WHO WANTS TO TALK ABOUT MONEY

Money Is Important. I’m sure that most of you read this column with the hope of gaining some insight as to how to manage your finances. For the most part, that’s what I try to convey. There are a lot of important things to talk about at this point like how to manage your cash flow in light of future tax increases, the soft real estate market, and potential estate tax changes. These things will have a profound effect on our financial future, but frankly, I am bored with talking about money. You can read a myriad of discussions about these topics in previous posts which started in 2006 but I would ask you to grant this old coot an opportunity to talk about something else.

We Took A Walk In The Woods. The woods next to our house bear little resemblance to the way they were when we bought the land in 1995. Two major hurricanes swept through here and ruined almost 75 trees, some of which had been here for more than a century. One very large pine tree gave way to a lightening strike and pine beetles are slowly chewing on several more. If there is a benefit to any of this it’s that we can more easily see what’s going on here. For example, in the early morning, there is a doe and fawn that often come through on their way to wherever deer go in daylight. You can also stand in awe of the trees that are left, including a majestic pine tree that the beetles haven’t found yet. Another is the holly tree that is shown in the picture above. That poor tree is about 15 feet tall and has been battered by wind and larger trees that knocked off its branches as they fell. Still, it had the energy to cover itself with beautiful red berries for this, the Christmas season. Twenty years ago I might not have seen this tree. I might have walked by it with my brain too consumed with day-to-day problems to bother converting the sensory input to the scene that I enjoyed so much on that sunny morning.

It is Christmas Eve. I have been thinking about miracles. I have read the Christmas story in Bible and watched several visual versions on TV. It is a beautiful story whether or not you believe in miracles. I recently watched a U-tube version of a good-bye speech made by a middle-aged lady dying of cancer. Much of her speech discussed the impossibility of the miracles reported in the Bible, including the virgin birth. While I respected the courage she exhibited mere days before her death, I must disagree with her statement that these miracles were impossible. As I look at the holly tree with its red berries, I am incapable of understanding the theory that this beautiful specimen originated from random collisions of molecules and subsequently evolved to its present state. That simple example is no more far-fetched than the Christmas miracle. Both the creation theory and the random collision theory may be possible and I am capable of fully understanding neither.

I Don’t Have To Understand To Appreciate It. Perhaps turning 70 has changed me but the beauty of this Earth leaves me in awe. I apologize to my friends who are of different faiths and those who are atheists. I am in no way attempting to influence the beliefs of others. For my Christian friends I say Merry Christmas and for the rest, I say Happy Holidays. I value relationships with friends and family more than any measure of wealth I could attain now or in the future.

Time To Learn To Dance

“Life Is Not About avoiding the storms. It’s about learning to dance in the rain." Quote of Unknown Origin.

Are You Ready To Dance? I stole this quote from a friend who doesn’t really recall where he heard it. The beauty of the quote is that it can apply to a variety of life situations. I have been thinking a lot about investment risk lately and I wanted to share some of these thoughts with you.

Let’s Just Not Take Any Investment Risk. I have heard that statement a lot lately. Do you think you can avoid risk by putting all your investment capital in one year, certificates of deposit? In the early 80’s, you could get 11% on a one year CD. A million dollar nest egg, spread around in $100,000 increments would give you an income of $110,000 per year and be totally insured against loss by an agency of the federal government. If you stayed with that philosophy for the next 30 years you would find that your income dropping $30-40,000 per year at current rates of 3-4%. Of course, you would still have your million dollar principal but you could find your lifestyle significantly curtailed by the reduction in income. This type of risk is called
reinvestment risk.

How About a 30-year Government Bond? You could have been guaranteed an income of about $120,000 a year for the next 30 years and you could always get your principal back by selling the bond on the secondary market. Sounds good doesn’t it? But what if rates had increased to 16% instead of dropping? In 2 years your 30-year bond would be worth only $753,000. This type of risk is called “interest rate risk.” Even if you could have afforded to leave the money invested for the full 30 years, inflation would reduce the purchasing power of that million dollars to $308,000 (assuming an average inflation rate of 4%). This type of risk is called purchasing power risk.
Let’s Just Put It All In Gold. While that may sound like a ridiculous statement, let me assure you that I have had clients who made that very suggestion. Given the hype you hear on radio commercials today, you would be tempted. For example, if you had put a million dollars in gold at the average prices 9 years ago, you would have just over 4.1 million, a hefty return of almost 18% per year. These radio commercials tell you that and try to alleviate your fears of risk by saying “Gold has never been worth zero.” What a comforting statement that is. What they don’t tell you is that if you had bought gold in 1980, almost 30 years ago, your million dollar investment would be worth just $2 million, a return of 2.4%. Even worse, if you had panicked and sold your gold 20 years later at the average price of $279 per ounce, your million dollars would have been just over 455,000, a compounded negative 4% per year. I call this type of risk, timing risk. The worst thing about this type of risk is that, in times of high prices, you will be bombarded by radio commercials and sales calls telling you about the high returns available and by the time they say “past performance is no guarantee of future results” you are hooked When prices are lower, these sales people go back to their regular jobs at convenience stores or driving taxis. These market forces direct you to buy high and sell low, and many investors fall into this trap. For example, mutual funds have to tell you their average return over a long period of time. Unfortunately, most individual investors fail to get close to that return because of the natural tendency to buy when prices are high and sell when prices are low.

Let’s Take A Look At the Stock Market. Pretty scary isn’t it. Most of us have suffered substantial losses in the past 2-3 years. Again, it’s a matter of timing. If you would have bought stocks in 1980 and received the average return of the S&P500 average. Your million dollars would have received a compounded return of 7.87%. Added to this would be an approximate dividend yield of 3% (Average of 53 years, best number I could find). If you had invested a million in 1980, you could sell out now for around 9.7 mil. In addition, you would have received approximately $30,000 in dividends that you could reinvest or spend each year. Just like in the gold investment, you would have timing risk along with market risk and some purchasing power risk.

What About Real Estate? Unlike the stock market, there is little in the way of statistical data on real estate returns. The nearest thing I could find was the Case-Shiller Indices that show the nationwide average returns on investment in single family housing was 9.31% from 1998 through 2007. This compares with 5.91 for the stock market. It should be emphasized that this was a very favorable period for housing. It should also be noted that Case-Shiller doesn’t give much detail on whether these returns are leveraged or whether they include rents and professional management costs. For the purposes of this review let’s just say that real estate offers an alternative and could part of any investment portfolio. Risks are market risk, timing risk, and some management risk.

None of These Investments are “Bad,” The main purpose of this column was to let you know that there are real risks involved with any investment vehicle; however, each one of these investments are appropriate for certain purposes. The trick is to pick the ones that are right for your risk tolerance and unique needs. Like the quote at the beginning implies, no one can predict the future. What we have to do is design a strategy, monitor that strategy, and make changes when necessary.

Reflections on a Fall Day

South Texas Is not Known For Beautiful Fall Foliage. Fall colors have been almost non-existent for two of the past three years, mainly due to hurricanes which blew the leaves off trees while they were still green. In my area, the woods look a bit scruffy because even the trees that were spared were damaged by wind or falling trees. Finally, the past few years have brought a drought which inhibited some of the fall colors. Still, even with limited Autumn colors, there is still ample beauty here if you know how to appreciate it. Sumac trees at the edge of the woods are a bright scarlet and Chinese Tallow, normally considered a trash tree, add some additional red color. Another thing that adds to the beauty of the South Texas fall is the flowers, which have virtually disappeared in cooler areas, are still blooming here. Looking out my front door, I see the Salvia, Knockout Rose, and Geraniums blooming with the red Sumac blooming at the end of the yard. One thing I know is that life is better now that I’ve learned to appreciate nature’s beauty.

Cash Is King??? I don’t know who invented that saying but I have seldom agreed with it. Of course, any financial rule depends on the needs of the individual. For example, if you are stuck in the middle of a small rural area and you want a hot dog from a small rural operator who doesn’t take credit cards, cash may be king at that moment. But if you are an investor, afraid to take risk in the financial or real estate markets, the return available on your cash equivalents are so low that the income you can generate will do little to supplement your cash flow needs. This results in reluctant investors being forced into the markets to keep from spending down assets that are critical to survival in their later years. A number of investors I know are in that very situation, having exited the market and missed a dazzling rally while waiting for a signal that it was safe to re-enter the market again. While I admit to selling some assets and increasing my cash allocation in the past year, I have never been completely in cash. In fact, cash has never been the majority of my investment portfolio.

