturing sector even pulling back. This makes everyone wish they knew whether recent trends will continue down, or if a rebound (or central bank support) is on the way.

The reason people care is that it makes a BIG difference on short term returns. If the economy and markets roll over, then you want to be in long bonds, which do great under that scenario. If recent numbers are just a head-fake, and we're going to see growth resume, you want to own stocks and commodities because they're dirt cheap assuming growth resumes.

But, the above thinking assumes that it's possible to know whether the economy and markets will turn down or resume growth. Such an assumption is, however, suspect.

Can experts accurately predict either economic or market downturns? Their track record, contrary to popular belief (and the amount of money you pay for it), is terrible.  

Economists and market strategists, brilliant people who parse economic data on a full-time basis, are dreadful forecasters. As a group, they have never--not once--predicted a recession beforehand. 

Individually, most of them are wrong most of the time. Every once in a while, an economist or market strategist "correctly" predicts a recession or rebound, but no one--and I mean no one--gets it right more than a couple of times. 

Keep in mind that a broken clock is right twice a day--that doesn't mean it correctly tells time. A market strategist who calls for a downturn all the time will look right one third of the time, and an economist who always calls for growth will be right two thirds of the time. That doesn't make them accurate forecasters, and that won't help you get into and out of investments at the right time.

If the experts are consistently wrong, maybe the right place to look is the aggregate opinions of millions of market participants.  Do markets correctly predict market downturns or rebounds?  Not at all.  One famous quote is that "the stock market has predicted 9 of the last 5 recessions." Translation: markets predict recessions and rebounds much more frequently than they actually occur.  Once again, such guidance does investors more harm than good.

Well, if brilliant experts tracking all the data can't get it right, and the judgment of crowds can't do it, what's to be done?  

First off, accept the premise that, at present, no one has figured out how to consistently time markets over the short term. It's like forecasting the weather--it's such a complex and adaptive system that no one knows what's going to happen ahead of time (even though they can tell you precisely what happened in the past). 

If no one can successfully time the market, then don't try to do it--don't try switching in and out of stocks, bond and commodities in a failed attempt to get better returns. Channel Nancy Reagan and just say "no" to market timing.

Instead, do what has worked over the long run: buy cheap and sell dear. Instead of spending gobs of time, effort, and money trying to guess market direction, spend your time trying to figure out which companies to buy and then calculating what price to buy and sell them (relative to underlying fundamentals).

It doesn't work every time, and it won't necessarily work over the short term, but it does work over the long term with a high degree of confidence.

Avoid the rat-race of unsuccessfully wondering if a downturn is ahead, and focus instead on underlying value. Your results and your psychological well-being will be better for it.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Prior assumption: saving

As much as I love to blather on about investing in this blog, I must also make clear that all investing rests on a prior assumption: saving.

Put logically, saving precedes investing. Whether you can generate better or worse returns matters little if you don't save or don't save enough. A 100% return on $100 dollars will move your retirement meter an immaterial amount more than a 2% return on $100.  

Even prior to saving, you must manage your money. You must earn more than you spend or spend less than you earn to have savings. After that, you need to set aside that money for investment. Only savings can be invested.

My point may seem so blatantly obvious that it goes without saying. But, the truth is, people focus too much on investing (including yours truly) and not enough on saving.

There are two additional points with respect to saving that should be highlighted: 1) the more you save, the better; and 2) the earlier you save, the better.

To elaborate on #1, even if you generate moderate or weak returns, you can reach your goals if you save enough. For example, someone who saves $2,260 a year and generates 10% annual returns from the time they are 25 to 65 will have just as much money as someone who saves $8,278 a year and gets 5% returns from 25 to 65. 

Yes, the second person must save much more than the first, but savings can make up for poor returns. It's smarter to adjust your savings to the returns you get rather than vice versa.

Also, the impact of compounding is greatly enhanced by saving more over time.  Even if you don't get great returns, you can always work hard to save more money (earn more, spend less). The more you save, the better the outcome, all things equal.

The second point is probably even more important: the earlier you save, the better.

Early savings benefit more from compounding than later savings. For instance, if you assume two people get 10% returns, someone who saves $1,000 a year from age 25 to 35, but then doesn't save another dollar, will end up with $278,100 by age 65; whereas someone who saves $1,000 a year from 35 to 65 will end up with $164,500. Even though the first person saved only $10,000 and the second saved $30,000--three times as much--the fact that the first person started earlier means they end up with 70% more money and therefore a 70% higher standard of living.

