Dec 23, 2023

Christmas 2023

Merry Christmas, if you can call a green one merry. OK, I admit that I don’t really mind Duluth warming up a bit. If their predictions are correct, we’ll eventually own some of the most valuable real estate in the world.Our granddaughter, Azzy

This is the time of year we look back a bit and maybe ponder the recent changes in our lives. However, last March 14, Ann and I went out on the 40th anniversary of our first date. In this case, we pondered forty years! It was great fun. We discussed things we had never talked about before. It was especially fun sharing our first impressions of each other, and how those panned out.

Let’s just say that 2023 has been an “interesting” year. I’m still unemployed, looking for My New Frontier, whatever that is. I’m taking cues from 80-year-old Mick Jaguar, who just released a new album. He once couldn’t imagine turning 45! Interestingly, his peers, including Bob Dylan, Paul McCartney, and Eric Clapton—artists I appreciate—also appear to have missed that memo.

ChatGPT says that here is where I tell you what I’ve learned and where I’m going. But I really don’t have an answer to those $64,000 questions. Maybe next year’s Christmas letter.

While I was wondering what I do, Ann spent months as the portable nanny caring for two grandchildren. It started later in 2022 and ended this August, with some time off for good behavior. She had a wonderful time getting to know our grandchildren. She especially enjoyed spending extended time with our daughter-in-laws—and with our sons, too.

We also got in a couple of trips. We spent nearly two weeks this spring in the French Quarters of New Orleans. That was an adventure into a substrata of American society, a place steeped in history that never shuts down. One of our favorite stops was Café du Monde, a large cash-only outdoor doughnut shop where we stopped after our morning walks.

More correctly, it’s a coffee and beignet shop, which is about all that you can get there. A beignet is a fried fritter covered with powdered sugar, an item brought to New Orleans from French who had settled loosely in New Brunswick (Acadians) and then made their way to New Orleans. They are only served in orders of three. Did I mention that New Orleans is its own land?

We also did our 2nd annual vacation in Seattle. Again, Ben rented an Airbnb (his employer) near Mt. Rainier. We hiked and hung out at a wonderful place, complete with half-tamed elk walking down our street. It was fun just to throw Azzie into her stroller and take a walk through the very small town we were staying in.

Ann and I spent the last half of this year working out a new house routine for both of us. We’re normally up early with fresh coffee followed by a five-mile walk. We’ve reserved specific days for ourselves, whether hanging out at the house, catching lunch or running some errands.

We continue to run Celebrate Recovery, just completing our 15th year. Ann leads several women’s groups, including some at area group homes. I still run the band. I also oversee basic administration, whether scheduling activities, balancing our money or chasing down outreach materials, such as the great new banner we have up at our church.

We’re still rebuilding since the COVID debacle. Just recently, we restarted our program for teenagers. We’re tracking at least as well as the rest of the country.

Ann and I also work one lunch a week at Union Gospel Mission. Ann works with food prep and serving. I run the dishwasher. It’s mostly several of our friends from church working alongside a small group of young people employed by Union Gospel. It is a nice and physical break to our week.

I’ve resurrected a couple of old interests of mine. The first is working on cars. I did my first oil change in over twenty years. I’ve vowed that I’ll never run another truck into the ground, but my current one is into its thirteenth year.

I replaced the cracked rear taillights, got fluid levels adjusted and put in a new battery. Once I found the replacement part, it took a friend of mine ten minutes to repair my heater fan. The truck’s like brand-new!

My surprise this year was getting back into camping. I went four times, all in the Superior National Forest, twice into the Boundary Waters with David and his dog Freyja. We used the same canoe I bought in college.

The highlight of the year came very early one morning in June at a forest service campground. I crawled out of the tent to a gorgeous blue sky. I turned on the propane grill to brew my coffee and then got a fire going.

Soon I was sitting in this wonderland of peace with a hot drink and a crackling fire, a sort of transcendental moment. Oh, and it was 35 degrees out. We eventually packed up, drove into town and got a local breakfast.

I also resurrected my interest in birding, a hobby I started in college. How things have changed! There are now amazing online tools to help with finding and identifying birds. I dusted off my old life list and got myself e-listed into the birding world.

I’ve been to Hawk Ridge several times to watch the spectacular fall migration of hawks and other raptors. I saw dozens of eagles, including a couple of goldens. I’ve gone to Sax-Zim Bog, a famous birding place an hour west. The birding is incredible. Let’s be clear—this is two tiny ghost towns set within 300 square miles of bog that is good for little but boreal birding. In the worst of winter, there will be huge Great Gray Owls sitting in trees, bothered little by your presence.

Ann’s always been an amazing cook but she’s gone into overdrive since returning home. All three of our sons enjoy cooking, trying new foods. Ann is following suit. She is now making more artisan breads, plus Thai, Chinese and Indian cuisine. They are all fun, but Indian may be her favorite. We both like spicy foods and this has been wonderful!

David hosted the Midwest Anderson Thanksgiving dinner at his house in St. Paul. He served smoked beef ribs, potato salad, homemade baked beans and blackberry cobbler. It was all good but the beans and the cobbler were to die for.