Is The Long-Awaited Stock Market Correction Finally Here? I think so but I can tell you that I have thought so for some time. My fear has kept me from being as aggressive as I could have been to maximize returns in this situation. Still I have to go with my instincts and continue to move slowly. Part of the reason our markets have been as strong as they are is that those of us who already have all the houses and cars we need are subsidizing those who want to buy in this market. Cash for Clunkers and new home buyer subsidies are providing temporary props for the housing and car markets. This amounts to doing more of what got us in trouble in the first place. What happens when these subsidies are withdrawn? My guess is that things will slow down even more. I believe that the risk in the market exceeds the reward right now. Does that mean we should get out? ABSOLUTELY NOT. For my part, I will continue to emphasize dividend paying stocks and try to increase incremental returns by selling calls against those stocks. Of course, I might raise some cash now and then when I am holding assets that are fully valued or even overvalued, but getting out totally is not an option.

Should You Buy Real Estate? Not with your last dollar. Lack of liquidity can sink you in a hurry. If you are looking to pull some money out of the markets and, if you can put up with the stress of an uneven cash flow and occasional maintenance problem, there are signs of improvement in the local housing markets. In my last post, I talked about the shrinking inventory of resale houses on the market. Obviously that is a positive sign. Another positive sign is the lack of builder activity. So far this year, there have only been 1,787 single-family home permits along with a paltry 471 condo and townhome permits. This is the lowest since 1989 when the population of the metro was fifty percent lower than at present. (See John Rebchook Insiderealestatenews.com). Not all signs are positive. The low rate of job formation, high foreclosure rate, and low sales levels indicate that we may not be at the bottom yet; however, I’ll tell you the same thing I told you when the Dow-Jones average was below 7000. There is more risk than reward in the housing market.

Either Way It’s Not Time To Complain. I have been on this planet for more than 70 years and there is no comparison between how well we live now and how we lived when I was growing up. The typical person has three times the buying power that his parents had in 1960 (The year I got my undergraduate degree). In the 2000 census, less than 1% of our families were without inside plumbing. ( Our family was one of those until I was 10 years old). The average new home is 2349 square feet as opposed to 1100 in 1950. Lest most of you think the 1950’s is ancient history, let me remind you that I graduated from high school in 1956. Don’t think I am complaining about how poor our family was. Most of our friends were in the same boat and I have many happy memories from that era. Rather than complain and expect the government (meaning our friends and neighbors) to take care of us, most of us just need to take responsibility for our own lives and appreciate what we have. Here's to a happy Thanksgiving for all.

The Old Man And The Bass

November 11, 2009. Veterans Day

Dedicated to My Friend Larry Davis, First Seargent. Retired .

Back In Texas. It’s nice to be back in Texas after a 3-week visit to Colorado. Day before yesterday, I caught the biggest bass I have ever caught. It weighed 8.4 lbs. The first thing I did was call Ms. Betty and tell her to meet me at the dock with a camera. I must admit that my main objective was vanity, which meant getting a picture of me with this creature. My next objective was getting him back in the water. Twenty years ago I would have cut slabs of meat from each side and thrown the remainder in the woods for the buzzards. What a shame that would have been. The most memorable part of the whole incident was watching his tail swish back and forth as he swam near the surface across the lake. Maybe my grandchildren can catch him again.

Waiting For The Elusive Stock Market Correction. Everyone expected the market to correct in September. Didn’t happen then or in October. While we expect some tax loss selling in November and part of December, late December and early January have historically been good months. It all boils down to a quote from my friend, Don Kramer. “The market will do everything it can to prove the maximum number of investors wrong the maximum amount of time.” I’m sure Don would tell us that that quote didn’t originate with him. Indeed, there is a large amount of empirical data that shows this statement to be true. This backs up my contention that it is virtually impossible to time the market with any degree of accuracy. If a number of my clients are any indication, a very large number of investors got out of the market at the very bottom, some of which vowed never to risk money in the market again. They missed the almost 50% rebound that occurred shortly thereafter. Again, there is a large amount of empirical data that shows that very few investors receive the average returns obtained by most mutual funds. Most get in when the markets are hot and out when the markets are down. The problem with exiting the market after a major drop is that no one knows when to get back in. My philosophy is not to be totally in or out of the market at any given time. Although our emphasis on cash flow didn’t totally protect us from the downturn, at least we were paid to hold on. I will continue to manage my own portfolio with an emphasis on current cash flow.

The Real Estate Market Is A Bit More Predictable. If you follow certain market statistics, you can have some idea of when a rebound is almost certain to occur. Perhaps the most reliable statistics are the number of homes on the market and the average number of sales per month in a given year. This is a measure of supply and demand. As an example, in October 2008, the inventory of properties listed for resale was 23,120. A year later there are only 18,945, a drop of 18%. This inventory is the lowest level in the past 8 years. While this is encouraging it must be considered along with sales levels. Through October of 2008, there were 41,683 properties sold or an average of 4168 sales per month. The same period this year saw an average of 3551 sales per month. This means that the current supply would be expected to last for 5.3 months as opposed to 5.6 last year at this time, indicating that we are not significantly better off than we were last year. Our experience indicates that we are near an supply/demand equilibrium when the inventory is less than 6 months. The lack of builder activity along with low interest rates are an indication that the unsold inventory will continue to drop. For those of you who would like to stay more informed about the real estate market, I highly recommend a blog by John Rebchook, with the address insiderealestate.com. That is the site where I obtained these current statistics.

I Haven’t Felt Too Much Like Writing Lately. That doesn’t mean I’m not keeping an eye on the markets and trying to keep you informed of developments in the financial markets. Stay tuned for more frequent posts in the future.

SOME INTERESTING REAL ESTATE STATISTICS

"The ability to manage the unexpected consequences of our decisions is the real secret of investment success". Peter Bernstein.

The Last Two Years Have Been Difficult. It seems like there are so many unexpected consequences that expected consequences don’t exist any more. We can use the statistical tools, the laws of probability, and our experience but we can’t avoid the events which take us by surprise. Many so-called experts tell us that this is a difficult time to invest. I have news for them. It’s always a difficult time to invest.

I Discovered A New Source of Data. It’s been around for a long time and I don’t know how I missed it. It’s called the Case-Shiller Report and it’s published by Standard and Poor’s. It follows real estate statistics in 20 metropolitan regions. Fortunately, Denver Colorado is one of them. The unique thing about their housing statistics is that they have the most accurate statistics on home appreciation rates that I have seen. In the past, I have used increases in the average sale price for a given area to determine appreciation rates. This leaves a lot to be desired since it doesn’t account for increases in home size or the proportion of homes that sell in a given price range. The Case-Shiller Index employs a technique in which they keep track of the sales of individual houses and derives an index to illustrate the increase or decreases in sale price. Data has been collected for 20 years.

Appreciation Rates Are Highly Variable. As an example, consider the period from 1988-1990. In Denver, the appreciation rate was zero. Contrast that to the period from 1999-2001 when the appreciation rate was approximately 13%. During the next 5 years, the appreciation rate slowed to about 3%. July 2006 was close to the high point in the market as prices began to deteriorate at the rate of about 2.8% per year. That period is the only one during the past 20 years where there has been a substantial depreciation in the area. This is a good example of unexpected consequences. The question is, can we use these and other statistics to predict the future of the housing prices.

What Can We Learn About The Future. From last month’s data, it appears that prices are stabilizing; however, one month doesn’t constitute a trend. Positive factors are a rapidly declining number of new building permits, declining inventory of existing homes for sale, and a slower rate of job loss. Although Case-Shiller does not publish some statistics for individual areas, we can learn something from their national statistics. On a national level, homes in foreclosure have increased by 23% from a similar period last year. Even more troubling is the delinquency rate which has increased by 44% from last year. This indicates that we will be seeing a consistent supply of new inventory via foreclosures. Even though the government brags about the success of their foreclosure avoidance program, they say little about the fact that 50% of the loans that are modified to help the consumer are delinquent again within 6 months.

