America needs to rethink retirement

Very thought-provoking article on rethinking retirement.

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.

Try to time the market: get lousy returns

More evidence pours out each year that investors get worse returns than the mutual funds they invest in.  The reason isn't high fees, but the actions of investors themselves.

Basically, investors try to time their purchases of mutual funds.  

They buy mutual funds that have "been working" and sell the one's that "haven't been working."  

They "go to the sidelines" when markets look scary, like they did in 2008-2009, and only put their money back to into stocks after "the coast is clear."  

They try to buy into "alternative" investments, or speculate in commodities, or decide to jump into and out of foreign markets.

All of this action causes them to buy and sell at the wrong times, thus dramatically reducing the returns they receive relative to the underlying performance of the mutual funds they choose.  

The solution is to stop trying to buy and sell at all.  Instead, investors should do enough homework to pick the best investment choice, and then stick with it.

Will their net worth go up and down with crazy market swings?  Yes.  Would such investors get better returns?  Also, yes.

Sometimes the hardest decision is the decision of what not to do.  

Investors should decide not to buy and sell in an effort to time the market.  They would end up much better off if they did.

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.

Buffett's advice

Part of Warren Buffett's annual letter to shareholders appeared in Fortune magazine this week (click here to read the article).  It's short and worth reading.

In it, Buffett spells out the investment advice that he and his mentor, Benjamin Graham, have spelled out for years.

"Investing is most intelligent when it is most businesslike."

Buffett describes two real estate investment he made that have done well: one a farm in Omaha and the other a New York City retail property.  In both cases, the properties were purchased when no one wanted to own them, so he bought at very reasonable prices (10% yields with the potential for asset growth over time).

He was investing in real assets, not pieces of paper on an exchange.  He evaluated the cash flow potential relative to the price to be paid, and recognized a good deal with limited downside.  He didn't care if others liked or didn't like the price.  He didn't care if they generated excellent returns right away.  He was thinking long term, and he was thinking about the specific properties and his ability to evaluate them.

"You don't need to be an expert in order to achieve satisfactory investment returns."

"Focus on the future productivity of the asset you are considering."

"If you instead focus on the prospective price change of a contemplated purchase, you are speculating."

"Forming macro opinions or listening to macro or market predictions of others is a waste of time."

"Stocks provide you a minute-to-minute [quoted prices] for your holdings, whereas I have yet to see quotation for either my farm or the New York real estate."

"Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well."

"When...I buy stocks -- which [I] think of as small portions of businesses -- [my] analysis is very similar to that which [I] use in buying entire businesses."

"Most investors, of course, have not made the study of business prospects a priority in their lives.  If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power."

"The goal of the nonprofessional should not be to pick winners -- neither he nor his "helpers" can do that -- but should rather be to own a cross section of businesses that in aggregate are bound too do well."  By "helpers," Buffett means financial planners or investment advisers who don't understand how to value businesses, or choose not to make the effort.

If you or your helpers don't know how to value businesses, then a low cost index fund is the way to go.

Don't try to time the market by getting in when it is "hot," and out when things look "scary."  You will do worse if you try.

"Price is what you pay, value is what you get."

After Buffett dies, his advice to the trustee who will manage his wife's money is to invest 10% in short term government bonds, and 90% in a very low cost S&P 500 index fund.  He's putting his money where his mouth is.

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: simple but not easy

As Warren Buffett said, investing is simple, but not easy.

The concepts are simple to understand, but executing those simple concepts isn't easy.

People shoot themselves in the foot by paying too-high fees, trying to time their entry and exit from the market, and by picking lousy advisers.  Our psychology makes us our own worst enemy.

Instead of doing the homework necessary to get and stay on the right track, most want short-cuts.  Those short-cuts lead to a ditch.

When picking an adviser, the most important thing to know is their character.  Not their credentials, not their schooling, not even their knowledge.  Smart people with bad character are just better at ripping you off.

How do you know a person's character?  It's not easy, but it is simple.  Look at how they are compensated.  Find out if they follow their own advice.  Talk to their current and former clients.  Are they willing to admit their own mistakes?  Are they forthright, or evasive?  Does such homework take some extra work?  Yes.  Is it worth it?  Yes.