Another of our routines is connecting up with the kids. About once a month, either we’re in St. Paul or one of them is in Duluth. Jason et al. came up the weekend before Christmas, David is coming here for Christmas, and after the holidays, Ben is coming here with Azzie to introduce her to a real winter.

It’s a challenge to teach Azzie everything she needs to learn about life in the Northland—OK, let’s say real life—in just a week but we’re up to the task! Jyri’s an easier sell—we see him a lot.

The kids are all good with their jobs. Only one of the three ever goes into an office. Five years ago, one was in Texas and two were in San Francisco. Since then, two own homes in St. Paul along the Mississippi River an hour walk from each other, and Ben owns a home outside of Seattle.

We’re wishing all a Safe, Healthy and Blessed Christmas.

Ann and Jon

Nov 20, 2023

Social Security plus

The U.S. provides diverse retirement options, from 401(k)s to Social Security. This system can work very well, providing even those who have earned a modest income the ability to retire financially secure.

It works especially well for people who understand money and investments enough to make reasonable financial decisions. If you work most of your adult life, save 10% of your income and invest heavily in low-cost indexed equities, you are virtually guaranteed to be able to maintain the lifestyle you had while working.

But life is messy. Even successful people will not save and invest well; they divorce, lose their job or become disabled; and to add insult to injury, they then take Social Security at their first opportunity. But even with the best of planning, one may just outlive their savings.

One of several problems with this system is that it puts too much responsibility on the employee to essentially manage a life-long personal pension plan with some vague promise that with some luck, they will survive.

Often one is asked to estimate how long they will live and what their expenses will be. Yeah, no problem here - my electric bill will be about $4,000 a month and I expect to die at 83, hit by a Greyhound bus. They're mostly ridiculous questions for a thirty year old - or anyone. What happens when one lives another twenty years longer that life-expectancy tables predicted? I guess they're just out of luck.

And if you do it right, you will probably die with a large amount of money for your heirs. Like I said, it's a crazy system.

Today's retirement system faces a fundamental challenge. We've transitioned from employer-managed, risk-bearing defined-benefit plans to employee-controlled defined-contribution plans, requiring that workers fund their own retirement, shouldering most of the associated risks.

For example, today's system provides little opportunity to take your life savings and lock it up so that you can never lose it all. For all its problems, Social Security does just that. Benefits are inflation adjusted and last as long as you live.

My thoughts for fixing at least some of the problems with these defined-contribution plans is that the government establish a voluntary, self-sustaining Social Security-like pension. I call it Social Security plus. It’s not in place of Social Security, but rather an additional saving alternative. Here’s how it might work:

  • Pays out a fixed, inflation-adjusted income for life based on your contributions, a sort of hybrid defined-pension, defined-contribution personal pension plan.
  • Contributions are voluntary and tax-deferred. Employers may choose to match donations, as they often do for 401(k)s.
  • Benefits can only be taken at a high minimum age (I suggest 70) regardless of employment, health or other circumstances, and contributions can never be withdrawn, just as Social Security is today.
  • Independence is critical. The agency receives no government funding and is actuarially sound, similarly to a defined-benefit pension plan. And the agency is free to invest as private pensions do.

It's also critical that the fund can't morph into funding other needs. Organizations struggle to keep their hands off any pot of money, but this system is doomed if if becomes another social equity funding for the latest meme injustice. This is a personal retirement pension savings plan, not a redistribution program.

For those who are comfortable with savings and investments, they may well do better doing it themselves via 401(k)s and IRAs. Remember, there is a lot of good in today's system, such as the ability to maintain control of your savings.

This system has drawbacks, most notably that due to its undefined payout period, its payouts will be conservative. And regardless of intentions, the Federal government becomes its the insurer of last resort, which in reality is about the only way to ensure it never fails.

Ensuring lifetime security for people that could live decades longer than imagined is difficult and expensive. But this model is a means to avoid some of the bigger problems with today’s defined-contribution system that requires workers to spend a life-time preparing for their later years. For those who struggle to save and invest - a majority of workers - this is a way that one can easily save money that virtually guarantees a better retirement.

Nov 2, 2023

Fathers, Sons and the Land in Between

I recently read a book by Hisham Matar, “The Return: Fathers, Sons and the Land in Between.” I was very excited to read his story about him and his father.

He tells us how at age 8, his family was forced to leave their homeland, Libya, a place they deeply loved. At age 20, his father, a vocal critic of Muammar Gaddafi’s regime, was kidnapped and imprisoned in Libya. Mr. Matar spent most of his adult life on a relentless quest to find his father, not knowing whether he was alive or dead.

Llyod's Pool Hall, Michigamme, Michigan
Lloyd's Pool Hall, Michigamme, Michigan

“The Return” is an intriguing story of how a boy lives being separated from both his father and his homeland. He writes passionately about his love for both, with his father becoming an almost mythical figure in his life. The pain of his absence is a constant companion, an inconsolable emotional state.

He seeks any morsel he can find about his father, any input from someone who once knew him or maybe had seen him since his arrest. He remembers things his father said or was, small details such as the look of his hands.

He articulates the very nature of grief, questioning whether the dead can ever truly be gone. “I think this because absence has never seemed empty or passive but rather a busy place… The body of my father is gone, but his place is here and occupied by something that cannot just be called memory… (Grief) is an active and vibrant enterprise. It is hard, honest work… My father is both dead and alive. I do not have a grammar for him.”