So Is Now The Time To Invest In a Single Family House in Colorado? You definitely have less competition from other buyers. The $8,000 new home buyer tax credit is expiring soon and I suspect that there will be less competition from other investors and buyers of second homes. In 2007, 21% of buyers were investors and 12% were buyers of second homes. This means that fully one third of buyers were in the market for something other than a primary residence. I suspect that many of these have left the market for lack of confidence. You will also have more renters in the market place as those who lose their homes to foreclosure have to live someplace. You might have heard that it is more difficult to qualify for a mortgage in this market. That’s true; however, lenders are always eager to loan to buyers with good credit and a substantial down payment. It is my opinion that buyers of single-family home investments will do better than other investors in today’s market place.

I Am In Colorado For Awhile. Give me a call on my cell phone at 303-902-3940 if you would like to get together.

GLOBAL WARMING. HOW BAD IS IT?

There is No Way I Can Answer That Question. Despite 6 years of scientific education and 20 years of working for energy companies, I can't find the answer to that question. It's hard for me to believe that a divinity school drop out can state with certainty that he knows the answer to the extent that he can declare the debate to be over. Another thing I can't quite figure out is how a scientific issue has almost completely morphed into a political one. Polls show that the vast majority of liberal voters agree that global warming is a serious problem while a vast majority of conservative voters claim that the whole thing is a hoax.


One More Question Needs To Be Answered. To what extent do humans contribute to the problem? Climate cycles have existed since long before we appeared on this planet. Carbon dioxide, the supposed main culprit, has existed since prehistoric times. Without it neither plant nor animal life would exist. Proponents of the man-made nature of the problem state that the concentration of CO2 in the atmosphere has increased by 25% since the use of fossil fuels became prevalent. This sounds significant until you become aware of the fact that, this increase means that there is one more molecule of CO2 out of 10,000 molecules of other gasses in our atmosphere. Is it possible that this low concentration substance could really be the culprit? I am skeptical.


So What Is The Next Step. 1. We could do nothing and take the risk that the problem is real and man made with potential disastrous consequences. 2. We could outlaw the use of fossil fuels and face a certain worldwide economic collapse. Of the two, option 1 is almost certainly preferable. Perhaps, the best option lies somewhere in between, which brings us to the point of this article: The cap and trade legislation passed by the House of Representatives involves an attempt by the government to encourage development of renewable energy resources by taxing fossil fuels and using the proceeds to subsidize development of alternative sources. Of course, in typical government fashion, the bill contains several additions. One of these is requiring energy audits on properties being sold (including single family houses) and requiring properties be brought up to some standard of energy efficiency before closing.

Why the Plan Won't Work. Consider our utility energy as an example. Virtually 90% of our utility energy comes from three sources. coal (48.5%), natural Gas (21.3%), and nuclear (19.6%). None of these is popular with the environmental crowd. The rest comes from renewable sources: hydroelectric (6%), other renewables (2.5%), miscellaneous (.5%). When we take hydroelectric out of the mix (we have virtually exhausted the potential for new dams) we are left with only 3% currently coming from renewable resources. Although some technologies like cellulostic ethanol, wind, geothermal, and solar have promise, they have had promise for 20 years now and still account for only a fraction of our energy production. I could never support a program that taxes 90% of our resources in order to fund research on the other 3%. If you think the government knows how to encourage new technology by subsidies, consider the huge sums of money thrown into the corn ethanol fiasco which added little or nothing to the availability of renewable energy and caused food prices to increase by large amounts. Finally, someone discovered that production of corn and converting it to ethanol burned up almost as much energy as it produced.

I Am In Favor Of Renewable Energy Research. But we must develop products that are economically feasible. Adopting a program to tax 90% of our energy sources will only make us less competitive with OPEC. As the availability of fossil fuels diminishes, renewable resources will become more usable. Until that point, attempts by government will only cost taxpayers money and produce minimal environmental benefits.

MORE MARKET STRATEGIES

Simple Pleasures. Every once in awhile, life gives you a little bonus. I’m not talking about winning the lottery. I am talking about the simple things that you might even miss if you aren’t paying attention. The picture is of a flower I observed in the woods where I live. I have no idea how it got there. Perhaps it was planted a long time ago by someone or perhaps it has always been there obscured by other plants and I didn’t notice it. Anyway, I discovered three more after that one. I hope they come back next fall and I am here to see them.

The Market Is Up Again Today. It really seems overvalued; however, one explanation I read is that there are large amounts of cash on the sidelines held by investors who are disappointed that they missed the recent rally and have grown tired of getting virtually zero returns on their “safe” bank deposits and money market funds. Another explanation is that when a large majority thinks the direction of the market has to change direction, they are usually wrong. Your guess is as good as mine but I continue to look for new strategies that will do well in a market that is flat or declining.

There Are Reasons To Be Cautious. Perhaps the main reason for caution is consumer behavior. The consumer accounts for 70% of our economic growth they are scared and finally beginning to realize that borrowing to fund a lifestyle they really can’t afford can’t go on forever. Of course, they are also worried about potential job loss, decline home values, and declining investment values.

If You Got Out Of The Market, It May Be Too Late To Get Back In. You might re-enter the market with some of your cash but it certainly isn’t time to jump in with both feet. I may sound like a broken record but I still believe in investing for income. The following is an example of an income portfolio. These stocks survived the debacle and the odds of dividend cuts or devastating price decline are not large.

American Electric Power Price 31.9 Yield 5.21 Utility Company

AT&T Price 26.5 Yield 6.19 Telecom

Bristol Meyers Price 22.2 Yield 5.57 Drug

Kinder Morgan Price 54.42 Yield 7.72 Energy pipeline

Prologis Preferred Price 19.73 Yield 8.74 Real Estate

Apollo Investment Price10.2 Yield 11 Business Development

Prospect Capital Price10.6 Yield 15 Business Development.

By way of disclosure, I own all these companies in my own portfolio except Kinder Morgan and American Electric. Those I don’t own are companies I may buy in the future. I might also add that I bought some of these at a considerably higher price than those listed here. As long as I get the dividend, I am not overly concerned about the current price.

Don’t Bet The Farm. Any or all of these stocks could go in the tank next week. I am not recommending that anyone embark on a venture to purchase this portfolio, just giving you some ideas as to ways to get a bit higher return than on guaranteed investments. If I thought this portfolio would go to zero, I would take my money out. If I thought the value would skyrocket, I would put all my money in. Undoubtedly, this is more risky than insured deposits but some risk is necessary in order to generate sufficient cash flow to fund my living expenses.

MORE STRATEGY CHANGES

A Forecast Tells You A Lot About The Forecaster But Nothing About The Future…
Warren Buffet.

With All Due Respect To Mister Buffet…It is impossible to plan your financial future without making some assumptions about what you anticipate will happen in the future. These assumptions constitute a forecast. As the future unfolds it is advisable to think about those assumptions in order to determine if those you made when you put your financial plan in place are still valid. If not, does your present strategy still fit in the current environment/ In my case, the strategies I developed 30-years ago when I first got serious about the planning process, have changed numerous times. Some of the changes were in response to changes in the environment while others were because of changes in my investment philosophy. In one of my August posts, I listed assumptions about changes that might chang to compensate for the over-use of leverage by the government, business, and consumers. These changes have caused me to challenge one strategy that I have held of several years. Perhaps you might want to consider a similar change.

Earlier Withdrawal From Qualified Plans Might Be Advisable. One commonly accepted principal is that retirees should first withdraw funds from non-qualified plans in order to allow tax-deferred funds to accumulate in qualified plans. For those of you who may not know, qualified plans are contributions made with funds which were not taxed. An example is a 401-k or IRA account. While the assumption that it is best to withdraw non-qualified funds first may still be appropriate for some retirees, others might want to begin withdrawals earlier. The reason for this is the potential for much higher taxes later. The huge federal deficit along with deficiencies in the social security system are almost certain to cause tax increases in the future. Just as social security became taxable for higher income beneficiaries in 1984, other increases will probably be necessary in the future. In fact, a recent change in Medicare part B premiums has been enacted for retirees earning more than $160K per year. This increase can constitute a major reduction in net social security income those affected taxpayers. Another reason that this year might be a good year for withdrawal, is that many of us had lower overall incomes in 2009 compared to what we hope to have in the future. Finally, an early withdrawal can benefit your heirs who might find themselves subject to estate taxes as well as income taxes on inherited benefits.

When Will The Anticipated Correction Occur. The market is approaching 10,000, a level that most of us were not expecting until next year. Most analysts are anticipating a correction because they believe the market has moved too far too fast. In addition, statistical analyses indicate that returns are much lower during the last four months of the year. My strategy is to raise some cash by selling stocks that appear fully valued and those in which we have deductible losses in the current year. I am not recommending carrying this strategy to the extreme and selling everything but a slight increase in cash allocation appears prudent at this time. As usual, I favor retaining or making new investments in companies that pay higher dividends or offer attractive option opportunities.