If they have credentials, are those credentials legitimate?  Seeing that someone has some letters after their name is not due diligence.  Some programs are a sham done over a weekend.  Others take years and are excruciatingly difficult to get through.  If you don't know the difference, how do you know how your money will be handled?

What is an adviser's investment process?  Can they explain it, or do they talk patronizingly to you as if you were a 5-year-old?  Does it make sense to you, or does it sound shady?  If you don't know how they do what they do, then you'll panic at the first difficulty--and there will always be difficulties.  

Respecting and admiring your investment adviser is important; thinking that you'd like to spend your free time with them isn't.  You aren't looking for a buddy, you're looking for sound financial advice.  If you want a loyal friend, get a dog.  Nothing is more likely to prevent you from reaching your goals as not wanting to hurt a friend's feelings.

Be objective in this process.  Pick character first, check up on an adviser's background, know and agree with their process at some level, and pick someone you respect over someone that seems oh-so-nice.

Reaching your financial goals is too important to take short-cuts.  Do the work, reap the benefits.  It's not easy, but it is simple.

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.

I wrote a couple weeks ago about the right stock/bond mix before and during retirement.  

Another good article appeared in the WSJ this past week that is also worth reading on the same subject.

The concept of reducing your stock exposure slowly as you age is being questioned.  Perhaps it's better to have a lot less stock just before and early into retirement, but then increase the stock portion as retirement goes on.

I think this is a much more intelligent way to think about retirement planning and should be reiterated.

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.

So much for the safety of bonds

Bonds had a lousy 2013.  Most investors think bonds are always safer than stocks, but it depends on what you are buying and the price you pay.  

Last year, the 1-3 year Treasury Bond ETF (SHY) generated a 0.23% return.  That's one-tenth of inflation.  

The 3-7 year Treasury Bond ETF (IEI) returned -1.95%.

The 7-10 year Treasury Bond ETF (IEF) returned -6.12%

The Treasury Inflation Protection Bond ETF (TIP) generated -8.65% return.

The 10-20 year Treasury Bond ETF (TLH) returned -8.48%.

The 20+ year Treasury Bond ETF (TLT) returned -13.91%.

Oh, by the way, the S&P 500 ETF (IVV) returned +32.31%.

What happened?  As has been long predicted, interest rates went up.  That's it.  When interest rates go up, bond prices go down.

When you buy bonds at high prices and low yield, you get return-less risk instead of risk-less return.

Bond yields are higher, but not high relative to history.  The bond bull market that began in the early 1980's saw yields in the teens.  Today long government bonds are yielding 2.6% to 3.6%.  I don't know which way they will go, but yields still have more room to go up than down.

Bonds are safe when they are priced to provide good returns, not at any price--just like stocks provide good returns when priced accordingly.

No financial instrument is inherently safe.  It depends on what you buy, and the price you pay.

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.

In retirement: how much bonds and stocks?

Most people cling to the idea that people should invest in stocks when young and bonds when old.  

Specifically, many believe that young people can stand the risk of stocks and retirees can't, so you should start 100% stocks when young and gradually increase your bond percentage until you have 100% bonds late in retirement.  Sound familiar?

This advice tends to sound like:

• own 100% stocks when you are 25
• 80% stocks and 20% bonds when you are 35
• 70%/30% at 45
• 60%/40% at 55
• 50%/50% at 65
• 40%/60% at 75
• 20%/80% at 85
• 100% bonds in your 90's

Some provocative research indicates this may be the wrong way to think about asset allocation.  

The riskiest period for retirees is right before and early in retirement.  If they own a bunch of bonds or stocks that tank in that critical time period, it is hard for them to recover.

Added to this, as a retiree ages, their greatest risk is running out of money because their assets don't appreciate enough relative to inflation or how long they live.

Instead, the new approach indicates a U-shaped path, with lots of stocks early and late, and more bonds in the middle.  The idea is that you get lots of growth early, less right before and early in retirement, and then ratchet up the stocks to make sure you outrun your age and inflation.

Although I think that is better advice than just increasing bond holdings linearly over time, I think it may miss the risk of stocks and bonds at certain times.

Bonds had a lousy year last year, and stocks did wonderfully.  The extremely low rates on bonds should have been a warning, but many people think bonds are inherently safe and don't understand that bonds decline in price when interest rates rise.

