connecting the dots

[gelos]

Hi All,

Never posted on iTulip before, but been reading it for awhile. Great place, helps to cut through the crap of mainstream media and get a lot of insight to what is really going on.
I’m an amateur and try to improve my understanding of markets and economy. I have rare moments of clarity, but more often than not it goes back to confusion :)
I’m experiencing one of such moments of back to being confused and if somebody can take a few moments to connect a few dots for me I’d really appreciate it

Here it goes:
Unwinding of leverage. The picture I had in my mind just a few days ago was like this: there are a lot of highly leveraged institutional and individual investors out there, economy is tanking due to housing mess, sooner or later the extent of problems will become apparent to everybody, stock market will go down, decline in stocks will be self-reinforcing and will lead to margin calls, liquidation of assets and as a result decline of all asset classes across the board. After the overall decline the assets classes will decouple and commodities in general and gold in particular will do well in the inflationary environment that follows.
The picture above made sense and the drivers of the above were high leverage and poor fundamentals. Now after the Feds move this week I started to get a sense that many people think that the Ka phase is over and we are already in Poom and that gold is already decoupled and is surging ahead, etc. Perhaps I don’t appreciate the power of the rate cuts and how it influences things, but I fail to see how the highly leveraged situation with recession looming is going to change because of the cuts.
Any insights?

Risks to banks and financial instrumentsI read many times that the risks are significant and that in certain scenarios a lot of banks can fail and even things like ETFs aren’t solid. So the thinking goes that one shouldn’t invest in FXEs and GLDs of the world, but buy physical stuff
I confess that I never clearly understood why such companies as Vanguard or Fidelity for example will fail and it’s another one of mine missing dots. The same goes for FXE, GLD, etc.

401K scenarios 401Ks allow doing tax-deductible saving and essentially amounts to instant 30% initial return. The problem is choices of investments are very limited. Let’s say all one can get that makes some sense in the current environment is a money market fund. Does it still make sense to do it or the inflation will get so bad that it’s better to pay the tax and buy gold or foreign currencies or whatever? I can’t quite calibrate it.

Thanks in advance

[Tet]

Hi All,

Here it goes:

Unwinding of leverage. The picture I had in my mind just a few days ago was like this: there are a lot of highly leveraged institutional and individual investors out there, economy is tanking due to housing mess, sooner or later the extent of problems will become apparent to everybody, stock market will go down, decline in stocks will be self-reinforcing and will lead to margin calls, liquidation of assets and as a result decline of all asset classes across the board. After the overall decline the assets classes will decouple and commodities in general and gold in particular will do well in the inflationary environment that follows.
The picture above made sense and the drivers of the above were high leverage and poor fundamentals. Now after the Feds move this week I started to get a sense that many people think that the Ka phase is over and we are already in Poom and that gold is already decoupled and is surging ahead, etc. Perhaps I don’t appreciate the power of the rate cuts and how it influences things, but I fail to see how the highly leveraged situation with recession looming is going to change because of the cuts.
Any insights?

Welcome to the forum, leverage works in both directions, margin calls impact shorts more than those long the market, my read would be market heads higher from margin calls. Rate cuts are the power to create pent-up demand waiting for prices to fall. My business line of credit just became cheaper and my home equity line of credit just became cheaper. Were I planning on using either of these to purchase something that asset class whether it was PM, real estate or POS stocks all just became cheaper.

401K scenarios 401Ks allow doing tax-deductible saving and essentially amounts to instant 30% initial return. The problem is choices of investments are very limited. Let’s say all one can get that makes some sense in the current environment is a money market fund. Does it still make sense to do it or the inflation will get so bad that it’s better to pay the tax and buy gold or foreign currencies or whatever? I can’t quite calibrate it.

Thanks in advance

Money Market depends on the 401K administrative fees as to whether it's a good investment or not. The hypsters don't like you holding cash whether it's the right call or not and do everything they can to push you into the funds. Inquire with your 401K plan administrator as to whether you have the option to have a self directed brokerage account. Just because they don't tell you about it doesn't mean they don't have one and if they have one you have to ask to find out. Good luck.

[Andreuccio]

401K scenarios 401Ks allow doing tax-deductible saving and essentially amounts to instant 30% initial return. The problem is choices of investments are very limited. Let’s say all one can get that makes some sense in the current environment is a money market fund. Does it still make sense to do it or the inflation will get so bad that it’s better to pay the tax and buy gold or foreign currencies or whatever? I can’t quite calibrate it.

Thanks in advance

This is something I've been thinking about too. I have a great retirement plan with Fidelity: we can invest in about 100 different funds, but I'm still not sure if that's the right place to be vs something like gold outside of the fund. There are no easy answers.

One tool you can use, though, to get a better handle on how things might play out is a retirement calculator. There's one at money.cnn.com here:

http://cgi.money.cnn.com/tools/savingscalc/savingscalc.html

You can play out different scenarios and see how it would work out for you in the end. The problem is nobody really knows the answer to questions like what inflation will end up being or where gold will go to. You pretty much have to guess that based on whatever information you can gather from here and other sources.