Coming Back To Colorado. Betty and I will probably come back to Colorado in early October. I regret that I didn’t get to visit with everyone on my recent trip and look forward to meeting with others later.

LABOR DAY REFLECTIONS.

"In England, a coal miner's son will almost certainly grow up to be a coal miner, In America, he can be anything he wants". Rick Bragg.

In Case You Don't Know..... Rick Bragg is a Pulitzer Prize winning author with several best selling novels to his credit. He writes about growing up poor in Alabama. The reason the quote meant so much to me is that, if you look at my birth certificate, my father's occupation is listed as a coal miner. I am a perfect example of that boy who grew up to be "anything he wants." Unlike some folks who might be ashamed of a blue collar background, I am proud of it.

It's Not That I Claim A Lot Of Credit For Coming Out Of Poverty. Most of that credit belongs to others. I remember my grandparents saying, "That boy is smart. He won't have to work for wages like the rest of us have." I remember my mom saying, "I want my boy to grow up like those self confident college boys I wait on at Paul's Diner". Then there is my dad who didn't say much but made sure I knew what it was like to work six days a week for a pittance. He always let me know that wasn't what he wanted for me. Growing up in a loving family is a better legacy than money any day.

I Can't Leave Out The Privilege Of Living In The Land Of Opportunity. We had great schools. There were 32 of us who graduated from ""Fruitdale School" (Better not laugh). It was a 55-year old building with only two restrooms and no gymnasium. We played basketball on an asphalt court, sometimes covered with packed snow but somehow we managed to beat a number of schools with modern gyms and locker rooms. We had great teachers who sacrificed much to teach a bunch of unruly kids. I still remember much from some of the books we were forced to read and poetry we were forced to memorize.

What About Colleges? In Colorado, state schools were forced to admit anyone who graduated from high school in the top 75% of their class. This year my grandson was not admitted to the University of Texas because he was slightly below the top 10%. He is ten times the student I was. Tuition was dirt cheap, even relative to the lower wages of that day. I'm not sure I could make it as an undergraduate in today's competitive environment.

How Fortunate I am. Yesterday, I spent several hours on the dock in my back yard, watching my grandson catch fish. Sixty years ago, if someone had told me, an 11 year old boy just starting to work summers in Mr. Montgomery's celery field, that I would be living this way in 2009, I would have been filled with joy. There is no reason I shouldn't feel that way today.

Back To Talking About Money. Please excuse the musings of a sentimental old coot. I promise to get back to the subject of personal finance next time.

WHAT GOOD IS A BROKER

Broker: A person who acts as an intermediary…Webster’s New Collegiate Dictionary.

The Above Definition Is Woefully Inadequate. The main problem is that it does little to help the reader understand the value to be expected from a broker in a transaction. Occasionally, articles appear in the financial press that question the value of many types of brokers, including real estate brokers. Most of these articles reveal that the writer has little understanding of what a broker brings to the process. Although there are many kinds of brokers, including those in real estate, insurance, securities, and mortgage transactions, this discussion will be confined to the role of real estate agents

Agents Have Knowledge Of The Marketplace. Unless you are a very experienced, full-time investor, chances are this knowledge is much more extensive than yours. A typical investor may only participate in one or two transactions per year while the agent is out there every day seeking to help their clients accomplish their goals.

Contacts. Agents have relationships with allied professionals including title examiners, lenders, property inspectors, and attorneys. These relationships help agents get things done because these professionals see the agent as a continuing source of business. As a result, the agent has much more influence than a buyer or seller who only brings in a limited amount of business.

Familiarity With Standards and Practices In The Industry. A real estate transaction can be incredibly complex. Unforeseen problems can arise such as title defects, boundary encroachments, and ownership disputes can and do occur. An agent brings problem solving skills that can resolve these problems and allow the transaction to proceed.

Negotiating Skills. Nothing gives you a negotiating edge like information. The more you know about a property, it’s location, the supply and demand of similar properties, and the market value, the more likely you are to be able to structure a transaction that meets your needs. In addition to information the agent already has, the agent should know what additional information might be helpful, and where to find it. The agent may also be in a position to find out about the motivation of the other party and what kinds of offer would be most appealing to that party.

What’s Going On In The Denver Market? Perhaps the most encouraging sign in the Denver housing market is the drastic reduction in the number of building permits being issued. Just about the only builders still producing now homes are those with land inventory who have to build new homes in order to sell the land reduce costs required to hold it. The number of building permits being issued has reduced significantly over the past 4 years and it is difficult to believe they could still be going down but, during the second quarter of this year, total permits fell from a very low level of 2871 in 2008 to 1194 in 2009. That represents a drop of 58%. I expect this low building activity will continue until the foreclosure rate drops. Does this mean that it’s a good time to invest? I believe it is; however, only for those with adequate liquidity to hold out if the recovery takes awhile to materialize. The last time this happened was in the early 90’s. At that time, it took awhile for new building to begin since developed land inventory was low and the lead time to get new projects through the approval process was extensive. This long lead time is likely to continue to exist for some time.

Back To Denver. I’ll be back in town late next week. Those who wish to arrange a meeting should call Susan at 720-449-0200.

MORE NEW STRATEGIES.

If inflation continues to soar, you're going to have to work like a dog just to live like one. ~George Gobel.



George Gobel Has Been Gone a Long Time. So has inflation. In the early 80's, if you would have told me that we would have inflation levels below 5% in the new century, I would have laughed in your face. For the year 2009, we will actually have negative inflation. Those on social security have a surprise coming in 2010: There will be no cost of living adjustment. In fact, depending on what happens to Medicare Part B premiums, many may actually see their net social security income go down. Combining this with reduced investment income could make things difficult for many seniors.

Inflation May Not Be Dead After All. The current low inflation environment is not likely to continue if the predicted future federal deficit levels actually occur. The combination of low revenue, due to the slow economy and high spending levels will make it extremely difficult to reduce these deficit levels. If this trend continues the probability for increased inflation is difficult to ignore. For this reason, most investment portfolios need to contain some exposure to assets that do well in a higher inflation environment. Here are some areas to consider.


Energy. Oil prices have rebounded strongly since the low levels earlier. Most oil stocks have rebounded off their earlier lows; however, if the economy rebounds and inflation picks up, the shares of most oil companies will become more valuable. One of my favorites in this area has been Marathon Oil, a 22 billion company selling for around 8 times last year's earnings. Natural gas is selling at historic lows relative to oil and is almost certain to rebound; however, it is difficult to find a company to recommend at this point because the shares of companies producing natural gas have not fallen as much as the basic commodity. Finally, pipeline companies such as Kinder Morgan Partners have an excellent history of increasing dividends and should benefit as more products go through their lines.



Real Estate Securities. Shares of Real Estate Investment Trusts have been beaten down in the market place as investors fear their exposure to the credit markets and potential higher vacancy rates. I have done well in selected companies such as Health Care Properties and Pro Logis Trust. The key to safety in this area is low debt levels or their ability to handle higher levels. While many have loans coming due that will be difficult to refinance, their lenders may find it beneficial to renew these loans on a short-term basis rather than foreclose and find themselves responsible for managing properties, a task for which they have little or no experience.


Direct Ownership Of Real Estate. I have worked with real estate investors for many years and participated in acquisition, development, financing, management and sale transactions. This type of ownership is more complex than investing in listed securities. Successful direct ownership investment requires considerable skill in negotiation and management. Poor performance in either of these areas can keep you from realizing the full potential of your investment. Conversely, you can create a good investment from a mediocre one by superior skills. Small investors will likely do well buying in this environment. The combination of low interest rates, low sale prices, and limited new building bode well for those who buy in this environment. Unless you are a very experienced investor, your interests would be well served by retaining the services of an experienced agent to represent your needs. One additional note, there will probably be less competition for the acquisition of lower end properties after the government's $8,000 tax credit expires at the end of November.