Same with stocks.  Stocks are better investments when they are cheap than when they are expensive.  Knowing when to own one versus the other may mean the difference between collecting cans or enjoying retirement.

Having the right mix of assets before and during retirement is vital to successfully navigating retirement.  The task shouldn't be taken lightly or with imprecise rules of thumb that don't always work.

Fortune favor the prepared mind.

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.

2013: tough year for stock pickers

Research from S&P Dow Jones reported in Pensions& Investments shows that 2013 was a tough year for stock pickers.

The average variance in returns between stocks in the S&P 500 was at its lowest in more than 20 years!  That means for people making a living trying to pick the winners and avoid the losers (like, well, me), 2013 looked like a fruitless year.

This is great news for passive, index investors, and bad news for active investors trying to beat the market--at least in hindsight.

This last point is important.  Either the average variance is low and staying there or headed lower, or it will regress to the mean and stock pickers will be able to add value by picking winners and avoiding losers.

My experience is that years like 2013, where most investors are focused on government action, Federal Reserve policy, and international macro-economics, are lousy for stock pickers.  Instead of focusing on sales, earnings, profit margins and returns on capital, investors were trading stocks en masse based on the latest government report.

But, stocks aren't claims on future Federal Reserve policy or macro-economic output, they are claims on future earnings of specific businesses.  Unless you think all businesses are equal, then some will do better, some will do worse, and buying the ones that will do better will reward you as will avoiding their opposite.

I know what I'll do as always: spend all day researching specific companies to figure out which ones will win in the years to come.  At some point in the not-too-distant future, this will be profitable again.

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.

Wall Street 2014 forecasts = random dart throwing

Further support for my recent blog about Wall Street's stock market predictions for 2014.

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 will you spend in retirement?

The Wall Street Journal just published a good article about retirement income.

I tend to be conservative in my planning, so I assume 100% pre-retirement spending, and spending 3.33% of savings per year, but the article highlights the more conventional view of 75% to 85% pre-retirement income and 5% per year spending.

The choice is really up to each individual, but I prefer a bigger rather than a smaller margin of safety.

If you were told you had a 1 in 20 of getting into a major car accident today that would cause debilitating injuries, you probably would elect not to drive.  But, when people are told they have a 5% chance of running out of money in retirement, they don't seem to grasp that 1 in 20 and 5% are the same odds.

Depending on the kindness of strangers--or worse, family members!--in your 80's or 90's sounds about as enticing as a debilitating car accident, to me.

The issue isn't so much what numbers you plan for retirement spending and saving, but that you think about it.  The article referred to above gives a great set of ideas to consider in your retirement planning.

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.

2014 Stock Market Prediction! NOT!!!

It's that time of year again, when the public eagerly eats up articles, speeches and sound bites predicting where the stock market will close in 2014.

My problem with this annual ritual is that it's a ruse that distracts people from investing, and leads them instead into unprofitable speculation.

No one knows where the stock market will end 2014 any more than someone knows that one roll of a die will land on 6.  Someone may get lucky and guess 6 correctly, but everyone acknowledges it's luck and not skill.  

The skill with rolling a die is knowing that any one roll cannot be predicted, but that several rolls will converge on an average number of 3.5.

I just rolled a die 57 times.  On the 11th roll, the average converged above 3.  On the 57th roll, it had converged on 3.175.  If I kept doing it, it would converge on 3.5.

The same is true with the stock market.  Predicting one year's return is impossible, but knowing the trend over time leads to a converging solution.

By my estimates, I think the S&P 500 will return 0.9% over the next 5 years.  Now, that's not one roll of the die, but several.  

And, that could occur as 5 years of 0.9% returns, or as 4 years of 12% returns and one year of -33%, or as 2 years of -33% returns and 3 years of 33%.  You get the idea.

I don't know any one year's return, but I can understand the underlying nature of the system and predict where things will converge.  

The longer the period, the more confident I am in my prediction.  That 0.9% 5 year prediction doesn't carry a lot of confidence any more than 5 rolls of a die will end up averaging 3.5 with much confidence.  But many rolls makes me more confident in my prediction.

That is why I more confidently predict 4.4% returns over the next 10 years, and even more confidently predict 5.6% returns over the next 15 years.
Thinking about next year's return and acting on that "thinking" is pure speculation, and a sure-fire way to lose money over time.