He also reflects on the idea of leaving one's homeland, an issue that many struggle with. Some have said that one should never leave their homeland. He ponders the question, "what do you do when you cannot leave and cannot return?"

I so relate to his question. I grew up in the Upper Peninsula of Michigan, a region rich with family history. My Nordic grandparents immigrated to the Upper Peninsula, where they built their lives around the local iron ore industry, still one of the largest in the world.

I, too, was separated from my father. At the age of 8, he died suddenly. Then years later after completing college, for economic reasons I made the difficult decision to leave my homeland. These events have left an indelible mark on my life. This is my own experience with fathers, sons and the land in between.

Now in retirement, I reflect on three pivotal moments in my life: the loss of my dad, my sojourn in Minnesota and my marriage that brought me three sons of my own. I say 'sojourn' because although I'll probably never return to the Upper Peninsula, in another way, I've never left.

For instance, the master passwords I use are mostly places I cherished as a child, such as remote towns or rivers I was introduced to by my dad. They are etched into my memory, often unintentionally.

Sturgeon River, Michigan

One of my sons has my dad's middle name. Another’s middle name is my dad’s first name.

Up until my dad died, I believe that I lived an unimaginably wonderful life. My left brain tells me this cannot be true. But that's another world. I'm talking about fathers and sons.

I could go on all day about this past life. My dad built us a sandbox that was the envy of the neighborhood, and in winter, he constructed a saucer slide that all the kids enjoyed. Our house served as a hub of activity for both our extended family and the neighborhood, where we heard endless stories from the past, particularly of the Great Depression and the finer art of fishing.

He built our house himself (he didn't but he designed it and did some of the work), he and our family also built our cabin (neither is true, but so what), he walked to work when the roads were closed due to horrendous winter storms—and he didn't wear a hat. That's what real men do. And my dad did them all.

Our cabin was in a nearby town, Michigamme, a very small mining community that died decades earlier along with its mines. It’s one of my most memorable places that I associate with my dad, a place he loved as did I.

The most devastating day of my life is still the day my dad died, August 10. We had plans to spend the weekend at our cabin. As he often did, my dad arrived early to set everything up, and later, my mother brought us there, stopping along the way at our favorite swimming hole, Champion Beach.

But this time, we were suddenly hurried out of the water, packed up quickly and drove to neighbors just down the road from our cabin. They served my sisters and me ice cream at the dining room table while adults huddled in the kitchen. Something didn’t feel right.

Eventually, I was told that my dad was "very, very sick." I could do sick. I remembered that my sister had been in the hospital once, and she was fine. But it didn't take long for me to learn that he wasn't sick – that he was dead. He had died outside our cabin from a heart attack. I remember returning home to a houseful of people, crying on my bed with a kind neighbor consoling me. I had no idea what to think. And I had no sense of the changes coming.

I remember the funeral home, his casket and where I sat at the graveside service. My Uncle Bill assured me, "Don't worry, Jonnie, I'll take you fishing." They say orphans wonder who is going to teach them how to drive. My fear was who was going to take me fishing. I loved to fish.

Had someone told me then that my dad would be absent for even ten years, I could have handled that. But I couldn’t comprehend forever. Forever he was gone. And as much I wanted to believe I’d see him again in another life, I knew I could dig down into the dirt and run my hands through his rotting remains. I struggled to come to terms with the permanence of this loss.

The grief I felt during those days was indescribable. I would lie in bed, practicing holding my breath. I was going to hold my breath until I died. And then I decided to try living one more year.

No one can truly replace a father. I remember what I was doing August 10 ten years later, the summer after I graduated from high school. It was like his death had happened yesterday, the pain as raw as ever. A decade later, working at my job, the pain had dulled a bit.

Tens year more, I was married with identical twin sons. But even then, I remember when they were born, thinking, “Wouldn't dad be proud.” He was never far away.

There’s a flower’s scent that I associate with my dad’s funeral. Occasionally I smell it, and in an instant, I’m back at the Bjork & Zhulkie funeral home, and I can hardly breathe. Yes, I get over the flower in a few minutes but I never get over his death.

Some may insist that we should "get over" our losses. One of the many things Mr. Matar and I have learned is that you can't simply "get over" everything, that some scars run too deep to ever fully heal.

I once suggested organizing a family reunion on my father's side, much like the multi-day gala we had held for my mother's side. The idea was met with stone-cold silence. It wasn't a topic that could be discussed. There would be no reunion.

Leaving the Upper Peninsula was one of the most difficult decisions I’ve ever made. I mostly had to leave to pursue a career in software engineering. Soon after college graduation, I relocated to Minnesota, where I’ve been since.

Mr. Matar describes his eternal struggle with having left his homeland. Me, I've never really left. A part of my soul will always remain there.

For example, just a year after starting work in Minnesota, I bought a half acre of land on a small lake in the Upper Peninsula, Little Brocky Lake. On a cold, rainy, miserable fall day, I signed for the property. Years later, I accepted an unsolicited offer to sell it. While it made logical sense, it left me feeling like I had sold off part of my soul.