Precious Metals. Although there are several precious metals available for direct purchase, the most widely traded of these is Gold. It is virtually impossible to listen to the radio without hearing commercials touting the ownership of gold as an investment. Most will tell you that if you had bought gold in 2003, the value of your investment would have increased by 203%. This represents a compound return of 20.7% per year, outperforming virtually any alternative investment. What they won't tell you that if you had bought gold at the average price 29 years ago, your investment would have increased by 55%, an anemic 1.53% per year. Another thing I dislike about gold ownership is that it provides no interim cash flow during the holding period. Finally, unless you make sizable investments, much of your potential profits will go to dealers in the form of mark-up from the price at the time of purchase and a discount from the market price at the time of sale. Despite these disadvantages, there is no argument that gold has done very well over the past seven years and it can provide some stability in certain environments. If you decide to devote some of your capital to direct ownership of gold, the best bet is an established product such as Krugerrands or Canadian Maple Leafs. These have very little premium value over the price of the metal and are most easily traded.


These Are Not Recommendations. They are ideas for you to consider. Every person needs an investment portfolio designed to meet his or her needs. Selection of the investment that is right for you will require considerable research and constant monitoring.

ITS NOT ALWAYS ABOUT MONEY

To The Memory of J. L. Neeley, An Uncommon Friend

Costs and Benefits of Growing Old. Growing old has its advantages. One benefit is that you have some really good friends you have known for many years. One of the costs is that those old friends are growing old and either you die and leave them or they die and leave you. I knew J. L. Neeley for 42 years and and, although we sometimes went for years between visits, each new visit was just like we had just been together the week before. I know you didn't stop by this site to hear about my grief but I couldn't resist a small tribute to him the day after I learned of his passing. My life was better for having known him.

I Bet You're Tired of Hearing Depressing News on This Site. I'm a little tired of it myself. In my last post, I discussed some of my expectations for the future which also sounds a bit pessimistic but, as a notable TV personality says, "There's always a bull market somewhere." Perhaps its more important to discuss coping strategies for a recessionary environment than wealth maximization strategies for a growth environment. What are some of the things we can do to cope with this environment?

Control Your Expenses. I have spent considerable time with clients discussing the fact that retirement security is really about replacing the cash flow from your employment with cash flow from other sources. Clients are very interested in these discussions as long as we are talking about income opportunities but, when the subject of decreasing expenses is brought up, the atmosphere can become almost hostile. Like the lady who spent $300 a month at an upscale coffee restaurant who informed me that this was her main form of daytime recreation and elimination of this activity was "off the table." She maintained this position even after I informed her that it requires $60,000 in investment capital to generate that kind of income at 6%. In Colorado, I recently changed my phone, cable TV, and internet service, from $160 per month to $40. That reduces the capital I need to generate income to pay those expenses by $24,000 and, considering the small amount of time I spend there, the sacrifice is well worth it. Of course, you might remind me that the best thing to do is sell the Colorado property. I'm working on it.

Analyze Your Mortgage. Having spent many years counseling mortgage clients, this is one area in which I have a lot of confidence the expertise of myself and Susan at Westmont Companies. One of the biggest mistakes I see from retiring clients is over-emphasis on the interest rate of their current mortgage. For example, let's consider a soon-to-be retired client with a $200,000 5% mortgage with 10 years remaining. Payments on this loan are $2,121 per month. In order to generate cash to pay $2121 per month you would have to invest $425,000 at 6%. Granted the loan has an attractive interest rate but the principal payments of approximately 1300 a month is murder on the cash flow. There are a number of strategies for dealing with the situation, from paying off the entire balance with funds from other sources, to a reverse mortgage, to refinancing to a longer term mortgage. As an example consider the possibility of refinancing the entire balance with a 5.5%, 30 year fixed rate and payments of $1,135. Even though the interest rate is increased by .5% per year, the payment drops by almost $1,000 a month. It's about cash flow, not interest rate. Of course, you may have to give up on your idea of a free and clear house in 10 years but is the sacrifice worth $1,000 a month during the most enjoyable years of your retirement? This discussion just scratches the surface of the many things that can be done to improve retirement cash flow by restructuring a mortgage. There is no single answer that fits everyone but there are many opportunities available.

What About An Annuity? A lot of people don't consider fixed annuities because they consider them to be poor investments. While this may be true, an annuity is not really an investment but an insurance product. You are insuring that you will have an income as long as you live. A 66 year old male can purchase a guaranteed income of $1,500 for life with a payment of $250,000. Under this plan, a spouse or other beneficiary is also guaranteed to receive this income for 20 years from the purchase date in the event that you die during this time. Again, this may not be that great from an investment point of view but, in an environment with high investment risk, this may be highly beneficial for risk averse investors. Again, there are a number of different annuity strategies available each with different opportunities.

Investing With Options. I have attempted to discuss options strategies on this site several times but it have given up because they are often too complex to discuss with inexperienced investors. The most important thing to mention here is that, many investors and experts alike consider them to be highly risky. This can be true; however, there are a multitude of different strategies, some of which are considerably less risky than conventional investments. If you want to take the time to learn these strategies, the best place to start is a 1000 page book by Lawerence McMillan entitled, Options as a Strategic Investment. I have been reading and studying this publication for several years and am convinced that I am a better investor because of the knowledge I have gained from this publication.

Coming Back To Denver In September. The main purpose of my visit is to attend a gathering of several friends I have known for almost 60 years. You might guess that the death of my old pal, J. L. Neeley had something to do with that.

NEW TIMES CALL FOR NEW STRATEGIES.

Some Things Never Change, Others Never Stay the Same.

It's tempting to do what you are comfortable with instead of what you need to do.... George Guerin.

It's Been An Interesting two Weeks. I've been here in Colorado for almost two weeks and neither my body nor my mind have slowed down during the whole time. I've had interesting conversations, picked up some new ideas, and have reached some new conclusions, one of which is that we can't continue to do what we've always done. The the picture above shows a scene that Native Americans could have seen hundreds of years ago. It looks pretty much the same today as it did then. As you head down the mountain towards civilization, you can see immense changes that have occurred even in the short time I have occupied this planet. If i had my "druthers," I might prefer fewer changes but times are different and we must adapt.

The Demographics Of Our Society are Changing. Anglos will represent a smaller proportion of voters, consumers, and workers in the future. Even if immigration slows, differences in birth rates will force this change. The anglo section of society is rapidly aging and will place pressure on entitlement programs such as social security and medicare. Continuation of these programs in their present form is highly unlikely.

Growth In The Financial Markets Is No Longer a Foregone Conclusion. As older Americans look to liquidate their investments to fund living expenses, selling pressure may increase making it difficult for markets to grow as much as they did in the past. We are quite fortunate that the recent rally in the markets has allowed us to recoup much of our losses, it is unlikely that this rally will continue for long.

We Will Consume Less In The Future. Americans have rapidly changed their spending habits. Consumers can no longer borrow on their home equity to buy luxuries because many have no equity. Credit cards are being restricted. Despite a perfect payment history, Bank of America recently cut my credit card limit in half. I really didn't need the $33,000 limit they gave me but it illustrates my point. I also no longer receive five or more offers of new pre-approved cards a week. An aging population will also affect this trend since older people have less energy to roam shopping malls looking for things to buy. Since the consumer accounts for 70% of our economic growth, this will continue to put a damper on things.

Tax Rates Will Increase Regardless of Which Party is Elected. Eventually, we will have to support our government instead of vice-versa. Foreign investors will grow weary of buying our treasury debt unless they see that we are serious about reducing our debt levels.

Increased Government Regulation In The Future. Lack of responsibility in corporations and on wall street has resulted in the call for more government regulation. If what they have done in the real estate and lending industry is any example, this won't work. It takes longer to get a mortgage loan because of new regulations which will do little to help the consumer. Changes in the appraisal process will echo through the economy as appraisers will be selected at random rather than being directed towards the more competent practitioners. While I admit that free markets may not work perfectly, these industries are so complex that effective government regulation unlikely.

Stay Tuned For Strategies To Cope With The New Reality. I am leaving Denver to go back to Texas on Tuesday. I will continue to think about these changes and propose new strategies for dealing with them in future posts.

IGNORANCE AND LEVERAGE.

"When you combine ignorance and leverage you get some pretty interesting results." Warren Buffet.

Happy Days Here Again? Certainly we all feel better now that the Dow Jones average is above 9,000. There is also some good news in the real estate market that shows the precipitous drop in the housing market is slowing. It can't be denied that this is good news; however, I don't share the optimism of those who are predicting 15,000 in the Dow. What I think might be happening is that the markets are starting to recover from the drastic combination of ignorance and leverage and the rush to de-leverage. Earlier this year, hedge funds had to sell into an extremely weak market in order to pay off huge amounts of leverage which had come due. This pushed the price of many solid companies below fair value as sellers far outnumbered buyers in the marketplace. While this may not be over, it has certainly slowed down. Residential real estate has performed similarly as over-leveraged families found themselves with mortgages they could no longer pay.