Many people think such an argument is pointless if you aren't 25, but the math is the same with 40 to 50 and 50 to 80, or 55 to 65 and 65 to 95. The earlier you save, the better.

The prior assumption of saving before investment is frequently overlooked, but need not be.  

• Saving precedes investment
• Raise your savings to meet future goals
• Start investing earlier rather than later 

Getting great returns is only relevant once you've saved enough--so focus on saving first.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Patient capital

People are generally too impatient. Unfortunately, this doesn't serve them well.

Whether chasing crash diets, miracle cures, or playing the lottery, most people want quick fixes. They understand that longer term paths to success--eating less and exercising more--work, but they aren't willing to put in the time and effort to succeed. They want results NOW, so they end up with results alright--bad results!

One reason people do this is they get fooled by randomness (to use Nassim Taleb's phraseology). Short term solutions sometimes appear to work, and long term solutions sometimes appear not to work. Luck and timing plays a much bigger role in the short run, and this throws people off. If they were more patient, they'd figure out what works over the long run and stick with that instead of chasing quick fixes.

This phenomenon is readily on display with investing. Value investing--making investments with low price to fundamentals (sales, assets, earnings, book value, etc.)--consistently beats growth investing--high price to fundamentals--over the long run. But, randomness leads growth to sometimes out-perform value for a period, which leads impatient investors to chase what is "working" in the short run. They begin their chase only to find value out-performing growth yet again.

Why not just be a value investor through thick and thin? Because it requires a lot of patience.  

Just like people jump into fad diets, they won't stick to value investing because it isn't "working" right NOW. After all, it's hard to stick with something that isn't working, especially because this under-performance can go on for years (the last 7 being a good, but not historically unusual, example).  

But, just as night follows day, value investing will win over time, and patient investors will be the one's retiring on time while their impatient brethren are putting off retirement for a few more years.

Such is life.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unsurprising drop

The stock market was down 2.5% on its first trading day of June. This follows a decline of 6.8% in May, leaving stocks down 10.2% since its high of April this year, and down 18.9% since the high of October 2007. This seems to have surprised, and even shocked, many investors.

When asked what the stock market would do, J.P. Morgan famously said, "It will fluctuate." Benjamin Graham told investors (in his book The Intelligent Investor) to resign themselves in advance "to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent of one-third or more from their high point at various periods."

In other words, the stock market is a roller coaster, and investors should anticipate and even expect frequent stomach-churning drops and thrilling climbs along the way. These drops are not a sign of something unusual and dreaded, but something expected and even eagerly anticipated. Why? Because drops lead to opportunity as merchandise that cost $100 a few days ago is now on sale for less (sometimes, much less).

As I pointed out in my posts, Better than zero and "Where's the market going next year?", the math underlying expected future returns should have warned investors to anticipate drops. And, as I expressed in my post, All eyes on China, news of slowing growth from China would likely lead markets lower, and it has.

I think investors were surprised because they don't think of the stock market as a roller coaster, or they try too hard to relish the climbs and forget the inevitable drops. Perhaps they also suffer from myopia, attending to recent company reports and economic news instead of thinking about longer term data. 

Nevertheless, drops will happen, and they should be exploited instead of feared. Lower prices mean higher future returns--clearly a good thing. Panicky investors that sell as the market drops benefit longer term investors that buy from them. I'm not saying the drops won't pull at your stomach--they will. What I'm saying is drops are to be expected and wise investors will have the courage to act as the market drops to exploit short-term oriented investors.

I'm not panicking as my portfolio drops, but lining up my buy list and making purchases as the market sinks. The more it sinks, the more I'll buy. Just like riding a roller coaster, I look forward to the plunges and climbs, because that's the nature of the beast.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Sound and Fury

JPMorgan Chase announced it had a $2.3 billion trading loss last Friday, and politicians and the press are having a field day.  

To put this loss in perspective, the company made almost $5.4 billion last quarter, and $18.8 billion over the last 12 months.  That $2.3 billion loss occurred relative to an asset base of $2.3 trillion (the loss was 0.1% of assets), with $190 billion of equity (the loss was 1.2% of equity), $256 billion of long term debt, and $78 billion of short term debt.  In other words, JPMorgan would have had to lose $1.1 trillion before even one depositor with the bank would have been at risk.

