For you Bob Brinker fans, here is an excerpt from my recent newsletter.
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service.
Web site: begininvesting.com
BOB BRINKER STRONGLY RECOMMENDS I-BONDS!
Brinker Comment: The high headline inflation number is making the I-Bonds more attractive than they have been in a long time. If you purchase I-Bonds prior to the close of business on October 31st, you will get an annualized rate of return of 4.8% for the first six months that you own them. After that, the rate is reset every six months. The current rate consists of a 1.2% base rate and a 3.6% inflation component. You can purchase up to $60,000 per individual if you follow the rules, which means a married couple could purchase $120,000 per year.
Bob predicted that after October 31st, there would be a HUGE jump in the November rate given the recent inflation figures. Bob thinks the rate on those I-Bonds would go way way up, and the annualized rate of interest on the new I-Bonds being issued in November could be as high as 6.7% to 7% which would be paid on the first six months that you owned them. Bob thinks the differential is so much from current rates, it argues in favor of purchasing them on November 1st. There is no risk in holding the I-Bond, the government will pay it off.
Editorial Comment ("EC"): That's a major endorsement from Bob and I agree with him. Bob's last prediction of the I-Bonds in November was for the annualized rate to be around 5%. That prediction was made just a few weeks ago. Clearly, he has modified that prediction by a significant amount. To find out about purchasing I-Bonds, go to the Treasury Department's web site at this link:
publicdebt.treas.gov
Caller: This caller noted that you can't compare the I-Bond rate of return during a six month period to a long bond, since the rate will be reset every six months. Bob noted that you can always cash your I-Bonds in after five years without a penalty if they become an unattractive investment.
Caller: Do you recommend holding I-Bonds in a self-directed IRA? Bob said he didn't like that idea because they can already be used tax-deferred. If you buy them, you can place them in a taxable account and defer the taxable interest for up to 30 years. For that reason, there is no point in holding them in an IRA and for that reason, Bob wouldn't do it.
Caller: If we purchase the I-Bonds, are we responsible for their physical protection? Bob said if he bought them outright, he would put them in a safe deposit box.
EC: Physical protection? Maybe hire a bouncer. You don't even need to take possession of the I-Bonds. In a galaxy far far away, they were once sold and redeemed only as a paper security. However, now they are also available in electronic, paperless form. As a TreasuryDirect account holder, you can buy, manage, and redeem I-Bonds online. Learn more about it here:
tinyurl.com
Caller: If we get these great rate on the I-Bonds purchased on or after November 1st, how long will we keep that rate? Bob noted that they reset the inflation-pay-through rate every six months. If you buy the I-Bond on November 1st, you will get the new setting which could bring the rate close to 7%. After that, the inflation pay through will be reset on May 1st. The caller then asked if the government might run out of I-Bonds if there was a huge demand for them. Bob said the government needs to borrow money to pay for all of its spending, so it is doubtful that at this point in time they will limit the amount of I-bonds they sell to the public. The only limit is the maximum of $60,000 per person.
EC: I would like to point out that you can also purchase I-bonds with as little as $25. This is a great conservative investment and makes a good gift for children and grandchildren because they are easy to buy and don't require any tax reporting until they are redeemed.
ENERGY PRICES
Caller: Do you see us getting any break in the price of energy? Bob said he saw something fascinating happen with respect to energy prices in September. When Hurricane Rita became a category 5 hurricane, it was threatening the energy infrastructure in Houston. During that time, oil was unable to make a new high and showed "relative weakness." The price of oil had reached about $70 a barrel on August 31st-September 1st in response to Hurricane Katrina, but it was unable to make a new high when Rita was barreling toward Houston. Bob thought that was an indication that there was some inherent weakness in the price of oil at the upper levels. Low and behold, what has happened since then is that oil really has weakened, and has been spending most of its time in the low $60s.