I remember the day my mother told me she was selling our cabin in Michigamme. This was the practical thing for her to do and I couldn't afford to buy another piece of land. But feelings aren't logical and dads are eternal – I felt awful all day. My grasp on my dad and my homeland kept slipping further away.

I've been away from the Upper Peninsula for over forty years, and I have no intention of returning permanently. One sister owns the house I grew up in and another resides nearby. Despite the decades that have passed, I continue to traverse the roads from Minnesota to Michigan, each journey feeling like a new adventure. My heart longs to keep exploring the Upper Peninsula, to visit any of its lakes or hills or small cafes.

And on and on, a feeling I can’t turn off. There's no end to the land I came from, a land that has had 32 inches of snow fall in 24 hours and once had nearly thirty feet of snow in a winter.

In L. Frank Baum’s “The Wonderful Wizard of Oz,” the Scarecrow asked Dorothy about her home in Kansas, and she told him about how gray everything was there, and how the cyclone had carried her away. The Scarecrow said, "I cannot understand why you should wish to leave this beautiful country and go back to the dry, gray place you call Kansas." And Dorothy answered, "No matter how dreary and gray our homes are, we people of flesh and blood would rather live there than in any other country, be it ever so beautiful. There is no place like home."

I agree. And as Mr. Matar states it, can anyone ever truly leave their homeland. There's no place like home.

It's an interesting process how humans work together to help each other, especially in tragedies. I had many people who looked out for me, including relatives, teachers, pastors and neighbors. My uncle Bill was one of many.

Remembering my wonderful relationship with my uncle, I wanted to pay it forward. After settling into Minnesota, I joined the Big Brothers organization. I was paired with a nine-year-old boy who, like me, was growing up with an absent father. We were inseparable for years and I'm still close to him. Once, I told him what a wonderful friend he was and that if someday I had a son half as nice as he is, I'd be thrilled. In fact, I have three sons, and they're all at least half as nice as he still is.

They say that men marry their mothers. Maybe. But my wife, Ann, who I fell madly in love with reminded me of my dad. Ann and I had a tumultuous dating cycle over years. After a long breakup, we got back together again. Her friend wrote me that Ann was interested in trying one more time. It was a nice summer day in Minnesota. I sat on my couch reading the note, and in an instant, I felt like my dead father had walked into the room. I just sat there and enjoyed the moment. I didn’t know what to do with my feelings.

Mr. Matar eventually returned to Libya for a visit, part of his long search for his father. I’ve thought that I’d never return to Michigan. But lately, I’ve been thinking of buying two burial plots in the cemetery four blocks from the house my dad built, where my dad, his brother, sister and parents, my mother and many others of my family are buried. Maybe I too will return home.

Jun 26, 2023

The Struggles of Investing With Funds

Jason Zweig recently wrote a post on how relatively easy it is for amateur investors to beat the pros (Wall Street Journal, April 14, 2023 I couldn't agree more. But as I've written before, I also think amateurs can beat the indexes, although it's considerably more work.

Here's some of what Mr. Zweig says, with my thoughts.

Essentially, Mr. Zweig points to the handicaps fund managers work under, handicaps that, according to a recent 30-year study of thousands of U.S. stock mutual funds, results in most funds underperforming the market.

The first problem is their insidious fees. I used this word deliberately. According to the Online Etymology Dictionary, it comes from a Latin word insidiae meaning “ambush, snare, plot,” which is derived from the Proto-Indo-European term sed, “to sit,” usually with a suggestion of lying in wait with the intent to entrap. This is fitting, as “insidious” often carries the meanings “deceitful,” “stealthy” or “harmful in an imperceptible fashion.”

This is just how fees work in the financial world. Generally speaking, financial instruments are far better at finding ways to get more money out of you than they are at managing your money. And I do mean “far better.”

Today's online world has an abundance of low-cost offerings that with their low fees offer you a significant advantage over an actively managed fund. Unfortunately, this is not where financial firms guide your investments, simply because they make a lot less from these offerings. It’s a sort of bait-and-switch tactic.

There are many indexed funds charging 0.03% to own most of the U.S. stock market. This is not 3 percent, not 3 tenths of a percent, but 3 hundredths of a percent, about $30 a year in fees on a $100,000 investment. The typical actively managed fund charges over 1%, or $1000 a year on this same investment, 33 times more than you can easily find online. And many funds charge significantly more than the 1%.

The typical fund analyzed in this study returned 7.7% a year after fees. However, the funds’ investors earned only 6.9% annually because of the compulsion of clients to chase hot performance and to sell when things go bad. This is your classic buy high, sell low problem where you should instead do just the opposite: buy low and sell high.

For the fund managers, though, they are forced to buy high priced stocks with the flood of money that comes in from investors chasing high returns, and in reverse, are then forced to sell stocks when they are low to generate the cash needed for their investors who are selling out of their fund when prices drop. Mr. Zweig states it well that "the managers can perform only as well as their worst investors allow them to." And that is not a good return.

The total cost to the fund that is forced to buy high and sell low is nearly as high as the drag from annual fees. What do these actively managed funds cost investors? From 1991-2020, investors lost about $1.02 trillion dollars, money they could have saved if they had instead bought a low-cost index fund tracking the S&P 500.