Businesses will have losses as well as profits, and in this case JPMorgan's loss doesn't and couldn't possibly impact the solvency of the bank much less impact depositors or tax-payers.  

Politicians and the press are generating a lot of sound and fury at present, but don't seem to know or care what kind of business JPMorgan is, or whether it has put tax-payers in any way at risk.  

The reality is that a $2.3 billion trading loss is egg on the face of JPMorgan and Jamie Dimon, but has little impact on the viability of the bank, depositors or tax-payers.

To assume--as politicians and the press do--that regulators would have prevented this from happening is to forget the last 200+ years of banking regulation, which always has and always will manage to close the barn door long after the animals are gone.  

Regulators are human beings, too, and just like the hard-working people at JPMorgan, can and will make mistakes.

The assumption that more controls and regulations would prevent such events is pure fantasy, and is more likely to create than solve any problems.  Chasing down minor events like this loss that will have minimal impact on equity investors that have knowingly and voluntarily put capital at risk is worse than a waste of time--it's counter-productive.

JPMorgan's loss is bad for JPMorgan shareholders, not bond-holders or depositors.  The press and politicians are eager to use this event to call for increased regulations and control, but a short evaluation of JPMorgan's capital position and the "success" of previous regulatory reforms should make people pause and think before listening to the press or politicians.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Quantity AND Quality

When I offer my daughter the option of ice cream or cake, she frequently replies she'd like ice cream AND cake. To her, I offer a false alternative when the "OR" can very clearly be an "AND." In this case, her reasoning is sound.  There is no need to give in to the tyranny of "or," instead we should--as Jim Collins recommended in Built to Last--embrace "and."

I see this every day while investing. Should you invest in Growth OR Value?  Properly understood, this is a false alternative, because growth is one of the most important inputs to value.  

The value of a company is based on it's future cash flows. If those cash flows are growing, the company is clearly worth more than if they are not (you get more cash flows over time, all things equal). Value is based on Growth, so Value AND Growth must be understood.

For example, if you want a 12.5% return over the long run, you should pay eight times earnings for a 0% growth company, and 15 times earnings for a 6% growth company (almost twice as much!).  Growth has a HUGE impact on Value.

Another mistake investors make is to focus on either Quantity OR Quantity. Once again, Quality is a key input to Quantity. For instance, a company with high barriers to entry and superior management is more likely to achieve quantitative measures of performance like sales per share, profit margins and growth rates than a company without these qualities.  

The degree of certainty that a quantitative result will occur is a qualitative factor, so the quantitative result is driven by the qualitative situation. Once again, Quality OR Quantity is a false alternative--you must pay attention to Quality to correctly grasp Quantity.

Just think about Coke. An inexpensive, frequently purchased product with addictive qualities (caffeine, taste, habit) is much easier to quantitatively predict than an expensive, infrequently purchased product with no addictive qualities (like washing machines). Quality heavily impacts Quantity.

Successful investing is about understanding the nature of each investment. To successfully do this, you must focus on Growth AND Value, Quality AND Quantity. Don't suffer from the tyranny of "or," do as my daughter does and embrace "and."

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Picking a money manager

It has been well documented (by organizations like Dalbar as well as tons of academic research) that investors get lousy results over time. 

One reason is that they try to do the investing themselves, but lack the knowledge, skill or temperament to invest successfully. Another reason is that they're lousy at picking money managers. I can't help with the first problem--it's up to each person to be honest with themselves about their own abilities and results--but I can help with the second: picking money managers.

There are basically two ways to pick a money manager:

1. Examine past results
2. Examine a manager's process to see if it is a good one

The benefit of examining past results is that it can be done quickly and seems objective. The problem is that separating random luck from real skill is extremely difficult. 

Every money manager's past record includes a component of randomness, or luck, and a component of skill. How do investors know whether they are seeing a record due to luck, or skill? They don't.

Investing results are much more random than most investor recognize, especially over the short term. Looking at a record of less than 3 years is likely meaningless. Records of more than 3 years are more meaningful, but even outstanding money managers can under-perform for 5, and sometimes even 10 years!  Correlatively, some managers have great records that don't last because they were lucky, not skillful. 

Most investors examine past records, but their ability to pick good managers by looking at investing results is terrible. Even professional consultants and investment committees filled with experts get this wrong much more often than right.

Examining past records has a dreadful track record of successfully picking managers.

The other option, examining a manager's investment process, is much more time consuming, but has a much better chance of being done successfully.