EC: Interesting comments from Bob, albeit made in hindsight as far as I am aware. Bob applies this same type of analysis to the stock market when he is trying to pick a market top. Its a theory that old Jesse Livermore first discussed when trying to time the market. Livermore would carefully study individual stocks after they made a new high. When the stock made an attempt to break through to a new high but was unable to do so, that suggested to Livermore that there was too much selling pressure at the high level and posed the possibility that the stock had reached its peak and would begin a new downward trend. Keep in mind that there are many more variables at play than simply the one Bob mentioned. I could give you many examples, but if terrorists hit the oil refineries, that is one example of how oil prices could easily spike to new highs, regardless of what they had done in the past. For now, however, let's hope that oil prices have peaked.
Caller: Do you think we will get some relief from high natural gas prices. Bob said that natural gas is a totally different animal than oil. It is very hard to predict because we don't have reserves like we do with oil. Natural gas is a wild card and Bob thinks people are going to be paying a lot for natural gas.
EC: According to the Energy Department's annual fuels outlook released on Wednesday, households that heat with natural gas could expect to see their fuel bills rise 48% this winter! A typical household heating with natural gas is projected to spend an additional $350 this winter. That's cold man. More on this story here:
tinyurl.com
BOND INVESTMENTS
Caller: This caller just retired and is transferring her retirement account to a Vanguard IRA. She asked Bob why he didn't recommend the Vanguard Total Bond Index. Bob said he hasn't needed that fund because for that portion of his bond allocation he has been extremely pleased with the performance of the GNMAs which have payed a premium yield due to the mortgage interest pay-through. This year, the GNMAs are out-performing the total bond index by 70 basis points which is a big difference and Bob is going to stay with the GNMAs.
EC: Um Bob. You "forgot" to mention that the Vanguard Total Bond Index has outperformed the Vanguard GNMAs over the last 5-years period.
Caller: So is it ok to put a huge chunk of money in the GNMAs, even with interest rates on the rise? Bob tempered his prior comments by noting that the GNMAs are included in his model portfolio as part of an overall diversified bond portfolio and it is up to each investor to determine their own appetite for risk.
EC: Please don't "interpret" my last EC to suggest that I dislike the GNMA fund. In fact, it has done very well over the long haul. I am just ribbing Bob because I know he likes to spin his recommendations to make them look as good as possible, and part of my job is to keep him honest and objectively evaluate his calls.
EC: Before I leave the topic of GNMAs, it should be noted that the Vanguard GNMA fund (ticker: VFIIX) has seen its net asset value fall to a 52-week low, closing at $10.25 on Friday. The culprit? Rising interest rates. See the chart here:
finance.yahoo.com
INTERNATIONAL INVESTING
Caller: This caller owns 80% of his portfolio in the Putnam International Equity Fund Class "A" shares that he purchased through his work. Bob asked if they force him to pay a sales charge to pay the fund. The caller wasn't sure, but knew that there was a 2% penalty to leave the fund. Bob said he does not invest in funds that require a penalty to get out of them. Bob then said he has a much smaller percentage of his portfolio in the international arena, and the vast majority of his portfolios is in the United States and he has had that allocation since he issued his major buy signal in March, 2003. Bob said he would be much more comfortable with that type of allocation than what the caller had chosen to do.
EC: There are at least 6 different share classes of the Putnam International Equity Fund. I did some research on them, and they actually all appear to have outperformed the S&P 500 since March of 2003. I was actually wondering why Bob didn't do his usual fund-comparison analysis on the radio, and I think it might be that Putnam has outperformed the U.S. market! A bigger exposure to international markets is what several of Bob's guests have preached, but something Bob has not chosen to do.
REBALANCING
Caller: This caller is invested in Bob's Model Portfolio I, but the fund balances are no longer in line with the recommended weightings. Bob said he recommends rebalancing in January so it will show up on your tax return next year.
EC: I fond an article that might interest you if you follow Bob's advice. Entitled, "Rebalancing vs. Market Timing" you can find it at this link:
tinyurl.com
REAL ESTATE AND HOUSING
Caller: A caller with a second rental property wanted to know if Bob thought he should sell it given the run up in price, or hold onto it as a potential vacation house down the road. Bob ran some numbers, but in the end said he thought it was mostly about a quality of like decision. In general, Bob views vacation property as a quality of life question. If you are going to buy a home by the lake, ocean or whatever, as long as the finances work, the quality of life impact it brings to you and your family is far more important than whether it is a great financial investment. Bob added that many times properties that are purchased as vacation homes see their values increase over time and if you put in effort to fix them up, it can become another valuable asset that you own.