One approach might be to assign different probabilities to different outcomes depending on how likely you think they are, for example gold at $1000: 40%, gold at $2000: 40%, and gold at $3000: 20%, and then weight those results accordingly when you compare gold to the MM fund in the 401k. (Those percentages are completely random.)

Don't forget to subtract tax on the back end, too. That is, not only do you pay tax on income if it doesn't go into your retirement account, but you have to pay tax on the sale of your gold, too. That's what makes the decision easier for me. After both shots of tax I'm at somewhere around 40-50% of my original balance. Investments outside of my retirement account would have to double for me to break even. So I max out my retirement account first. (There will be, of course, taxes on my retirement account when I withdraw it in the end. One more level of complication.)

You also need to consider your personal situation, when you'll need the money, your appetite for risk, all that stuff. Maybe you want to do some of both options: some in the 401k and some in investments outside of it.

I hope that's helpful. Good luck.

[c1ue]

Andreucchio,

I would seriously consider taking some type of part time position at a place which lets you open self directed brokerage accounts.

At least with a brokerage account you can buy/short stocks and ETFs; that's close enough for reasonable maneuverability hedging.

Then roll everything retirement related into it and quit the job.

I've worked in 5 different places, plus had an IRA as a youth on top of that; it is all now rolled into my last job's self directed.

Never have I been so happy as when this task was finally completed.

I've probably missed out on 60%+ delta in the last 8 years due to not being able to replicate my non-retirement investment strategies via available mutual funds.

I agree taking money out of 401K/IRA/Roth is a losing proposition - violates the first principal of investing which is to NOT lose principal - but being tied into a mutual fund only strategy is right after that.

Of course, I HATE mutual funds - and by all other vehicles where some dude is playing (I win = I win, I lose = you lose) with my money.

[raja]

Regards GLD, the gold ETF, James Turk has a lot of criticisms . . . didn't stop me from using it, however. Maybe it should have . . . .

Anyway, here's the info:
http://www.financialsense.com/editorials/turk/2007/0305.html

Example: Notwithstanding my previous writings, with an open mind I downloaded GLD’s latest prospectus and 10-Q to see if anything has changed. It hasn’t.
The same loose custodial controls remain in place, which is a critical shortcoming. GLD has not been structured to provide the assurances of integrity needed to establish that all of the gold that it supposedly owns is safe, secure and properly accounted for.
In the absence of these strong custodial controls, there is not any certainty that GLD has been increasing the physical demand for gold, which means that it has not achieved its original objective. It set out to create a vehicle that would provide the ownership of physical gold through a listed security that can be conveniently purchased and sold through stockbrokers. The idea was to increase the demand for physical gold through this new investment vehicle, thereby improving the gold price and as a consequence, increasing the revenue of the gold mining companies that fund the WGC.
GLD is of course a listed security, but there are many reasons to conclude that it is not an alternative to owning physical gold. The most important is that the gold supposedly held by GLD is not audited.

[raja]

Checked out the calculator . . . . seems good for what it is, but it's not really the info one needs to know for retirement.

If you have a lump sum, it tells you how much money you will have after X number of years. But you can't just take that amount and divide by the number of years you will live, because in reality you will be constantly taking money out of your nest egg to live on, while continuing to invest the balance.

The question that needs answering is this:If I retire with X amount of money, how much can I spend each year so that I end up with zero at death (or, so that I end up with a certain amount left over for my heirs).
I was unable to find a calculator that would give me that answer, so I wrote a program myself that would.

For those who are interested in the mathematical aspects here are the steps. (Of course, the program does all this automatically after entering in some variables, such as starting amount, estimated inflation rate, estimated years to death, tax rate, etc.):

Say you retire with $1 million.
In year one, you take out $35,000 to live on, while the rest is earning you interest.
You add that interest back to your nest egg, but since that's income, you also have to take off tax.

The next year you want to take out another $35,000 again, but because of inflation you have to take out $36,050 ($35,000 increased by whatever you think inflation will be) to maintain the same standard of living.

So now you've now got $1 million, minus $71,050, plus whatever that amount earned through investment, minus tax.

And so on, for as many years as you think you will live . . . .

As you see, it's quite a tricky calculation, and it's not surprising that this type of calculator is not available (as far as I could see through an internet search).

Using this program, you can find how much you can spend yearly (nominal and inflation adjusted) if you want to retire with X amount of money. Or conversely, you can choose how much money you want to spend yearly, and find out the sum you need to have upon retirement.

Much more useful than the CNN calculator, in my opinion . . . .

[Andreuccio]

Checked out the calculator . . . . seems good for what it is, but it's not really the info one needs to know for retirement.



It's true that the CNN calculator is very limited in scope. I linked to it, though, because it's useful in answering gelos's specific problem: how do you compare yields of taxable and tax sheltered accounts, in different investments, over x period of time.