Specifically, there are two measures that seem to be both reliable (persistent) and valid (actually lead to the desired result).

The first is called active share, which is a measure of how different a money manager's portfolio looks from the general market. To beat the market, you have to be invested differently than the market. You want to find a manager whose portfolio looks different than the market, and therefore has high active share.

The second measure is called tracking error, which is a measure of how differently a manager's portfolio moves relative to the market. If a manager is all in cash, his portfolio will not move up and down with the market at all, and that leads to high tracking error. A manager who owns the same stocks in the same proportions as the market will move in lock-step with the market, and that leads to low tracking error. 

A manager with a good process tends to have moderate tracking error, which means his portfolio neither moves precisely with nor against the market. Such a manager doesn't try to time market segments (all technology or all energy), nor does he try to pick "winning" asset classes (all cash or bonds to get in and out at the right times). A good manager picks investments that don't mirror the market, but that do tend to move in the same general direction as the market over time.

Most investors use the wrong methodology to pick money managers and their results suffer. Instead of looking solely at past records and hoping they can guess whether that record reflects luck or skill, investors should look at a manager's process. 

If a manager picks investments different than the market (especially if those investments have been carefully analyzed), and doesn't try to time segments or asset class exposures, you're likely to have found a manager that will get good results in the future.

Examine a manager's process, not just their record.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Forever growth?

Growth stocks have been crushing value stocks over the last several years, by:

• 6.3% year-to-date
• 7.1% over the last year
• 3.8% annually over the last 3 years
• 5.5% per annum over the last 5 years

Such a strong run leads many investors to question if growth has formed a permanent advantage over value.  

Briefly, the answer is no.

Over the short to intermediate term, it's quite normal for growth or value to out-perform for a time. But, these periods always end. Just looking back over the last 10 years, value beat growth by 1.1% annualized (even including the last 5 years of dramatic out-performance of growth over value). Over the last 80 years, the data are even more compelling: value has out-performed by over 3% a year.

What gives? Basically, investors tend to herd. They run in one direction for a while, take that too far, and then reverse direction. Value, after under-performing for 5 years, goes on to crush growth for the next 5 years. And then, following that, growth goes on to crush value for the next 5 years. Rinse and repeat. (It's not always 5 years at a time--sometimes it's 1.5 years, sometime 3, 5, 7, or even 10.)

Just like night follows day, growth and value go in and out of favor only to see that reversed time and again. Smart investors look to benefit from this regression to the mean by examining 20 years of results instead of the last 3 or 5 years. You can't time the reversals, so don't try.  Instead, bet on the long-run winning hand, and over time you'll do very well.

You can well imagine that Apple's outstanding growth and performance has greatly contributed to the excellent run of growth stocks over the last decade. Apple now accounts for 4% of U.S. Gross Domestic Product (GDP) and 4.4% of the value of the S&P 500.  

Even if Apple starts producing oil, cars, food, and all the other things in the economy (highly unlikely), its growth will eventually regress to the 3% growth of the underlying economy. When that happens, and it's likely sooner than most think, Apple's growth stock tailwind will turn into a headwind, and value will come back into favor.

I have no idea when this will happen, but I do know growth's out-performance will end and value's out-performance will re-emerge. In the meantime, I've positioned myself to benefit from long-run, time-tested investing wisdom instead of trying to play the short-run, unreliable trends of the moment. Over time, that is the winning hand.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Investing: 3 part harmony

Investment returns seem mysterious to most. You buy one investment and it takes off; you buy another and it tanks; you buy a third and it goes nowhere. Why? It seems more random and unpredictable than the weather at times.  

The underlying reality is more simple than that, though.  Investment returns can be broken into three parts and analyzed individually. Understanding that three part harmony makes investing seems much less mysterious and more practical--and so it is.

Investment returns consist of:

1. dividends relative to price paid
2. underlying earnings growth
3. change in the multiple to underlying earnings

The dividend seems like the most straightforward part of investing returns, but many people seem to overlook the importance of it. What matters is the dividend relative to the price paid over the full period of investment. If that dividend is eliminated (like banks in 2009), shrinks (Real Estate Investment Trusts) or grows (Johnson and Johnson), that can have a big impact on your return. It's important to understand the dividend yield as well as the sustainability of that dividend (whether it will grow or shrink).

