Lessons from The Big Short

Michael Lewis is the author of: Liars Poker, Moneyball, and The Blind Side among others: all informative and entertaining. He does it again with The Big Short.


Lewis tells the story of the financial meltdown through the history of several who saw it coming. At the heart is mans greed. Even those who should have known better - the Wall St firms, let greed consume them and  they ignored the unreasonable assumptions on the continued growth of property values and risk, then continued to buy and sell bad investments because they did not want to be left out of the party.
You will be angry at the hubris and irresponsibility of those that should have known better.
For me this is another episode in the history of human greed. Greed drives human behavior so often and so often leads to destruction. It makes us blind to rational decision making and we end up following Madoffs, buying pets.com,  buying gold today,  Wall St creating or buying mortgage backed securities knowing that they were a house of cards. All for fear of being left behind and not making money when it appears everyone around us is getting rich quick.


Whether you are Morgan Stanley, Merrill Lynch, Bear Sterns, Lehman Bros etc. or you are an average investor, the lessons, and they are not new, are:


1. There is no free lunch
2. If it is too good to be true - it is. Do your homework, especially when it appears everyone is making easy money.
3. The higher the return the greater the risk and  the potential to lose your investment.
4. You do not get better than CD returns without the chance of short term losses. 
5. If you do not understand the investment you are buying don't buy it. 


Hopefully good investors and our financial leaders will be students of history, hopefully  they will learn from this story. But beware: human nature has yet too change, bubbles and irrational exuberance will reoccur, those that have learned from history and stay true to economic/financial fundamentals will generally survive the next bursting.  

Does a hybrid make financial sense?

At $4/gallon a hybrid may not make financial sense:

The following guest post is from Tim Chen. Tim is the CEO of NerdWallet, a credit card website that helps consumers find the best cash back credit cards for their spending habits.


Editor’s Note: As has been pointed out in the comments below, I believe Tim made a mistake in citing 40,000 as the average number of miles driven in a year. That number is more likely to be in the 15,000 mile range.

People have remarkably short memories when it comes to price changes. Retailers can attest to how quickly shoppers perceive sale prices as baselines, while a price increase must be sustained for quite some time before consumers shift their spending habits.

But the current rise in gas prices reawakened the memories of similar spikes in 2008 and has Americans considering long-term adaptations in addition to quick fixes like simply driving less.

Instead of opting for low-mileage giants that bear a strong resemblance to army tanks, many car buyers are considering hybrids instead. Soaring gas prices, combined with anticipated shortages following the March 11^thearthquake and tsunami in Japan, lifted demand just as production interruptions began to reverberate in America.

Car dealers see their hybrids flying off the lot, while selling used Priuses has become so lucrative that Toyota of Hollywood paid its employees a $500 finder’s fee for every Prius brought in.

Given the spike in Prius prices – used models sold for 30% more than the beginning of this year according to the National Automobile Dealers Association – and the admittedly fickle nature of gas prices, is a hybrid car still a solid investment?

New Prius vs. New Jetta

The Kelly Blue Book puts the fair purchase price of a 2011 Prius at $23,300, while that of a 2011 Volkswagen 4-door Jetta is $15,500. The Prius gets about 50 miles per gallon for both city and highway, while the Jetta gets 25 and 34mpg, respectively.

Setting aside the abstract benefits of owning a Prius, from saving the environment to establishing save-the-environment street cred, how long would it take to make up for the Prius premium?

We calculated the amount a consumer would spend on gas in a given year for different amounts of driving. By subtracting the amount spent with a Prius from that spent with a Jetta, we find the yearly savings on gas achieved with the hybrid.

Target: $7,800

Assumptions: Gas costs $4 a gallon, driving is split between city and highway

Miles Driven per Year	20,000	40,000 (national average)	60,000	80,000
Gas Savings per Year	$1,112	$2,224	$3,336	$4,447
Years to Reach Target	7	3.5	2	1.75

In order to make up for the Prius’ cost, the average American would have to hold the car for 3.5 years. Drivers keep their cars for just that long on average, so a Prius won’t save the typical driver any money even with the generous assumption that gas prices remain high throughout.

Used Prius vs. Used Jetta

Now we’ll compare the advantages of purchasing a 2006 Prius and Jetta, both with 200,000 miles, from a dealer. KBB puts the suggested retail price of the Prius at $11,500 and the Jetta at $8,000. Using the same assumptions as above, how long will it take to earn back the used Prius markup? The fuel efficiency of both cars is slightly lower: 48mpg in the city and 45 on the highway for the Prius, and 19 and 28mpg for the Jetta.

Target: $3,500

Miles Driven per Year	20,000	40,000 (national average)	60,000	80,000
Gas Savings per Year	$1,804	$3,609	$5,413	$7,217
Years to Break Even	1.7	0.8	0.6	0.4

The savings on gas are realized much sooner with a used Prius than a new one, which may, in part, explain Toyota of Hollywood’s juicy finder’s fee. Assisted by a larger absolute decline in price and comparatively better fuel efficiency, the used Prius easily beats out the used Jetta within a year.