Instead, focus on the longer run where the predictions are more accurate.  
The market isn't cheap, so don't expect high returns over the next 5, 10 or 15 years.  

But, that doesn't mean we won't have high returns in 2014.

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.

Objective advice, or shady recommendations

Another great article in the Wall Street Journal: this one about how investors are confused about adviser fees and regulation.

The issues may seem nit-picky, but they have a big impact on investor outcomes.

On the one hand, you have fee-only advisers who are paid as a percentage of assets under management, a flat fee, a per hour fee, or a per task fee.  

On the other hand, you have fee-based advisers, who are paid by a combination of fees and sales commissions.  

If the issue seems trivial, let me explain.  A fee-only adviser will not get $5,000 for advising that you invest $100,000 in a particular mutual fund.  A fee-based adviser will.

When you ask a fee-only adviser for advice, you know they aren't steering you toward a lucrative product which may not be right for you or any good.  With a fee-based adviser, you don't know.  

Asking a fee-based adviser for advice is like asking a barber if you need a haircut--the answer will always be yes.

Another issue is fiduciary duty.  An investment adviser (a regulatory designation: Investment Adviser's Act of 1940) must put the interest of clients' above their own.  A broker/dealer (Securities Exchange Act of 1934) has no such obligation.

When you see fee-based, think broker/dealer and barber.  When you see fee-only, think advice in your best interests.

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.

Investors are their own worst enemy

Jason Zweig had a excellent article in the Wall Street Journal about how investors get worse returns by chasing hot performance right before it disappears.

Essentially, investors get much worse returns than the funds they invest in.  The reason: they sell what hasn't been doing well and buy what has been doing well.  If they held the same fund over time, they'd get the same returns as the fund, but they buy and sell at the wrong time and get worse returns.

It's not just individual investors who are prone to this--professionals investors do it, too.  The problem is that investors are paying professionals to do the same thing they would do, but then they end up even farther behind because they've also paid a professional fee.

Investing is simple, but not easy.  To get good returns, you need to choose the right principles, and then follow them through thick and thin.  That's hard to do for most investors, especially because they pick professionals they like instead of the ones who are competent.

So was it ever.

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 NOT to pick a mutual fund

The Wall Street Journal had an excellent article recently about how NOT to pick a mutual fund:

1. Focusing too much on past returns.  Separating luck from skill is extremely difficult, so you don't know whether the fund with excellent past returns is going to do well going forward or blow up.

2. Not understanding how the money is invested.  The process of investing generates results, so you need to focus on the cause, not the effect.  If you don't understand the process, there's no proof it works, or it's too narrowly focused on what has worked well recently, stay away.

3. Diversification in name only.  Diversification is only worthwhile is if it's truly diversified and if it's very low cost.  If diversified means 5 different mutual funds focused on gold, you're toast.  If it means you buy 5 full cost (1% annual fees) mutual funds that cover large, small, value, growth, bonds, etc., then you're throwing your money away.

4. Chasing headlines.  If you buy something because it's in the headlines of the news, then you'll almost certainly get crushed over time. The smart money has already bought and sold before it's in the headlines.

5. Buying on ratings alone.  If you focus on the ratings/stars that most mutual funds advertise (there's a reason why they are advertising that fund now, and not at other times), then you'll likely get bad results.  Most returns aren't persistent (they don't continue in the future), so if you buy what has done well recently, you'll probably lose money.

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.

Ray Dalio explains how the economy works

Perhaps a little over-simplified, but an excellent explanation of how the economy works by Ray Dalio.  

Credit is not created out of thin air, as he says, but by those willing to save instead of spend (except for demand deposit accounts, but that's getting into details of how banks create credit apart from saving/investment, and still depends on people being willing to save/not spend).

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.

Fee-only in name only

If you receive advice or asset management services, ask how you provider is compensated.

Some asset managers are compensated as a percentage of assets under management.  This is how most mutual funds work (and how I'm compensated).  This compensation is referred to as a fee.

Some asset managers are compensated by a flat fee.  They charge by the hour or a flat rate $500) for services provided.  This compensation is also clearly a fee.