Caller: This caller heard that the Bush administration is studying the effect of changing the tax code which could possibly include eliminating the mortgage interest tax deduction. How do you think that would impact the housing market? Bob said there is absolutely no question that it would negatively impact the housing market. It would instantly increase the cost of borrowing money to pay for your house. Bob said from what he hears, there is talk about a dramatic reduction on the size of the loan you could deduct interest on, from $1 million to $300,000. Bob said it would be something they could probably get passed in Congress since there aren't many voters across the country that have a million dollar mortgage. The caller disagreed and said in California, many in the working class had homes worth over $300,000. Bob said they would be unhappy campers if the change was implemented.
EC: Currently, taxpayers can deduct the interest on mortgage loans up to $1 million. President Bush's tax-advisory commission is considering a new limit on the deduction -- using the levels that the maximum mortgage the Federal Housing Administration will insure, with a national average of $244,000. Here is an article that discusses the tax panel's target of mortgage interest deductions:
tinyurl.com
Brinker Comment: Why is the government even considerning reducing the mortgage interest deductibility? Because our government is in a bind. They are spending money hand over fist. They even make up new programs, like the prescription drug program for seniors. We have to borrow the money to pay for it. The tax advisory commission is trying to come up with ideas for President Bush. One of the items they are struggling with is the problems the alternative minimum tax has created. It was originally implemented decades ago to catch a few hundred people who weren't paying taxes. Now, it is impacting millions of people who do pay taxes. The law of unintended consequences has taken over. Many of the proposals on the table are to limit various tax breaks.
One of the proposals on the table, is to increase the tax brackets for the wealthy. For example, if Congress takes no action by 2010 to make the tax cuts permanent, some of the tax cuts implemented by Bush will be reversed such as the top tax bracket which will go up from 35% to 39.6% again. In addition, if Congress does nothing by 2008, the capital gains and dividend tax rate will revert back. What we know at this juncture, is that the government is looking for ways to increase revenue. If you are hoping for more tax cuts, don't bank on it. Bob said he doesn't think any politician is going to stake their reputation on new tax reductions. We are bleeding red ink with a national debt of an unbelievable $8 trillion.
SOCIAL SECURITY CHECKS
Brinker Comment: If you are one of the 48 million people that receive social security, you will see a jump of 4.1 percent next year in your check, with the average check going up $39 a month -- the biggest increase in 15 years. The average social security check will be $1,002 beginning in January 2006. The 4.1% increase is designed to address the increased cost of living for social security recipients. That is a number that should serve as a reasonable offset to inflation. This is is the same fundamental underpinning that is going to make the I-Bonds go up to the 6-7% area. All of this is coming from headline inflation.
EC: Some critics point out that one-fourth of the new social security payouts will be eaten up by the rise in Medicare premiums which will grow by $10.30 per month starting in January. Here is an article that came out this weekend discussing the increase in social security and related issues:
tinyurl.com
SELL SIGNAL QUESTION
Caller: This caller's retirement account at work only allows you to make changes once a quarter. If you issued a "sell signal" on the stock market at the beginning of a quarter, but I couldn't change my allocation for three months, should I just wait until the next quarter to sell my funds provided you are still on a sell recommendation? Bob said it would depend on the level of the market. Bob used as an example his sell signal in January of 2000. If someone had waited 2 years to sell, the market would have already have declined almost half. On the other hand, if the market moved sideways or slightly higher after the sell signal, and you were then able to implement the advice, then sure it would work out. If you are unable to take action in a tax-deferred account, you could take measures to hedge the portfolio in a taxable account.