Mr. Zweig then repeats a supposed axiom of market returns, and that is "in the long run, nearly all the market's return comes from a remarkably small number of stocks—giant winners that rise in value by 10,000% or more over decades."

He cites other research that shows that only 4.3% of stocks created all the net gains in the U.S. market between 1926 and 2016. This suggests that winning requires finding these very few stocks, and this is mostly a matter of luck. Which then gets you back to buying indexes that mostly ensure you get at least some of these gains.

I've never accepted the argument that very few stocks are good investments. First, almost no one buys stocks and holds them forever. So what an individual stock does over a lifetime is of little interest to most. I have all my stock transactions for over two decades available to search and analyze. I have not found it to be true that a very small proportion of my stocks have created most of my gains. I grant you that I also haven’t owned thousands of stocks so my example may be a poor one.

Yes, it's true that there's usually one hot stock for any given period that brings in a lot of my returns. But when I measure longer time periods, the number of stocks that bring in most of my returns gets quite large. I've drilled further into my stocks. When I eliminate the one or two best stocks and the one or two worst stocks (that is, the extremes), I find that the middle ground returns about the same as the edges. And this holds as I eliminate more of the extremes.

I did a quick test on Mr. Zweig's claim. I downloaded performance data from the largest 500 stocks as of April 24, 2023, which roughly approaches the S&P 500, and calculated their total return (gains, losses and dividends) for the prior 12 months. The stocks had lost about 5.6% of their total value in the prior 12 months.

However, the average stock lost only 2.6% during this same period, and the middle 50 stocks lost 4.6%. So the most middling stocks did slightly better than the entire index, and the average stock did 3 percentage points better than the entire index. This hardly suggests that over a defined period of time, such as one year, one needs to find a very few hot stocks to keep up with the indexes, and in fact, in this one look into a random 12 month period, the middle and average stocks both outperformed the index.

What I am saying from this simple test is that it doesn't matter if Apple or Tesla or Amazon or even Exxon-Mobile bring in an outsized lifetime return. I'm not buying stocks for a lifetime. I'm owning them up to several years, and I have no evidence that I need good luck to keep up with the indexes. I can buy average stocks and do quite well.

Indexes by their nature buy high and sell low. By their design, their simplicity, by their very nature they function well. Yes, they perform better than almost any actively managed fund—which is well documented—but not great.

I'm fairly convinced that an individual with a basic understanding of finance and math, with the emotional ability to see beyond the past year or two, and to accept some occasional deep drops such as we had in 2022, by owning several dozen stocks can beat the indexes—both with lower fees and with better returns. And they can do this by avoiding overpriced stocks that the indexes (and everyone else) love, that in the end do not do as well as perceived.

Mr. Zweig gives some additional good help for investors that want to try their luck with individual stocks. Avoid big, household-name companies and avoid following crowds into the latest meme stock.

He suggests that investors instead look for winners among smaller firms with good financials. Limit yourself to a handful of possibilities and don’t put more than a total of 5% of your money in them. Further, never add new money to a winner. This will help you win well when you’re right, and will limit your losses when you’re wrong.

And if you do find a winner, hold it as long as you can. Small potential fortunes are lost selling after a stock doubles or triples, watching on the sidelines while it continues to double and triple still again. By then, of course, you’ve lost this opportunity.

Against common advice, I’ve kept about 30% of my equities in individual stocks and the rest in low-cost indexed funds. Since the market peak before the Great Recession to today, which includes two bear markets, my individual stocks have performed significantly better than my index funds. The gains seems to be quite widespread, and not because of a couple of lucky purchases.

My additional suggestions with individual stocks is to be slow to buy and slow to sell, regardless of where their price is going. Keep an eye on the stock’s fundamentals: margins, debt and dividends. And don’t be afraid to check out an annual or 10-K report. If something smells bad, it may be time to sell it.

Although I generally recommend indexes over individual stocks, for someone who is willing to put time into stock research, there are a lot of fees to be avoided and a lot of money to be made following some basics with individual stocks. As my analysis on the S&P 500 shows, using a dartboard to buy a dozen stocks from the S&P 500 will probably outperform the S&P 500. And this is probably because you’re passing on overpriced stocks that are overallocated both by individuals and indexes.

Mar 27, 2023

My Move Out of Index Funds

I have struggled for years with the logic behind both asset allocation models and indexing, two tenets of modern investing, ideas I’ve used most of my investing life. Unfortunately.          

I recently posted my arguments against asset allocations. My frustration has been that asset allocation eventually got me to invest almost half of my wife’s and my life savings in bonds that historically barely keep up with inflation, and then in 2022 lost over 13% of their value. I’m already moving away from that model.

My next move is away from index funds. The very reasonable argument for index funds is that they may be your best bet for investing in equities rather than trying to “beat the market” by owning individual stocks. I agree that the easiest way to win in the stock market is owning low-cost index funds. A reasonable person can establish an allocation formula for their equities, for example, 70% of stocks in the US and 30% international, balance back to this allocation every year or two, and do little else for decades. It works and I highly recommend it.