Other ways to save on gas

Buying a car simply to cut down on gas spending doesn’t make financial sense, so consumers who don’t plan to trade in their vehicles in the near future will have to find other ways to cope with high gas prices. Despite rising fares and schedule cuts, public transportation remains a viable option. 

Gas credit cards and customer loyalty programs can shave off a few cents per gallon, and some gas stations charge lower prices for cash payments. Such strategies can help to ride out temporarily high gas prices without the significant cost of a new hybrid.

to see comments go to: http://frugaldad.com/2011/06/23/buying-a-new-hybrid-to-save-on-gas-smart-move-or-financial-folly/

Advice on what it means to be a Disciplined Investor

I am re-blogging yesterdays excellent post from Rick Ferri. Rick is the author of All About Asset Allocation and The Power of Passive Investing. 

The Disciplined Investor

June 20, 2011 By Rick Ferri

Investment discipline is misunderstood.  Too many investors, both individuals and professionals, say they are diligent at running their portfolios when they’re really not. Portfolio performance data proves it. Turnover rates in portfolios are high, mutual fund performance chasing is the norm, and investor sentiment shifts much more rapidly than good discipline would infer.

In my business, it’s common for investment advisors to claim they are disciplined in their strategy but also add that they’ll “adapt to changing market conditions.” This loophole leaves the door wide open to just about any change the advisor deems necessary and they use it to change strategy all too often, particularly when clients get anxious in bear markets. Loopholes in discipline statements may allow an advisor to retain skittish clients, but their actions usually hurt more than they help.

A disciplined investor follows these six guidelines:

1. Have a long-term investment philosophy.
2. Create an investment plan that follows this philosophy.
3. Form a prudent asset allocation around the plan.
4. Maintain this allocation through all market conditions.
5. Don’t change the allocation due to recent market activity.
6. Don’t hold back on new investments while waiting for market clarity.

I’ll briefly explain these six actions as they pertain to my own account to clarify each point:

Long-term investment philosophy:  My belief is that the markets are more efficient at pricing securities than I could ever hope to be.  I do not have enough skill to consistently add value to my portfolio by picking mispriced stocks or bonds, industry sectors, country selections, or entire markets. So, I don’t try.

Create an investment plan that follows this philosophy: Certain index funds and exchange-traded funds (ETFs) provide broad market diversification at a very low cost. Building a select portfolio of index funds and ETFs provides the highest probability for meeting my long-term financial goals.

Form a prudent asset allocation around the plan: I am a 53-year-old military retiree with a pension that begins at age 60, plus two smaller pensions from private businesses, and whatever Social Security my wife and I receive. Given this expected cash flow from pension sources, the asset allocation in my retirement account is more aggressive that a typical 50-something-year-old who has less in pension assets. My allocation is 80 percent equity and 20 percent fixed income, and I intend to stay that way for at least 10 more years.

Maintain this allocation through all market conditions: My retirement portfolio is rebalanced to 80 percent stocks and 20 percent bonds annually. Rebalancing is done when I receive an annual pension contribution from my company.

No changes to the allocation due to recent market activity: My portfolio is being managed for the next 30 years, not the next 30 days. It doesn’t matter what the market has done — or what others say it will do — the allocation stays 80 percent in stocks and 20 percent in bonds. I bought stock index funds in early 2009, stock and bond index funds in 2010, and all bond index funds in 2011.

Don’t hold back on new investing while waiting for market clarity: I have no desire to time entry points for new contributions. Money is invested as it comes in. If we change our pension so that money comes in every month, then my portfolio will be invested in the asset class where it’s needed every month and I will do one major rebalancing per year.

Some critics of my methods say these rules are too rigid and don’t offer any flexibly for what’s happening in the markets today.  Well, THAT’S what discipline means!

I’m not so rigid as to say never change. Investment plans have to change on occasion as unknown circumstances occur in life and as new information about old circumstances becomes available. These circumstances can be health, career, retirement date, and even wealth if an inheritance or bull market puts your savings at a higher level than you planned. How you deal with these new circumstances is also part of good investment discipline.

For more information on this topic, please read All About Asset Allocation, 2^nd edition, McGraw-Hill, 2010.

Good WSJ article on managing your credit score

The following link is to a good article on how to manage your credit score

Top 3 things:

1. 35% of score is dependent on whether you pay your bills on time.
2. 30% of score is your utilization rate (debt/available credit). Your credit card debt should be less than 30%    of your total available credit.
3. 15% is based on your credit mix. Do you have installment loans (auto, home) and credit cards.

http://professional.wsj.com/article/SB10001424052702304451504576394093505289846.html?mod=WSJ_PersonalFinance_PF4&mg=reno-secaucus-wsj