I'm surprised you weren't able to find a calculator that did more or less what you wanted. I thought I had seen that kind of thing. If I have time later I'll look around and tell you if I have any luck.

[Andreuccio]

Andreucchio,

I would seriously consider taking some type of part time position at a place which lets you open self directed brokerage accounts.

At least with a brokerage account you can buy/short stocks and ETFs; that's close enough for reasonable maneuverability hedging.

Then roll everything retirement related into it and quit the job.

I've worked in 5 different places, plus had an IRA as a youth on top of that; it is all now rolled into my last job's self directed.

Never have I been so happy as when this task was finally completed.

I've probably missed out on 60%+ delta in the last 8 years due to not being able to replicate my non-retirement investment strategies via available mutual funds.

I agree taking money out of 401K/IRA/Roth is a losing proposition - violates the first principal of investing which is to NOT lose principal - but being tied into a mutual fund only strategy is right after that.

Of course, I HATE mutual funds - and by all other vehicles where some dude is playing (I win = I win, I lose = you lose) with my money.


C1ue, thanks for the input. I always learn something from your posts.

I wish I could take a part time position, but it's not in the cards right now. Maybe 4 or 5 years down the road. And while I agree in principle that mutual funds only are inferior to accounts with more options, up until now my results with mutual funds in my 403b have been stellar, while my results in my other accounts have been, um, mediocre. It could be just random, or short time span (about 3 years), but I don't hate mutual funds nearly as much as you do.

I do have one question: you talk about losing principal when you take money out of 401K etc. Is there a penalty for moving into one of these self-directed accounts at a brokerage that you're talking about?

[c1ue]

I do have one question: you talk about losing principal when you take money out of 401K etc. Is there a penalty for moving into one of these self-directed accounts at a brokerage that you're talking about?

No, the penalty only refers to taking money out of a retirement account.

If you can't get Mohammed to the mountain, move the mountain to the Prophet.

See if you can't get a few people (and yourself) to write a letter to your company's retirement program administrator requesting addition of a self-directed brokerage account option.

Note that while you may not share my extreme dislike of mutual funds, you probably wished you could buy GLD or some such :o

As for personal investment - some part of it is like blackjack.

As a professional blackjack player once told me - you gotta lose $500K (total, not one bet). Until then, you just care too much about individual bets. This was 15 years ago.

Even knowing the percentages - not being used to playing with the big money means behavior can become twisted when losing unaccustomed large sums even when right.

Mutual funds are good because they keep you fully invested and remove this last tendency. The price you pay is shaving off both your best upside and the management fee. There is no downside risk reduction different than any other diversification.

For me - I'd rather not chance the mutual fund management lottery game and I've largely beaten out the irrational behavior from many years of both winning and losing.

[Andreuccio]

No, the penalty only refers to taking money out of a retirement account.

If you can't get Mohammed to the mountain, move the mountain to the Prophet.

See if you can't get a few people (and yourself) to write a letter to your company's retirement program administrator requesting addition of a self-directed brokerage account option.

Note that while you may not share my extreme dislike of mutual funds, you probably wished you could buy GLD or some such :o

As for personal investment - some part of it is like blackjack.

As a professional blackjack player once told me - you gotta lose $500K (total, not one bet). Until then, you just care too much about individual bets. This was 15 years ago.

Even knowing the percentages - not being used to playing with the big money means behavior can become twisted when losing unaccustomed large sums even when right.

Mutual funds are good because they keep you fully invested and remove this last tendency. The price you pay is shaving off both your best upside and the management fee. There is no downside risk reduction different than any other diversification.

For me - I'd rather not chance the mutual fund management lottery game and I've largely beaten out the irrational behavior from many years of both winning and losing.

LOL. "Moving a mountain" isn't just a metaphor when trying to get the company I work for to make a change like that. I'd probably have a better payoff in terms of time invested if I took that part-time job you spoke of, even at minimum wage.

The mutual fund options available to us are really pretty varied. My account is with Fidelity, and we can choose from about 30 large cap, 20 mid cap, 6 small cap, 20 different international, 45 focused industry, and a variety of bond, MM, and target date funds. Up until recently I've been mostly in their international (I picked Asia and Canada), natural resource, and gold funds, and I've averaged over 25% returns each of the last three years. (The gold fund's holdings, at least their top 10, are pretty similar to the XAU.) Recently I've moved a substantial portion into the MM option.

I'm not really afraid of making big bets. (While I'm not crazy about blackjack, I used to play quite a bit of Poker.) For me it's more an attempt to recognize my strengths and weaknesses. I've been pretty good at reading a lot, (websites like this, for example), synthesizing the information, and seeing general trends. But I have no expertise or skill in analyzing individual stocks. I was fairly certain gold, oil, and foreign markets would do well. But what companies to buy? No clue. Thus mutual funds aren't so bad for me.

One final thought: I do have some funds in my Roth. It's about 1/4 the size of my 403b, and I can buy pretty much anything I want to in it. If I'm going to do any hedging, maybe that's the place to look.

Cheers.