But I have a major issue with index funds. By their design, when you buy an index fund, you are overallocating to overpriced stocks, and underallocating to underpriced stocks.  What is overpriced and what is underpriced is subject to great debate, a debate index funds settle by declaring nothing is ever over or underpriced, a tenet of indexing, and that the best estimate of what a stock is worth today is what it is selling for today.

I disagree with this. Stocks often get overvalued and undervalued by almost any valuation measures. Great examples are the Dot-Com Bubble of 2000 and the Great Recession of 2008. But what the intrinsic value of a stock is at any given time is an endless and emotional discussion, a little like religion, and it won’t get settled here.

Let’s just say that I don’t buy this argument that stocks always trade at a price that best represents the value of that company at that time. A live example (and there are endless more) is Tesla. It recently had more market value than the market value of all other automobile manufacturers in the world combined.

Read that last sentence again slowly. No rocket science or deep financial analysis is required to recognize that this is either an overpriced stock in the long term, or all other automobile manufacturers in the world are collectively underpriced.

During 2022, from high to low, Tesla lost over 70% of its value without any significant change in the company. That’s how much variation there can exist in a stock that supposedly is trading at its fair value. And my bet is that at its low, it’s still way overpriced.

The most basic investing maxim that I learned in high school is that you should buy low and sell high. But indexes, by their design, buy high and sell low. It’s not intentional but it is part of their design, a design that is simple and easy, but causes other problems. An index fund mimics the composition and performance of a financial market index, such as the S&P 500 index.

So if in early 2022 you bought an index fund that tracts the S&P 500 index, you are overallocating your money into many overpriced stocks like Tesla, and underallocating your money away from many underpriced stocks, the opposite of what one should do.

There are other advantages to owning individual stocks besides this issue of index funds overbuying overpriced stocks. Although it is easy to find low-cost, low-turn index stock funds, stocks have even lower fees. Many brokerage firms have zero fees for their accounts and zero fees for buying and selling stocks.

So by owning stocks you can reduce any fees to zero sans spreads. If you then hold your stocks for long periods, real fees approach zero. You can have your entire life savings maintained online for years, with full access to the firm’s tools and services, and never pay a fee, directly or indirectly. How these firms make a profit is another discussion.

The arguments against owning individual stocks are many and valid. It takes a lot of time. It requires research and knowledge, although not necessarily any special cognitive skills. The best argument against it comes from Daniel Kahneman, the author of “Thinking, Fast and Slow.” He convincingly suggests that people have too much confidence in human judgment, specifically with forecasting.

His research on stock picking, a form of forecasting, shows overwhelming evidence that professional stock pickers have awful track records doing what they’re purportedly paid to do. It supports his claim that human are terrible forecasters, whether it’s stocks or anything else requiring a long-term view.

Finally, one more strong argument against owning individual stocks is that most money in the stock market is made in very few stocks. Therefore, regardless of one’s skills, the chances of hitting on these few stocks is slim, no matter how good one might be at their trade, and success mostly comes down to luck. And the best way to counter luck is to own all the stocks in a low-cost index fund.

Acknowledging these challenges, people have endless ways to try to make money in the market. I’ve already mentioned buying underpriced stocks and selling them when they return to their intrinsic value or higher. There are strategies for out-smarting other bad investors, such as the ones who bought Tesla in the last several years. These approaches are sometimes known as the “bigger fool,” assuming there will always be people willing to pay yet more for an already overpriced item.

Timing and technical exercises are endless, including the Santa rally and the "sell in May and go away" theory that tries to beat the historical underperformance of stocks from May-October. Apparently, there’s an argument for buying and selling anything based only on the day of the week or even the time of day. And technical analyses are endless, a little like reading tea leaves.

Most have some merit and for sure, someone has always made money doing all of them, which countless articles give undue attention to.

I bought my first stock while in college, Niagara Mohawk Power, a utility that still operates, now owned by a British utility. My next purchase was Manville Corporation, the manufacturer of asbestos-containing building products. That ended badly. I bought some stocks during the Dot-Com Bubble. They ended like most of the market. Ditto the Great Recession.

I mostly learned what’s often stated: It’s hard to beat indexes. I purchased stocks with full confidence they would rise quickly. But it was based on a lot of emotion and little information.

I never quit, probably for the reasons many buy stocks. It’s a little like gambling but with a far better chance of success. I’ve continued to entertain myself, randomly buying stocks based on various valuation theories, and then holding them as long as I can stand it. Since the Great Recession, I’ve usually had about a third of our equities in individual stocks, about as much as I could tolerate. I’ve had some disasters (e.g., Peabody Coal), some close calls and some wins, most notably Ford Motor that I bought during the Great Recession fire sale.

How have I done with these stocks? It’s hard to say because it’s hard to know what I would have owned if I hadn’t purchased them. And for various reasons, it’s hard to make an apples to apples comparison with comparable index funds I’ve had. For example, my 401(k)s have normally been funded by bimonthly purchases from my salary, commonly known as dollar-cost averaging. My stocks are purchased randomly. Comparing collective returns is difficult.

But as part of my look through the carnage of 2022, I noticed that my individual stocks dropped about half of what the S&P 500 did. Again, comparisons are hard because I own some international stocks and funds.