The second element, earnings growth, is (in my experience) the hardest to predict, and has  the second largest impact on returns. If earnings grow while you hold an investment, then you have a nice tailwind that can allow you to generate good results (Apple). If earnings shrink (Best Buy), or even tank (Citigroup), it probably won't matter what price you paid or dividend yield you start with, your investment results are likely to be unsatisfactory.  

Earnings consist of underlying sales and profit margins (or book value and return on equity in the case of banks, insurance companies, etc.). If sales grow and margins are stable (Wal-Mart), then earning will most likely grow. If margins grow and sales are stable (IBM), you'll likely experience earnings growth. If margins and sales tank because technology has become obsolete (Blackberry, anyone?), earnings shrinkage will be a big headwind to your results.

The third element, change in multiple to earnings, is the most difficult for people to grasp and is likely to have the biggest impact on return. The multiple people are willing to pay for earnings, which is frequently expressed as price to earnings ($10 per share stock price, $1 per share in earnings, 10x price to earnings multiple), is a reflection of how market participants think of a company and its future prospects. If people think very highly of a company (Amazon), they may be willing to pay 20x or more on earnings; if they think poorly of a company and its prospects (Xerox), they may be willing to pay only 5x earnings.

Market sentiment towards companies changes a lot over time. When people become despondent with a company, it can trade very low to fundamentals; when people become euphoric, a company can trade at very high multiples. Whereas one can analyze and predict dividends and earnings based on underlying evidence, multiples are more likely to be a result that must be judged and reacted to rather than predicted. Buying at a low multiple and selling at a high one gives a tremendous tailwind to investing results.

When you put together multiple change, earnings growth and dividend yield over the life of an investment, you have the three parts of investment return. By analyzing those three parts, you can understand why your investments do well or poorly, and then make adjustments to your investment process. The three part harmony of good returns requires a keen understanding and mastery of all three parts.  

Investment results can be clearly understood if you take the time to do so. Such an effort removes the mystery and reveals an understandable system that can be used to produce good results. This may not sound as exciting as shooting from the hip in hopes of a big win, but good results over time create great wealth, and that's as exciting as can be.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

How much money do I need to retire?

One of the most frequent questions I get is: how much money do I need to retire?

This is a much more complicated question to answer than most grasp. It depends on the returns you can get from now until the day you die, and that isn't a number you can look up on Wikipedia. It depends on how much savings you have, and how much you can and will save from now until you retire. It depends on inflation over the rest of your life, how much you withdraw each year in retirement, how long until you retire, how long you (and your spouse) will live after you retire, how much you need to live on each year, what tax rates will be over the rest of your life, what kind of accounts you have your money in (tax deferred: traditional IRA and 401k; pre-taxed: Roth IRA; taxable account, etc.), and so on.  

As you can see in the list above, there are so many unknowns and unknowables that you can't possibly come up with a precise figure. The best you can really do is calculate an estimate. Added to this, so many people make invalid assumptions (including many financial planners, I'm afraid) that they come up with misleading answers. Other people don't even try because they feel overwhelmed by the process or are just trying to get by from day to day.  

Unless you're in bad health and expect to die before you stop working, it's a very good bet you'll need money in retirement, so this is a number you really should think about. The ostrich technique won't work here any more than it does in any other part of life.

With this in mind, I believe there is a simple way to derive an estimate that will succeed. Like all simplifications and rules-of-thumb, it's not fool-proof, but having spent countless hours thinking about it, crunching the numbers, and applying it, I know it works.

My rule of thumb is to multiply the annual amount of money you want live on in retirement by 30. For instance, if you want to live on $100,000 a year in retirement, then you can retire when you've saved up $3,000,000. This estimate works at any age, too, whether 20 or 60 (although it's probably more than you'll need if you're over 70--and that's a high-class "problem" to have).  

A lot of people gasp when they hear my rule, because it's a lot higher than they expect. Most people don't have anywhere near that amount saved, and they feel daunted by a number so beyond where they are or believe they can get.

I'll admit, my "times 30" rule doesn't assume you have a pension, and it also assumes you won't get social security. This may seem like a gross simplification, but if you understand the adequacy of pension and social security funding, you may want to be prepared for that money to be reduced or cut altogether (especially if you're younger than 50). If you believe you'll get your pension/social security, just use my "times 30" rule for the amount you'll need beyond those retirement dollars (if you'll receive $30,000 from social security and need $100,000 a year in retirement, then use 30 times $70,000: $2,100,000).

