Market Musings Blog

This week, JP Morgan Chase revealed that hackers invaded its customer records. On the heels of that announcement, many banks assured customers that ‘security is important to us’. No doubt. The problem is that the evolution of hackers is just a fast as, if not faster than the evolution of defenses. Someday, hackers may not simply steal your social security number or account records. They will steal your money too, right out of your bank account.

You’re thinking that your deposits are insured, right? Aha, that is true, but only in the event of bank failure. Theft is not covered by FDIC insurance. Certain types of terrorism insurance exist, but exactly what they cover is somewhat open to interpretation. There’s no question that if a large bank were swept clean of deposits, its insurer would claim that the event fell outside the coverage in the insurance contract. In the meantime, there you are, with no funds.

The best defense is a good offense. It might be time to ask your bank exactly what happens in the event of a security breach that brings your deposit balances to zero. We don’t advocate any bank over any other, but put yourself in the hacker’s shoes: if you were reaching for the brass ring, wouldn’t you go where the money is – ie, the biggest bank you could reasonably hack? You probably would not bother with a small community bank. On the other hand, does your community bank have the resources to stand up to cyber crime?

We have the uneasy feeling that the various hacks, identity thefts, data breaches, and so forth over the past several years are practice. Eventually someone somewhere is going to figure out how to make a massive funds transfer from a very large bank. Better hope it’s not yours.

In a word, no. But stocks could rock and roll for a while. Geopolitical considerations have finally seeped into investors’ collective conscience, perhaps by dint of sheer number and degree of horror. Earnings have been pretty good, but the economy retains its ‘fits and starts’ feel. Confidence is sliding for the time being.

In times of high uncertainty, investors push asset prices down until they feel better about values. Stocks may be headed there for the time being. We don’t expect this to amount to more than the every-calendar-year 5% to 10% correction that’s normal throughout history, but it might be a good time to pare back any positions you think are overvalued.

One of my favorite horse trainers had a great saying. When shown a big, elegant, young jumper prospect, he would say ‘pretty is as pretty does.’ One of his most successful jumpers was a jugheaded, roman-nosed horse whose front legs ‘looked like they came out of the same hole’ as he put it. But that horse could jump the moon.
Still, his clients liked the pretty horses that were nothing but trouble. The world just works that way. Our stocks are inelegant to the extreme and often belong to the ‘old economy’. Clients often wish we owned Facebook and Tesla.

The same thing applies on a larger scale. We operate in the simple realm of stocks, bonds, cash, and for some, real estate. Private equity, hedge funds, currency and commodity funds are constantly sending out their siren songs in the media. First this one is ‘hot’, then that one.

But ‘pretty is as pretty does.’ Recently, the Wall Street Journal published an article, “Big Investors Missed Stock Rally”, detailing how large pension and endowment plans, because of increased allocations to ‘alternatives’ and away from plain vanilla stocks, experienced much reduced returns over the last few years as a result of those allocations. Granted, the funds’ ten year returns were buoyed by alternatives because of less volatile performance in the ‘08/’09 period. But that lower volatility could have easily been achieved with government bonds, one of the simplest, cheapest investments available.

We’ll stick with contrarian strategies that deliver controlled volatility and inches of incremental return over time, rather than miles of return at the cost of big swings in portfolio value.

A common college savings solution, 529 plans allow tax advantaged savings for college but only if the funds are used for education; and your money must be allocated among the funds allowed in the state’s plan, the account must pay fees to the state, and you must limit investment changes, etc. By now you are probably pretty familiar with the rules, but maybe you are less familiar with the mediocre performance at many college plans. Too, you need to keep an eye on the underlying funds – which have a habit of becoming more risky when markets are good – and can be changed by the state whenever a fund company’s contract doesn’t please the state. In short, these accounts have many pitfalls.

Call this the ‘Anti 529 Plan’. Tucked under a corner of the municipal bond market, you will find zero coupon bonds, which you buy at a deep discount, like the old government savings bonds. On maturity, the bonds mature to full par value. The difference between the purchase price and par is your yield.

Because the market prefers immediate cash flow, zero coupon bonds have higher than average yields, because all their cash flow comes at maturity. Since the bonds are municipals, your tax impact will be nothing, or very nearly nothing. Better yet, you can keep the bonds in your name, and if your child does not go to college, you can use the money yourself. No restrictions.

Zeros can be used to save for all kinds of things, but they work best for intermediate to long term goals, like college savings for a young child, or retirement savings.

There are two drawbacks to these bonds: they can be hard to find (you will need a broker to look for you, but a discount broker could do the job), and credit risk is a minor issue with some of these bonds. Stick to well rated issues in solid states, and you will be fine.

As a rough example of how these bonds work: You should be able to buy $50,000 worth of bonds due in fifteen years for a little north of $26,000. That equates to about a 4.4% tax free return every year. No mess, no fuss. Just salt them away, and you will find a pot of gold when you need it.

We usually advise that clients use this strategy in conjunction with something that offers higher returns, like stocks, but only if the runway is long. Last thing you need is for stocks to drop 20% just when you need to write a tuition check!

In our first post on how to get rich, we counseled saving money. The point of this exercise is not only to accumulate a few bucks, but also to get into the habit of looking for places to save money. That will serve you well, all your life.

Here is our second secret:

Be Patient.

Yes, I know, it seems so… mundane. And as Americans, we are notably impatient.  But patience is much overlooked in the quest for wealth. Articles, books, advisers – they all focus on what to buy, only rarely what to sell, and never how to behave once you own what you bought.

Ok, you have to start with a reasonable investment. You can’t buy a dud and be patient and expect great results. But what is wrong with buying a blue chip company or two and holding it for a long time? Basically what you want to do is turn the line on the right, which is how nearly all investments look in the short term, into the line on the left, which is how good investments look over time:

                                 Even if you are not that ambitious, and all you buy is something with a 4% yield, patience pays off. A 4% investment will net you just shy of 50% more than you started with after ten years.

So: save money, and be patient. These are the simple secrets to getting rich.