So I looked a little further and found that over the past many years, my individual stocks have performed nearly twice as well as my index funds have. Further, it held true for most of these calendar years. A look further back has more mixed results but in total, since the peak before the Great Recession to today, my individual stocks have performed significantly better than my index funds.

I considered whether I got lucky. So I looked at returns over several periods excluding the best and worst stocks. The middle ground held about the same as the extremes.

I’ve searched returns for a single year across the entire S&P 500 and contrary to what I’ve read, I don’t find it true that the vast majority of returns come from a very small handful of stocks. These winners make a lot of press, but that’s not the only place money is made. And it’s also where a lot of money is lost.

I did a backtest of what would have happened the past ten years if I had had all of our money in only the same stocks I owned at the time. That is, what would have had happened if I had not owned any stock funds or bonds. Again, it’s a mixed picture – higher volatility but the returns are significantly higher than what I experienced, and in only one year would our total portfolio value have dropped lower than what we actually experienced with our mix of bonds, index funds and stocks.

Another common mistake investors make is focusing on market extremes, the rises or falls from recent highs and lows, rather than long-term returns. For example, the S&P 500 dropped 56% high to low in the Great Recession. But if you limit your analysis to 12-month or other longer term views, the extremes are much less. So when I look through returns, I normally only look by calendar year, or other long periods. This removes so much of the noise that causes such emotion. These short-term variations don’t have nearly the actual impact to your portfolio that your emotions respond to.

Which brings me back to the same place. There is a high price for higher stability, and if one can ignore the noise, there is significantly more money to be made owning individual stocks than there is in either stock index funds or in bonds. As an aside, this is one of the reasons (along with paying their own salaries) that professionals struggle to do well – their clients respond quickly to this noise forcing them to respond accordingly, too, which often includes selling underpriced stocks.

This is where I’ve been stuck for years. I don’t trust indexes and I don’t trust professionals, but I’m never confident that I or anyone can pick stocks well. But there’s little evidence that my stock picking is any worse than index funds. And in fact, I’m reasonably confident that beating the indexes isn’t that hard, which has always been my theory.

To use stocks as long-term investments, I generally rely on three well-known factors: what the stock valuation is using some common metrics; the financial health of the company; and finally, some cautious consideration for what analysts might say about a company. I mostly ignore sentiment, inertia or any technical analysis, other common factors considered in selecting stocks.

Please note that I don’t trust analysts either. They have a Lake Wobegon tendency to rate most stocks above average. But they can highlight some issues. I trust their poor reviews more than their good reviews.

As for valuation, I try not to put much into a stock’s most recent numbers, and instead look closely at its last several years. In addition to profits, I also look at free cash flows and dividends. I also consider their book and enterprise values.

For a company’s financial health, I look at its return on equity, its margins and its liquidity, and very closely at its debt. It’s hard for a debt-free company to go bankrupt.

There’s no secrets to what I’m doing. This information is widely available online. And although it’s time-consuming, it’s not nearly as complicated as it sounds. My usual procedure for buying a stock is to first use various ways to come up with a large number of stocks that I may be interested in, whether something I hear about or see on a list.

However I get there, if I like what I’m seeing, I chase down several pieces of information on the company, and then score it across a half-dozen measures. The scoring is to help contain my emotions, which like most humans are terrible at predicting where a stock price may go. If it all adds up to a good score, then I’m serious about buying it, which I still may or may not do.

Most of my life, whether investing or anything else that requires time and work, I’ve leaned heavily towards the law of parsimony, a principle that recommends searching for explanations constructed with the smallest set of elements. Although my stock analysis can seem a little overwhelming, I suspect one could probably come to the same decisions with half of the information I use. Maybe debt, margins, dividends, and price to cash and earnings, with a look at any warnings from analysts.

I painfully hold to stocks I own whether they’re doing well or poorly. I consider selling when the same analysis doesn’t add up to buying a stock. But even then, I still give it some time. And time is one of many tricks I use to keeping my emotions out of these decisions. My default is to do nothing.

Yes, I miss out on Google and Apple and Netflix. But I also missed out on Tesla last year. Cummins, Emcor, Ryder, Amgen and Teck aren’t nearly as interesting, but I trust them a lot more. Index funds trust overpriced stocks much more than I do.

How far will I stray from index funds? I don’t know. I don’t make fast moves. After combing through scores of stocks over several weeks, I recently made a couple of new stock purchases. As I normally do, they’re a broad mix across sectors, capitalizations, and value and growth.

And that may be all I do for a while as I wait, watching what happens with the recession “everyone” is predicting. If I do beat the market, doing little or nothing will get me closer to where I want to be. If I’m wrong, I’ll find myself making some changes. And confessing my mistakes to you.

Feb 28, 2023

My Goodbye to Asset Allocation

For as long as I can remember, I’ve read endless variations on two basics of investing. One is that you should maintain an asset allocation between stocks (equities) and bonds (fixed income), moving to a larger percentage of bonds as you near retirement. The second is that you shouldn’t own individual stocks, and instead you should buy them in indexed funds.

There are valid arguments for both claims. But there are quieter places that challenge some of these assumptions. I’ve challenged both for years and now I’m slowly abandoning both.

Today, I will discuss my move away from the standard asset allocation formulas so widely recommended. Later in another post I will walk through my concurrent move away from any stock funds, including indexed funds.