Other financial planners or advisers are paid commissions.  In such arrangements, the professional is compensated when a transaction occurs.  For example, when you buy or sell a stock or bond, the stock broker gets a commission for the trade.  Or, when a financial planner recommends certain mutual funds, they receive a sales commission from the mutual fund (frequently as high as 5% of your money).  Or, when an insurance agent sells you life insurance or a variable annuity, they are paid a commission for the product they sell you.

Fees tend to be more transparent than commissions.  It's very hard for advisers or managers to charge fees without clients knowing because they send a bill or the client has to write a check.

Commissions, however, are harder to see.  When a mutual fund pays a sales commission, the client may not even realize that such a fee has been paid.  Commissions must be disclosed, but you must read the fine print and it's not as obvious as an invoice.

This distinction is not simply academic.  Advisers who claim to be fee-only are seen by many investors as more clearly and justly compensated, so many seek out "fee-only" advisers.

Shadier planners and advisers, however, have caught on to this designation and used it against clients.  It turns out many supposedly "fee-only" advisers are actually compensated with commissions.  See Jason Zweig's article in the Wall Street Journal from last weekend.

Not surprisingly, many of these "fee-only" advisers work at brokerage houses.  Surprising to me, many carry the CFP or Certified Financial Planner designation.  So much for professionalism.  

If you don't know how your planner or adviser is compensated, ask the question.  It may seem like an $800 fee for a plan is good money spent, that is until you find out your "planner" earned a $5,000 commission when you invested $100,000 in the mutual fund they suggested. 

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.

Above average returns are almost never comfortable

Every investor dreams of steady, 10% returns. That burning desire generates poor results because most can't tolerate the discomfort that accompanies such good returns.

Jason Zweig makes this point nicely in his Wall Street Journal article, Value Stocks Are Hot--But Most Investor Will Burn Out.

Excellent returns almost always require being out of step. But, straying from the herd is very uncomfortable. That discomfort tends to build over time until investors cry uncle to end the pain. Then they miss excellent returns.

Don't use steadiness or comfort to judge potential investments or your resulting returns. Great returns come in irregular lumps and from an uncomfortable place.

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.

Forewarned is forarmed: save more, withdraw less

Most retirement and financial planners assume you can withdraw 4% of your nest egg per year and not have to worry about running out of money before you "shuffle off this mortal coil."  

This 4% withdrawal rate is based on a multi-year analysis of PAST returns.  But, the future will not look like that past.  

Bonds' historic return of over 5% will not recur when 10 year rates are 2%, 30 year rates are 3%, and future inflation will likely be higher than today's 2% (when inflation rises, bond rates rise, and that means bond prices fall--leading to returns likely worse than 2-3%).

Stocks are not selling at price to earnings multiples of 15 times or less, so equity returns will not resemble the 10% many have come to expect.  My expectation is for -3% to 9% returns from equities over the next 6 years.  

No matter what combination you use of 2 to 3% from bonds and -3% to 9% from stocks, it will not add up the numbers used to derive the 4% withdrawal rate. 

So, what rate should you use for the future?

In my 2nd quarter client letter, I argued for the rule of 30, which implies a 3.33% withdrawal rate and 30 times your annual spending in savings.

Recent research from Morningstar and an article on Marketwatch argue that I may be too optimistic, that a 2.8% rate is a smarter aim-point (to have a 90% chance of not running out of money).

Regardless of how you want to look at it, the reality is that people need to save more to reach retirement and should plan to withdraw less when they get there.

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.

China syndrome

Some people think China will grow strongly forevermore.  That would lead to significant changes in both the political and economic landscape going forward.

Others think China will run into a brick wall because governments are terrible capital allocators.  That, too, would lead to significant changes on the political and economic front.

In other words, China will have a large impact on the future of politics and economics no matter what.  You can't think about the short, intermediate or long term without some attention to China.

With that in mind, I highly recommend a recent piece from GMO (a very good investment firm) regarding China.  

It points out the same problems highlighted in a book called Red Capitalism: that China's growth is built on a shaky and corrupt financial system.  

I hold the opinion that China is headed for trouble, although I have no idea when that trouble will come about (just like I saw the dot-com bubble and the housing/credit bubble coming, but couldn't predict when each would pop).  

China's trouble could be long term stagnation like Japan experienced over the last 20 years, or economic collapse like Europe and the U.S. experienced in 2008-2009, or outright revolution.  I really don't know.

But, I do know it's important to think about ahead of 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.

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.