What Happened to Government Efforts To Help Families Avoid Foreclosure? These efforts simply haven't worked. Despite the emergence of "Loan Modification Companies" and attempts by major lenders to hire extra labor force to handle the huge demand for loan modifications by troubled borrowers, the foreclosure rate remains high. In almost 50% of the cases where loans have been modified to cure default, the borrowers re-default within a year of the modification. Why is this the case? One of the main reasons is that it may be in the borrowers best interest to default if the mortgage far exceeds the property value. Of course, the benefits are often short term, but it appears that we have become a society focused on short-term benefits. A home owner who owes $200,000 on a house worth $150,000 can skip three or four mortgage payments during the foreclosure process and have the money to move and an immediate $50,000 improvement in net worth after the process is complete. The damage to the borrowers credit report and the trauma of moving the family to a rental is often deemed worth it to the borrower with a large negative equity. Again, this illustrates what happens when leverage and ignorance is combined. Of course, the combination s a two way street as lenders exhibited the same ignorance as borrowers when they financed 100% of the value of a property with little consideration given to the borrower's ability to pay.

The Housing Market Will Cure Itself. Builders are producing very little new housing inventory since buyers can buy cheaper than builders can build. Building activity has slowed to a crawl and existing housing inventories are shrinking. This cycle will continue until supply and demand is brought into balance. This is a regional phenomenon and some areas, like Colorado and Texas will rebound quicker than others. Many local governments, eager for revenue, can slow this process by adding more development and water tap fees for builders, making it more expensive to build new houses. The difference between real estate costs in high affordability states (like Texas) and low affordability states (like California) is often largely a result of high governmental fees charged to builders and developers.

Back To Colorado. Next Monday, I will be flying to Denver with the main objective of solving some problems with real estate I own. I am always eager to make time to visit with clients and friends. Call Susan at 720-449-0200 to get on the list.

REAL ESTATE INVESTMENTS: YOU HAVE TO NEGOTIATE

The Financial Markets Are Called Negotiated Markets. That's pretty much a joke. You don't know what negotiation is until you're bought a real estate investment. The trouble is that even experienced investors don't really know how to negotiate. Most employ strictly positional bargaining. The seller prices a property at more than he expects to get and the buyer offers less than he expects to pay and they meet somewhere in the middle. A very experienced high end investor explained that process to me and then told me "it's not rocket science." Given that attitude it certainly isn't "rocket science."

Perhaps We Should Study The Process A Bit More. Here are some things to consider.

1. Know your BATNA and try to project what the other party's BATNA might be. I guess every one doesn't know what BATNA means. It's "Best Alternative To a Negotiated Agreement". You may think you know your BATNA right away but if you spend some time contemplating what it might be, you may come to a different conclusion. When I bought a lake front lot, I started out with some strictly positional bargaining but when I thought about it, I concluded that although lake front property may be somewhat plentiful in East Texas, I wanted to be within a reasonable distance from a town, I wanted a wooded lot, and I wanted an area that might be attractive to potential retirees from an industrial area 50 miles down the road. A little research told me that the sellers were heirs to a sizable estate and could afford to hold the property since there was no loan on it. They could wait for another buyer easier than I could find another lot. With that in mind, I was willing to pay nearer their asking price than I had originally anticipated.

2. Retain your objectivity as much as possible. One of the main points here is to avoid letting your emotions interfere with your logic. I have seen transactions that were in the best interest of both parties fall apart because they made their differences personal rather than financial. One of the best principles I know is to be more rigid on substantive issues than personal issues. Give the other party every possible to save face while you stick to your guns on what's really important to you.

3. Remember there are several aspects to a transaction. A seller might be favorably influenced by a large earnest money deposit which could cost the buyer very little since it is ultimately credited into the transaction. Sellers might also be favorably influenced by a speedy closing date. Buyers can be favorably influenced by attractive seller-carry terms which can also be in the best interests of sellers who might not need all the funds from sale right away.

4. It's not over until its over. Just because you have a signed contract don't think you no longer have to negotiate. There are inspection contingencies and title issues to deal with. In large commercial transactions, there is often a "due diligence period during which a buyer can cancel for any reason. Once a buyer or seller discovers what he considers a critical issue, the negotiation process begins all over.

5. Both parties expect to win in the negotiating process. Most of us have heard of the "win-win" negotiating strategies. While this may sound a bit hokey, it is true that both parties can win in a mutually beneficial transaction. In reality, you can expect that neither party is going to participate in a transaction that is not in their best interest. A broker in a transaction can earn more than his fee by discovering the interests of both parties and facilitating an agreement.

Have You Read The New Financial Publication? It's called Rolling Stone. For all these years, I have considered this mainly an entertainment magazine and not bothered to read it. Ms. Betty bought home the most recent edition which featured an article that concluded that the next big bubble would be the green energy phenomenon brought on by the proposed "Cap and Trade" legislation. The author, Matt Taibbi, provides rhetoric that wall street firm, Goldman Sachs, has been involved in manipulating market bubbles ranging from the great depression to the "tech wreck" of the late 90's to the sub-prime mortgage debacle of 2007. During this time they have made a fortune participating in these markets. The "cap and trade" bubble will allow Wall Street to broker "carbon credits." Again this will make them a fortune by doing what they have always done: taking a very small piece of a multitude of huge transactions. While I don't like this author for a number of reasons, I must admit that it provided me with much food for thought as I endeavour to make investments for myself and my clients.

WHO IS TO BLAME?

"Many an optimist has become rich by buying out a pessimist." Robert Allen

Are You An Optimist? Robert Allen, author of the above quote made a fortune by being an optimist. He wrote a book entitled, Nothing Down in which he outlined how to buy real estate with no out-of-pocket cash. You certainly have to be an optimist to run up large amount of debt with no idea of how you might pay it back. Looking at some statistics I am about to share with you the only conclusion is that we have been a nation of optimists. While I strive to be optimistic, I don't want to carry it to the extreme of being stupid.

Not All Debt Is Bad. I have always believed that debt has a place in many financial strategies. You might say that one of my specialties has been one of helping my clients develop sensible debt strategies. Unfortunately, you can't say that all debt is good since one inevitable consequence of debt is that it adds risk to your life. Although you can utilize debt to create wealth, it can also destroy your wealth. When carried to an extreme, it almost always creates risk that is virtually impossible to manage. As a simple example, consider the purchase of a million dollar property with an operating income of $100,000 a year. If you buy this property with a million dollars worth of debt at 5%, your interest cost is $50,000 a year. If everything works right, you have just created $50,000 in income from thin air (since you have none of your money in the deal). You have also obligated yourself to pay $50,000 a year whether or not your tenant pays the rent. This situation can be managed, provided you have a secondary source to make those payments or liquid assets available to pay the loan. The trouble is that most people don't have a clue as to how they might make those payments without income from the property. The other problem we have is that too many of us used borrowed money to purchase assets that produce no income and lose value rapidly. When this happens we look around to determine who we can blame for our predicament.

We Have Converted The Blame Game To An Art Form. In the current environment, we blame greedy corporations, lax government regulators, the war in Iraq, and huge federal deficits for our situation. I know I sound like a broken record when I call your attention to irresponsible borrowing by consumers so I have found some statistics to illustrate what I mean. Morgan Housel, who writes for The Motley Fool Stock Advisor derived some statistics that show how we have consistently increased our debt levels relative to our income. In 1974, the average household had total debt equal to 63.5% of annual income. This meant that a family making $40,000 a year had total debt of $25,400. By 1988, this had increased to 81.2%. Ten years later in 1998 debt levels were 92.6% of family income. By 2008, we were at 130%. This means a family making $100,000 a year had an average debt level of $130,000. These high debt levels relative to income means that our lives become more risky all the time. Since consumer spending is 70% of our economy, if consumers decide to cut back on spending to lower debt levels, the effect can be highly detrimental to such factors as unemployment, price stability and the government's ability to sustain spending levels.