My "times 30" rule assumes a 3% withdrawal rate. Most assume they can get much better returns and believe they can withdraw more than 3% a year. The empirical evidence is against them--people who withdraw more than 5% a year are likely to run out of money before both spouses die, and people who plan to get 20% returns are living in fantasy-land.  

Most long term tests show that a 4% withdrawal rate provides enough money to last until death. My problem with that plan: it doesn't provide a margin of safety. Just like I'd prefer to drive over bridges that are designed to handle much more than "expected" loads, I want my retirement plan to be able to handle the unexpected, too, and I believe my "times 30" does this. I use the "times 30" rule personally, so I'm eating my own cooking, here.

Another issue is that most people don't really adjust for the destructive impact of inflation.  We don't know what it will be, so we want to be prepared come what may. I think "times 30" does this (along with a retirement plan that protects investments from the ravages of inflation).

Keep in mind, too, your retirement dollar number isn't something you want to under-estimate. Many who retired around the year 2000 thought the stock market would keep going up and ended up having to go back to work after they retired. That's not a very good plan. You'll want more than enough to retire so you don't end up in that situation.

If "times 30" sounds too difficult to reach, here are some things to focus on that will allow you to get there. First, save as much as you can as early as you can. The impact of compounding makes high, early savings worth a lot more money over time. Einstein called called compounding the eighth wonder of the world, and he knew a thing or two about math.

Second, try to get good returns. Other than saving as much as you can as early as you can, your returns will have the next biggest impact on how soon you can retire. This doesn't mean take your retirement dollars to Las Vegas or play the lottery, it means investing intelligently. Either work hard to find someone with investing skill, become an expert investor yourself, or buy low cost index funds and stick with them. Don't try to time the market or switch into and out of funds to get better returns. Make an intelligent plan and stick to it!

Finally, monitor your path and make adjustments as necessary. I review my retirement plan with my wife at least once a year to make sure we're on track. The way to get on track isn't to switch investments every three years, but to increase your savings to make up for any short-falls. If you have more than you'll need, it's probably because the market is over-valued, so don't spend that portion thinking you're ahead. Plus, there's nothing wrong with reaching retirement early, or with more than you'll need.

If you save 30 times the amount you'll need on an annual basis, I believe you can retire right away--whether you're 20, 40, 60, whatever. This rule isn't a cure-all, but it's an excellent aim-point for those who want to reach retirement and then have enough money to enjoy it.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stick to your knitting

There are many ways to invest, but, what's more important than any particular method you choose to is whether you stick to it.

One fundamental choice is passive or active. Passive investing is investing with the market. This method is agnostic about market value and broadly diversified. It's low cost and tends to beat most active managers, but can go through long periods of poor absolute returns, like we've seen over the last 12 years. If you don't want to search hard for superior investors and can't stand being out-of-step with other people, then passive is probably your best approach.

Be careful, though, not to waffle between passive and active. More important than your choice of passive or active is whether you can and will stick to your choice. Those who switch between passive and active do worse than those who stick to either passive or active.

Active is investing differently than the general market in an attempt to beat market returns. This is very difficult to do, but if you can find a superior money manager, it can make a huge difference in your long term wealth. Once again, you must stick with the approach for it to work, and this will be hard to do when your active manager is out-of-step with the market, under-performing the market, and charging you higher fees than passive investing. Once again, if you switch back and forth between passive and active, you will do worse than either approach.

Within active, there are several approaches, too. There's macro investing: trying to bet on economic trends in the attempt to have exposure to the best sectors or countries. There's market timing: trying to anticipate market sentiment and buy when things go up and sell before they go down. There's growth: trying to buy the fastest growing companies to beat overall market growth. There's value: trying to buy companies selling at the lowest price to underlying fundamentals. Value has the best long term performance, but even it goes long periods of under-performance between bouts of out-performance.  

I'm going to risk sound like a broken record, but it's too important not to emphasize again: it matters less whether you choose value, growth, marketing timing or macro, and more whether you stick to it. Value may out-perform over the long run, but it won't work if you try to do it when it's "working" and try to do the other methods when they're "working." The academic and anecdotal research on this is unequivocal, people who try to switch methods at just the right time grossly under-perform those who stick to one method consistently.

I'm a dyed-in-the-wool value investor, I'll readily admit, because it works better than the other options. To succeed, though, I have to stick to it in good times and bad, not just when it's "working."

If you want good investment results, pick your method and stick to it. Though some work better than others, nothing works as poorly as trying to switch between them.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.