EC#1: Bob's "tactical asset allocation" recommendation (later referred to as a "sell signal") was made based on the market's close in 1999, with Bob moving 60% of his equity portfolio into cash via money market reserves. He still kept 40% in stocks until August 2000, when he reduced his equity weighting by another 5%, and then in October recommended investing 20-50% of the cash raised into the QQQQ shares. If you had waited until the end of the first quarter of 2000 to sell, you would have done just fine. The market actually rose quite nicely following Bob's "sell signal." The S&P 500, Wilshire 5000 and Nasdaq didn't reach their all-time bull market highs until late March of 2000. Of course, following that point in time, the market began its downward descent in a brutal bear market that bottomed in October, 2002.
EC#2: The hedge that Bob is referring to, could involve shorting the market, or purchasing "bear" mutual funds in an amount equal to what you are long in your tax deferred account. This would essentially mean that any losses in your tax-deferred account would be offset by gains in your personal account. Obviously, there are tax considerations, as well as the risk always involved in such a strategy.
CREATING BALANCE
Caller: This caller wanted to know if creating a balanced portfolio could be as simple as buying a "balanced" mutual fund like the one offered by Vanguard. Bob said there is a very simplistic way to create a balanced portfolio without going into a managed mutual fund. First, you take the equity portion of your portfolio and invest it in a broad based no-load index fund that tracks the Wilshire 5000. Then, take the other 50% of your portfolio and invest it in the GNMA fund. Bob said he uses more diversity, but if you were looking for total simplicity, this is something you could do.
EC: You may recall that on Moneytalk two weeks ago Charles Ellis recommended these same investments if you wanted a simple way to create a balanced portfolio.
NEW BANKRUPTCY LAW
Brinker Comment: Bob noted that last week we saw thousands of people lined up outside the court house to file for bankruptcy before the new regulations go into effect on Monday. The new regulations make it harder and more expensive to use the bankruptcy code to run away from debt. This law was passed 6 months ago, and unfortunately is catching many victims of Hurricane Katrina and Rita off guard. From October 3-October 9th, there were over 103,000 bankruptcies. Contrast that to a year ago when there were 30,000 bankruptcies.
EC: If you have questions about the changes to the bankruptcy law, I found a very informative article on About.com which you can access here:
credit.about.com
CHILD'S EDUCATION
Caller: This caller already has a 529 plan for her 4-year old child that she contributes $100 per month to. She is about to have a second child, and wanted to know if she should open a second 529 account, or just split the proceeds of the first one. Bob said he would have a separate account for each child. Bob also suggested that she consider starting a Coverdell Savings Account which is tax-free savings account where the funds can be used for college and also for the costs of kindergarten through high school. So families who are planning on sending their kids to private school should be very interested in these accounts. You can invest $2,000 per child per year which is about $166 per month. The Coverdell has a lot of flexibility.
EC: Check out the Infernal Revenue's publication on Coverdell Education Savings Accounts at this url:
irs.gov
CLOSED-END FUNDS USING COVERED CALLS
Caller: This caller wanted Bob's take on a new type of closed-end mutual fund that takes advantage of writing covered-calls on equities to generate income. Bob said the concern he would have on these funds is the amount of expenses they charge. If you are buying the funds on the new issue, Bob suspects you will have to pay 4-5% up front which Bob would not pay. The second problem Bob thought you might encounter would be the annual expense ratio. This is an income-oriented investment whereby the manager is trying to convert risk into investment income by taking in the call premiums on their option portfolio. Bob said he thinks more funds are adopting this approach because the market has been flat this year and they probably think we need to take advantage of that fact as well as the fact that rates are still low. Writing covered calls is a tricky business, and you have to really watch your expenses. In addition, if you get caught in a bear market with this type of strategy, it can cost you a lot of red ink.