One Last Point. Our congress is dangerously close to passing something called "Cap and Trade" with the objective of decreasing our reliance on foreign oil and encouraging clean, renewable, energy. Most of us will support those objectives but the real question is the methods they will use to accomplish those goals. There are a number of things I dislike about this legislation but one of the worst is a provision that requires the seller of any piece of real estate to undergo an "energy audit." Those properties that do not meet government standards will have to bring the property up to standard before it can be sold. Many sellers can not afford these costs, especially in an environment where home values are often less than mortgage balances. I wonder how many of us would really support this level of government interference into our lives.

JUST THE BUSINESS CYCLE OR THE END OF AN ERA?

The Noah Rule. It doesn't help to know it's going to rain unless you actually build the ark.

It's More Than The End of The Old Business Cycle. It Could Be The End of An Era. We may never go back to where we were and that may not be such a bad thing. We have concentrated so much of our lives on consumption that we don't slow down and consider what is important. Having been born at the tail end of a huge depression, I can remember what it was like before we became so affluent and it wasn't that bad. It's not that I would like to go back, maybe just slow down a bit and concentrate on what's important. Making and spending money can be fun but so can spending time with friends and family.

It's Time To Start Building Your Ark. I don't say you should stop spending money, just slow down a bit. I recently got an e-mail picture from a long-term client showing him sitting on a tractor-mower. He recently retired from almost 40 years in the airline industry. He now works at a golf course doing what we might call blue collar labor. Rather than feel sorry for him, I admire his willingness to do this type of work when he can certainly afford not to. As an added bonus, he also gets to play golf free. Since that is his real passion, the benefit is probably more important than the money he makes. My hat goes off to him.

Look At Your Investment Portfolio. I still think you have to emphasize cash flow. Dividend paying stocks and high quality corporate bond funds can keep your cash flow up and, while you can't afford to ignore share prices, you can take some comfort when you get those dividend checks. This is particularly important if you need to withdraw from your account to fund your living expenses. Trying to live off capital gains can be dicey since they are several orders of magnitude more difficult to predict than dividends. We also can't afford to ignore the potential for renewed inflation due to the anticipated huge deficits. One of the better hedges against this would be various kinds of real estate investments, especially REITs that are not over-leveraged and have low payout ratios.

Here's To My Favorite Holiday. I've always loved July 4th, especially in Colorado where the weather is usually pretty close to perfect. Before this holiday is over, we will have 15 or 20 family members up here. We will all over-eat, consume large quantities of various beverages, play music, and watch fireworks. I will be in Denver towards the end of this month and hope to see many of you then.

THE TROUBLE WITH REGULATION.

The Regulators Don't Know What They're Doing. Regulators think they know the answer to all our problems but most of them have never worked a day in the industry they're regulating. A good example is their interference in the real estate industry. The mortgage industry has made great strides since I first entered in 1982 but you wouldn't know it from the attempts being made to roll back to those early years. When I first entered the industry, it took months to get a loan approved as we had to send out an average of six verification letters for each file and wait for the results to come back before we could begin assembling a package for the ultimate buyer of the loan. We had to write a detailed explanation for each derogatory item in the credit report. Once the file was sent to the ultimate purchaser, we were often told to go out and get more information. Some of these details were worth pursuing but most were a waste of time. One of the first things I learned was that common sense is out the window and I'll never forget the warning that, "There is a huge difference between a good loan and a saleable loan." It was our job to assemble a saleable loan package with quality out the window. The entire mortgage brokerage industry sprang up because large lenders found it less expensive to buy these loans from smaller companies than assemble the complex files themselves.

Borrowers Were Better Served When the Process Was Abbreviated. The trouble was that the process was abbreviated too much. This could be fixed relatively easily by correcting some of the excesses but government seldom does things the easy way. I could go through a multitude of examples but perhaps a description of the most nonsensical of these new regulations will let you know what I mean.

Huge Changes In The Appraiser Selection Process Lowers Quality. Apparently the government places much of the blame for recent problems on faulty appraisals. Further, they think that the appraisal problem lies with Realtors and mortgage lenders pressuring appraisers to over-value properties. Their solution is that appraisers are not selected by lenders any more. Instead they are assigned to each case by a central clearing house. The result is that the marketplace doesn't discriminate between those appraisers that provide a quality product within a reasonable time frame and those who don't. We can no longer talk to appraisers and point out obvious errors in reports. This problem and other new regulations have increased loan approval times to the point that you can no longer write a contract and expect a quick closing. If this really lowered the risk of foreclosure it might be worthwhile. Unfortunately, this isn't the case in my opinion.

A Mandate For More Regulation? Unfortunately, the government views the recent election as a mandate for more regulation. While I agree that corporate boards of directors have not done their job and corporations have not served shareholders and the general public well, I have no faith in the government to do anything to make it better. I am afraid the next 2-4 years will bring about some major changes in finance, energy, and health care that will be hard to undo once established. Hopefully, I am wrong.

HOT WEATHER COLD MARKETS.

Stopped on My Trip To Pull A Few Weeds Off Blind Lemon's Grave

In Case You Didn't Know. Blind Lemon Jefferson was a blues pioneer. He died in 1929 but had a strong influence over all the old bluesmen. He was relatively successful and had money in the bank when he died, still, they say he froze to death on the streets of Chicago. We just happened to drive by the old cemetery and see the "Blind Lemon Memorial Cemetery" sign. Those who know me very well know I could never miss a chance to stop. Several momentos were left at the grave including an unopened can of beer, an old rusty harmonica, and several guitar picks. The inscription of the grave says: "Lord it's one kind favor I'll ask of you see that my grave is kept clean." Maybe it sounds a bit morose, but I considered it my privilege to pull some weeds and make the place a bit more neat.

Still Watching The Markets. The markets are going close to what I have projected: Nowhere. I am still participating. Selling some stuff, collecting dividends, and writing some options. My assumption is that the market will stay within a trading between 8,000 and 9,000 on the Dow. I am buying only when I can find well-priced dividend stocks and attractive option writing opportunities. My last investment involved buying 1000 shares of Health Care Properties at 20.13 a share. It pays $.46 a share per quarter which amounts to an annual yield of 9.4%. I also hedged my bet by selling calls October 20 calls on the entire investment at 2.13 a share. This immediately reduced my out of pocket investment to 18.00. If the stock stays at the current price, I will have to sell it for 20 in October. That would give me a gain of 11.1% for 3 months (plus dividends). The key to success is sustainability of the dividend. If management finds it necessary to reduce that dividend, my return could go negative, a fact that never escapes me.

The Housing Bubble. There are a lot of folks who would like to blame the lenders for the huge debacle in the housing markets. The prevailing view is that the greedy lenders pushed their risky loans on unsophisticated borrowers while government regulators were "asleep at the switch." The fact is, government regulators contributed a great deal to this mess by trying to regulate lenders to make loans to more risky borrowers. Congress passed the "Community Reinvestment Act" to force lenders to make more loans to minority home buyers. This came about because of some questionable statistics indicating discrimination against minorities by the whole industry group. This was a flawed study as indicated by the fact that foreclosures were not less prevalent among minorities as would be expected if they were held to more strict standards than the rest of the population. The community reinvestment act required detailed reporting by mortgage lenders to prove there was no discrimination. A related Home Mortgage Disclosure Act required even more detailed reporting. As a result of all this, standards were relaxed and less qualified borrowers (minorities and non-minorities alike) entered the market in droves. The federal reserve helped things along by keeping rates on short-term loans at record low levels. The long period of low rates and virtually non-existent underwriting standards pushed housing prices to the stratosphere. So who do we blame? All of the above. Aggressive mortgage lenders, well intentioned legislators and executives who neglected the implications of pushing for relaxed standards, wall street for packaging these loans without really understanding the risk and selling them to investors who didn't understand the risk either, rating agencies who gave these mortgages ratings that didn't reflect the risk. Who suffered the most from mishandling these issues? The very borrowers these measures were designed to help. Why have I gone into this rant? Because I distrust the ability of the government (both parties) to solve our problems through more regulation and that appears to be the direction we are taking.

Waiting For Rain. It's really hot and dry here, in contrast to the rain in Colorado. I should be back in Colorado sometime in early July or late August. Send me an e-mail or call Susan if you want a meeting.

HOME AGAIN. FINALLY

Me and "Uncle Martin" with Lightnin Hopkins

It Was a Long Drive. The main purpose of the past three weeks was to get to Denver to work on some real estate but along the way we made a few important stops. We visited a religious shrine near Amarillo, Texas on the way up and made a stop at a farm established by Ms. Betty's ancestors on the way back. The farm has been designated as a historic family farm, having been in the Boyd family for more than 100 years. Betty's Uncle Robert has lived there for all of his 83 years with the exception of a brief trip to Okinawa during the 1940's. He told me that, at the age of 18, he used to view the sunrise in Okinawa with tremendous gratitude for surviving another day. He now views the sunrise at the Boyd Farm the same way. As I get older, I understand that more and more. The picture above was taken in Crockett, Texas by a statue of Lightnin' Hopkins an old Texas blues man.