Last year’s markets blew up the asset allocation model between stocks and bonds. In 2022, for a variety of reasons, stocks (S&P 500 including dividends) lost over 18%. But U.S. bonds didn’t do much better, losing over 13%. The theory for owning bonds is that they will neutralize some of the stock losses in a market downturn. That theory failed miserably this past year.

I acknowledge that bonds did perform five percentage points better than stocks. And I acknowledge that this is the worst bond performance in forever. But this is small consolation to the fact that over decades, bonds generally return about one percent more than inflation, and stocks return at least six percent more than inflation. In inflation-adjusted value, stocks have returned about six times more than bonds. Six times. That’s hardly reason to invest up to half of your life savings in bonds.

For years, Warren Buffett has repeatedly said that stocks are a better and an even safer investment for long-term investors. Yes, in the short-term, stocks can be painful. But in the long term, after inflation return on stocks is much, much better than bonds. Six times better, in fact.

But surprisingly, even in the short-term, bonds can be poor performers. Although 2022 is an outlier, bonds can lose money. And the short-term bonds that are almost certainly not going to drop significantly in value normally return less than inflation.

For my first 15 years investing in a 401(k) plan, I kept almost 100% of my wife’s and my retirement money in stock funds. They did fine. Turning forty, I bought into the asset allocation formula to a degree, and moved us to about 20% bonds and 80% stocks. As we aged, I did the "responsible" thing – something I have always struggled with – and increased our allocation of bonds. I entered the Great Recession of 2008 with nearly 30% of our money in bonds.

When stocks dropped 56%, high to low, in the Great Recession, I admitted defeat and slowly moved us to nearly 50% bonds. Now we were safe. Or so I thought.

Then 2022 came. After having up to half of our life’s savings in bonds during one of the greatest bull markets ever, I saw our bonds trashed. I expected it with stocks that had doubled and tripled and more. But bonds?

Yes, over the past ten years, our bonds have not even kept up with inflation. Safe? Secure? Hardly. And they were mostly investment grade.

I did a backtest of our investments the past ten years, testing my results if I had held no fixed income and instead had all of our money in the mix of equities I did own. Although returns are more volatile, the returns are notably higher than what I experienced. And it was interesting that the test never had us with less invested than we had with the asset allocation models I was using.

This reminded me again of other ideas I’ve heard periodically, probably from Jeremy Siegel or Jonathan Clements. The counter idea to asset allocation is to keep 5-7 years of money you may need for an emergency or a market correction in cash and short-term bonds. In the event of a strong market correction, you then have five years to wait it out, using this emergency fund that is virtually guaranteed to hold its value in any market.

(It is noted that as in life, nothing is guaranteed in the financial world. But for our discussion, let’s assume we trust the dollar to hold a reasonable value and for the U.S. government to honor all of its debts.)

For the rest of the money, if you can handle the turbulence, the best returns will be in stocks. However, if you can’t sleep at night, then adjust stocks downward to the point you can sleep. That’s different than keeping a set percentage of your life’s savings in bonds.

It's important to know yourself and how you handle volatility. If you know you're the sort of person who may panic sell when the market drops 25% in a short period, bonds might be safer for you. But if you can keep a long view and not make impulsive orders, over five years you are virtually guaranteed to be in a far better position with your money in stocks rather than bonds.

For me, I can’t sleep thinking what a mistake asset allocation has been. As we speak, financial analysts and journalists are busy both justifying and readjusting the asset allocation models they’ve pushed for decades. As is normally the case, they’re telling us to now go where we wished we had been a year ago.

As is true for most forecasting, there’s a heavy bias from the most recent history, a human tendency referred to kindly as “recency bias.” It mostly reminds us of how bad humans are at forecasting anything.

But I’ve already moved on. Been there, done that. I’m not interested in a new asset allocation model that may have worked in the past but probably won’t work in the future any better than past models.

I’m moving ahead with a 5-year emergency fund that will always have all the money we may need for five years sitting in a stable place that earns little – but doesn’t drop in value. That will be mostly I-bonds and short-term Treasuries. I can ladder Treasuries in over 5 years at over 4% interest. That should probably keep up with inflation. But they won’t drop. Both investments guarantee the return of our principal plus about 4% interest.

For the rest, I’m mostly walking away from other fixed income.

How far will I go? I don’t know. I don’t make fast moves. I started by ending the reinvestment of dividends and gains from bond funds. I’m looking for opportunities to sell longer-term bonds and replace them with either short-term bonds or stocks.

Then it’s a waiting game, watching what happens, monitoring everything we have. I hate selling anything, almost to a fault. And if markets go by their historical averages – which they rarely do – our allocation to bonds will continue to drop.

If I’m right that bonds are a lousy place to be, I’ll get to where I want to be without a lot more work. If I’m wrong, I’ll find myself writing a mea culpa – and trying something else.

But since I mostly don’t sell low, my opportunities to return to a higher bond allocation would only come when stocks are doing well. And then it’s hard to justify any such move since my theory is then working. That is, I may just be stuck in my own investment Catch-22.

My next step is to move away from indexing as my primary means of investing in stocks, and instead move to owning more individual stocks than I have in the past. But that’s another discussion.