EC: A couple of these funds that try to take advantage of writing covered calls including the Nuveen New Jersey Investment Quality Municipal Fund (Ticker: NQJ) and the Eaton Vance Tax-Managed Buy-Write Income Fund (Ticker: ETB). Here is a recent article about closed-end bond funds from TheStreet.Com which is worth reading if this type of an investment interests you:
tinyurl.com
MONEYTALK GUEST - JOHN BOGLE
On Saturday's show, Bob had on John Bogle, founder of the Vanguard Group. Bogle discussed his new book, "The Battle for the Soul of Capitalism." Bogle said that capitalism has had a wonderful history of being trusted back to the 19th century and it worked because we had "owners" capitalism. Owners put up the capital and took the risk and got the reward. In the latter part of the 20th century, that system turned upside down and now most of the rewards go to the managers. We now have "managers capitalism" instead of "owners capitalism." We can see evidence of this change in executive compensation, financial engineering and manipulation of corporate earnings. It is also in the mutual fund industry where management companies get far too large a share of the returns.
There has been some improvement of late with the passage of Sarbanes-Oxley, greater board room accountability and the inability now for auditors to be part of management. In the mutual fund area, there is an attempt (which is being bitterly resisted) to make mutual fund boards of directors more responsible to the shareholder. The law states that mutual funds should be formed in the interest of their shareholders, but that has often not been done. We would need an independent chairman of the board, the use of independent consultants, etc. These are little things that can bring the system back to balance.
Bob referred to Bogle's investment classic, "Common Sense on Mutual Funds." Bogle said he has been pleased the books have done well, and the proceeds go to charity. Bogle said that book is designed to present common sense intelligent ideas about investing. Themes like investing for the long term, don't pay a lot of money to your fund manager, not moving your money from one fund to another, not hovering over the rankings of mutual funds, and to own Americn business and hold it foreover. Don't trade, don't do anything. Bogle remarked that he knows that Bob shares at least some of the same investment philosopy.
About 30-years ago, Bogle created the "First Index Investment Trust" which is now known as the Vanguard S&P 500 Fund. People laughed at the idea when he first came out with it. In fact, people referred to it as "Bogle's folly." Today, it is the largest fund in the world.
EC: Bogle and Brinker have both done a great service in educating the public about the importance of watching expenses in your investment portfolio, the benefits of using index funds, and the necessity of diversification. The two individals, however, have different philosopies toward market timing. Of course, Bob is a practitioner of market timing, and even uses the name for his newsletter. Bogle, on the other hand, has this to say about market timers in his book, Common Sense on Mutual Funds,:
"The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody that has done it successfully or consistently. I don't even know anybody who knows anybody who has done it successfully and consistently. Yet market timing appears to be increasingly embraced by mutual fund investors and the professional managers of fund portfolios alike."
Bogle said there is a way to think about investing that he likes to share with individuals. Investors tend to pay about 2.5% in expenses, which is an incredible amout of money over an investment lifetime. Think about investing one dollar over your entire investment horizon which is around 65 years. You figure that you work for about 40 years, saving and investing your money, and then live another 20 years after that. If you invest $1 over 65 years without expenses, it grows to about $131, using a compound growth rate of about 8%. That's the magic of compounding. However, if you pay 2.5% in expenses, than your $1 will only grow to about $25! That's what we call the "tyranny of compounding costs." It utterly overwhelms the magic of compounding. After you consider the costs, you realize that instead of you, the managers get the lion's share of the returns.
A caller asked Bogle how the Vanguard Total Stock Market Fund has outperformed other similar funds that also track the market. Bogle said there are two reasons why. First, they charge less expenses overall, so they take less out in terms of returns. Second, in recent years they have been able to manage the changes in the index better than their competitors. The man in charge has been a very good administrator of these funds. By and large, however, its the lower expenses that account for the better performance.
Another caller asked Bogle for his opinion on the long-term prospects of the international markets versus the U.S. stock market, as well as his outlook for the dollar. Bogle said he is a low risk-taker in terms of moving in and out of international markets. Bogle said the first question is whether you even want to have exposure to the international markets. Many investors aren't aware that 25% of the revenue for U.S. companies is derived from international sales. That said, Bogle said he understands the logic of diversifying into the international arena. With respect to the dollar, if you look at the long run, the returns of international markets are not that different compared to the U.S. market. There are cycles where there is outperformance in international markets. Bogle said if you are going to invest internationally, he recommends going with an international index fund and sticking with it for the long term. Vanguard has such a fund.