Still Watching The Markets. I never missed a day checking the markets once or twice. If you didn't take my advice and lower the interest rate on your mortgage, you have missed an opportunity to lock in a 30-year fixed rate in the 4's. If you are looking for low closing costs, it is likely that you soon won't be able to find rates in the 5's. You might be hearing commercials about rates in the 4% range but, if it isn't totally a bait and switch ad, you will likely find out that there are numerous add ons for loans below $250,000 and credit scores below 725. Cash out loans often involve a premium and paying off a second mortgage can carry similar premiums in some instances. Investor loans are still available but with higher down payments and a substantial premium over owner occupied loans.

Bidding Wars For Lower End Properties. In many instances, we are seeing bidding wars for well-priced properties. If you are looking to pick up a foreclosure at a bargain, you will have plenty of company. We have made offers on behalf of our clients only to find out that we are one of 12 offers on that property. This will probably spread to other parts of the market if rates stay this low. One reason for this is the $8,000 tax credit being offered to buyers who haven't owned a property during the past 3 years. This will be discontinued after the first of next year so buyers are anxious to find a property before expiration date. Another reason is the lack of new inventory being produced by builders. Several builders have been forced to file for bankruptcy due to the high costs of holding inventory. Notable among these are two local builders, McStain and Village Homes. These were well-established companies who did an excellent job of providing quality properties and taking care of their customers. Hopefully, these two excellent companies can re-structure and survive in this difficult market.

What About The Financial Markets. The last few months have brought a strong rebound in the stock market. If you got out at the low point (and we know plenty who did) you missed out on a chance to recover much of what you had lost. Unfortunately there is a strong possibility that all the gains of the current rally can't be maintained and we can no longer say that there is more upside in the market than downside. There are some stocks that have been hit hard and not quite recovered. Among these are established companies like AT&T and Pfizer along with some speculative issues in the REIT and business development sectors. You can't go in and buy those at random but you may be able to tilt the odds in your favor by some careful due diligence. As I mentioned in my last post the stock market continues to have a better risk-return balance than many of the so called lower risk investments.

My Apologies To Regular Readers. I very much appreciate those of you who read this blog on a regular basis. Lately, I have done poor job of keeping you informed. It is my intent to post on a weekly basis and will do my best to re-establish that schedule in the future.

IT'S A NEW MARKET.

The Market Has Changed. For several weeks now, I have been saying that there is more upside potential in the stock market than downside risk. Now that the market has roared past the 8000 level that may be no longer true. If you will recall, when the market dropped to 6400 and reversed itself back to above 7000, I said that we now have weak support at 6400 and resistance at 8000. Once the market broke above 8000 and remained there for several weeks, 8000 again becomes a support level. This indicates there may be a potential for the market to reach 9000, the next resistance level.

How Valid is This Type of Analysis as a Predictive Tool. Perhaps the main reason for the validity of this analysis is that lots of trader/investors follow it. While I don't believe it is highly accurate, neither do I believe we can afford to ignore it. As I have said about other predictive tools, it is just another data point. What I have now concluded is that the market has reached a new level of stability. There is little reason to believe that fluctuations in the Dow of 500 points a day will return anytime soon. A strong indicator in this area is the VIX, a measure of implied volatility in the marketplace. This is also a measure of investor fear. Now that this indicator is in the low 30's, (As opposed to the 70's of a few months ago) it appears that fear has diminished to a large extent. The bottom line is that there may still be some more upside; however, the upside potential is no longer an order of magnitude higher than the downside risk. There are many hurdles in our economy and full recovery may be a considerable distance down the road. I believe a substantial recovery to prior levels will take several months, perhaps even years.

So Why Should We Be In The Market At All? Because there are few other places to invest. Bank CD's and long-term treasuries pay so little that those of us who need to support our retirement with our investment portfolio have little choice but to invest in the market. We can still get dividends that exceed those of fixed income investments from relatively stable companies like AT&T and Bristol Meyers. We can also speculate a bit in REITs and business development companies, some of which still pay dividends in excess of 8%.

What About Real Estate? There are a lot of reasons for housing prices to increase. Mortgage rates are still quite low, the government is giving $8,000 to first time buyers, and the affordability index is at all time lows. If those economists who predict that massive federal deficits will cause runaway inflation are correct, housing offers one of the best inflation hedges around. A word of caution: Don't expect this to be a passive investment. Even with a good management company like Westmont, there will be some hard decisions and difficult times in coping with with rent collections, maintenance, and vacancies. With all this, I believe real estate investment returns will exceed the stock market in coming years.

Coming Back To Denver At The End of May. I will be spending a couple of weeks in Denver at the end of May. Those I never got around to seeing on my last trip could call Susan (She always knows how to find me) to arrange an appointment.

IS THERE A PONZI SCHEME IN YOUR FUTURE?

How Do You Define A Ponzi Scheme? I would doubt I have many readers who aren’t aware of the definition of a Ponzi scheme; however, I will define it briefly for those who aren’t sure. In recent weeks it seems like each week you hear of an investment advisor who confesses to operating one of these schemes. The modus operandi goes like this: The advisor solicits clients by promoting a long track record of successful investments. This solicitation is usually accompanied by a list of satisfied clients who have benefited by this approach. While these satisfied clients have received excellent returns, the returns do not come from a successful strategy but from subsequent clients who’s funds are not invested but diverted to furnish returns to the previous client. This can last for a long time as long as new clients keep investing their money. Eventually, the system has to come to an end, as the current clientele grows so large that not enough new clients can be located to furnish their returns. When the scheme is finally brought to light, losses to clients can be astronomical.

How Do You Avoid Ponzi Schemes? Practitioners of Ponzi schemes include names like, Donahue, Hoover, Madoff, and Stanford. There are undoubtedly others who haven’t been discovered yet. Here are some of the characteristics they have in common. 1. High lifestyle including things like large boats, airplanes, multiple luxurious houses, and lavishly decorated offices. 2. Claims to have a unique insight into the markets. 3. A list of satisfied clients. 3. Consistent above market returns. 4. An intense sales approach that offers you membership in an exclusive “club” that isn’t open to just anyone. 5. They are prone to anger for those who decline to invest or who need time to think about it. Allen Stanford claimed to be a knight, owned a lavish offshore suite of offices and a bank and went by the title of “Sir Allen.” He tried to turn himself in last week but was turned down because the investigation is still incomplete and no warrant has been issued for his arrest. If you run into a prospective advisor who has two or more of these characteristics, back off in a hurry.

How Do Ponzi Schemes Get Started? I have often been amazed that advisors start these schemes despite an almost certainty of eventually getting caught. In a recent article posted on CObizmag.com,, Stephen Mauzy, Chartered Financial Analyst, offered some insight into how seemingly intelligent advisors end up in these quagmires. In the beginning many of them have an idea for a strategy that seems likely to work. It usually does work for a period of time. Unfortunately, virtually any strategy will eventually fail for a period of time, no matter how well it is thought out. When this happens some advisors, driven by ego, greed, or pride, resort to Ponzi schemes with the intent of making the clients whole again. Some may even be successful but the majority end up on an irreversible downhill slide. I recall, one Denver advisor pleaded with the judge for a lenient sentence so he could earn the money to repay all those who were cheated. The judge didn’t fall for this and responded with a 100-year sentence.

Investing Mistakes Are Unavoidable. In the late 90’s, I came to the conclusion that high dividend stocks provided lower volatility and cash flow for reinvestment or use in funding retirement expenses. This approach worked well throughout the late 90’s and early 2000’s. Using this approach, I was able to avoid the “tech wreck” of the early 2000’s and produce relatively consistent above market returns. While I never claimed that this strategy would always be successful, I was surprised when this sector was among the hardest hit in the recent debacle. Although, I still believe this strategy will ultimately outperform the others for clients who must draw income from their portfolio and I have never been tempted to try to placate clients by lying to them, I can certainly see how some might be short sighted enough to resort to these schemes. I will use this humbling experience to strive for more refined strategies that minimize the effects of the inevitable mistakes of the future.