Bob asked Bogle to explain how the structure of a Vanguard fund works for investors. Bogle said when you buy a typical mutual fund, it is really like a corporate shell that holds a package of stocks and bonds. The chairman of the board is usually chairman of the management company that determines the portfolio. The officers are provided by the managers. In otherwords, the fund is captive of the management company. The rewards are enormous for those managers. For example, the typical equity fund costs 1.5% each year, plus another 1% in hidden costs. Contrast that with Vanguard where the funds are directly owned by the shareholders. Bogle said you should always determine whether the manager's interests are paramount, or whether the individual investor's interests are. Of course, in the case of Vanguard, Bogle said they look after the individual.
A caller asked Bogle about the Vanguard GNMA fund and how interest rates will impact the net asset value. Bogle said that when interest rates go up, bonds go down as a general rule. Over the long term, however, keep in mind that interest rates will fluctuate and in most cases, the returns generated will be entirely a function of the income generated. That is the mathematics of bond investing. The net asset value will fluctuate in the GNMA. The net asset value is not guaranteed, and you shouldn't look at it that way, but you should view it as an investment that provides a steady stream of income over the very long term. If you really want stability of capital, you can't get stability of income. You can go with Treasuries where the capital is guaranteed, but the income provided by treasuries is very low. When you go with a fund like GNMA, the trade off is you get higher yield, but you have to deal with the fluctuations of the net asset value.
A caller asked Bogle about the Vanguard Extended Market Index exchange traded fund and was concerned about the low volume of trades. Bogle said if you are buying it as an investment, you do not need to be concerned. In the exchange traded fund (ETF) arena, there is a lot of trading going on, and Bogle doesn't favor that. Long term success is about investing, not speculating. The ETF is actually a little cheaper than the actual fund (not including brokerage commissions), but Bogle said he has not changed any of his holdings to ETFs.
EC: The caller and Bogle were referring to the Vanguard Vipers (ticker: VTI) which I own in my newsletter portfolio. They track the Total Stock Market Index. I like owning the Vipers because I could sell them (or buy them) in real time as I did just last week for my newsletter portfolio. The other benefit they have over the fund, is you can short the Vipers if you wanted to. The caller is correct though in that the volume of Vipers isn't that great, with the average volume about 20,000 shares traded each day. Contrast this with the SPDRs (a/k/a Spiders), which track the S&P 500 (ticker: SPY) which have an average daily volume of about 63 million shares.
Bob commented about how many shares are traded daily of the Spiders, to which Bogle said this just goes to show you that there are thousands of people shuffling money around each day. Bogle quoted Warren Buffet who said that the two greatest enemies of individual investors are expenses and emotion. Bogle said the Vipers take care of the first one, and its up to the investor not to be pulled into the latest hotest fund, whether it is energy, real estate, or whatever. Its hard to do timing, especially when commissions are involved.
Indeed.
Good interview by Bogle. If you want to check out his latest book, "The Battle for the Soul of Capitalism," you can read about it here:
tinyurl.com
Also, you can listen to an audio clip of the Motley Fools interviewing Bogle on National Public Radio at thus url:
tinyurl.com
FINAL THOUGHTS FROM DAVID KORN: If you have a question you want to e-mail me about, feel free to drop a line at davidk555@earthlink.net
DISCLAIMER: neither sanctioned by, nor written under the auspices of ABC Radio Networks, Moneytalk or Bob Brinker. This e-mail is not a substitute for listening to Moneytalk, it is only my interpretation and commentary of some of what is discussed on Moneytalk, along with additional educational information that I include, editorial comments about the market and helpful financial links. I also provide my own stock market commentary to subscribers as part of my service and give them access to my web site, www.BeginInvesting.com. If you want to know what was said verbatim on Moneytalk, listen to the show live or subscribe to "Moneytalk on Demand" which allows you to listen to the show in case you missed it live. The web site, bobbrinker.com has all the links to the ABC Radio Network stations that broadcast the show live. The information contained in this newsletter is not intended to constitute financial advice and is not a recommendation or solicitation to buy, sell or hold any security. This newsletter is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. Copyright David Korn, L.L.C. 2005. |
