Money Listens

a:  A dividend reinvestment plan

b:  The West Virginia Smart529 college plan

c:  ING Direct Online Savings Account

d:  The grocery store

All of these are good choices, but the grocery store might provide the greatest return on your investment.  Every time I go grocery shopping the prices are higher.  We’ve all read the newspaper– with energy and corn prices skyrocketing, producers are passing on these costs in the form of higher prices.  Bread, eggs, milk, and chicken are some of the items I’ve noticed.  Wal-mart and other retailers have been absorbing some of the increases, but that won’t last long.  Stocking up on non perishables, especially if you can find a sale, will pay off as prices rise.

Last week I found canned tomato sauce on sale for 25% off.  You won’t get that return out of the stock market this year!  Whenever you find a good buy on stuff you regularly use, buy about a 3 month supply.  Think of the items you like to have in your pantry.  Tuna, peanut butter, rice, chicken broth, flour, pasta.  Oreos.  (Ok, I don’t have space for a 3 month supply of those).  And don’t forget paper goods and trash bags.

If you don’t have a good idea of prices, start jotting them down on your shopping list.  After you go shopping a few times, you’ll have a list of the majority of items you use.  I bet you’ll see some price increases over the course of a month.  Then you can get out your shopping list with prices and compare the sale flyers.  You’ll know if something is a good buy or not.

But don’t overbuy; just because it’s non perishable doesn’t mean it lasts forever.  And it should be an item you use regularly.  Don’t buy only because it’s on sale.  It has to be something you will use.  Big Lots has Ocean Spray Cranberry Sauce on sale for 33 cents a can this week.  2 cans is a 3 month supply for me, so even though it’s a great sale price, I’m not going to get a whole case.

Dollar stores and other “non-grocery” stores sometimes have good sales on food items.  Check the expiration dates; they don’t seem to do as good a job on stock rotating as the grocery stores.

I’m a fan of Big Lots.  There’s one about a mile from my house, and it can get dangerous sometimes.  It’s a great place for pet food, cleaning products, shampoo, toothpaste, and the occasional can of Cranberry Sauce.  I’m a member of their Buzz Club.  You can join online and get email specials and coupons.  Every few months they have a 20% off everything in the store for Buzz Club members.

You probably don’t think of tomato sauce and paper towels as an investment.  But if you’re getting a good sale price, it beats the stock market.  Pull the grocery store ads out of the newspaper today and see what your investment choices are this week.

When I took Dave Ramsey’s Financial Peace Class he had one lesson on investments.  He was careful to explain that he was not an investment expert.  Most of his advice concerned saving regularly and putting money away in IRAs and 401(k)s.  But several times he said that his investments in “good quality growth mutual funds” were returning 15% annually, and you, too, should expect that.  Probably at the time he wrote that lesson, which was during a very good stock market run, he was getting those returns.

Today, he might admit to being a victim of what’s called recency bias.  That means you look into your crystal ball and see recent events continuing into the future.  The most recent events carry more weight than those in the more distant past.

This happened to me in one of my first jobs.  I had a very good month; a difficult project finally came together, and my numbers were really high.  My annual performance review was the next week and I was expecting a great review.  But my manager didn’t just focus on the last month.  The 11 months before that weren’t so good, and the one good month probably kept me from being fired.  Recency bias caused me to be overconfident.  The next year I learned about another force called reversion to the mean.  An extreme event is temporary and the next event is likely to be closer to the average performance.  My extremely good month was followed by several more mediocre ones.  I didn’t last much longer in that job.

Reversion to the mean also explains why Manu Ginobili can have a very poor performance in one game and his teammates are confident he will have a very good game the next day.  If his average is 19 points per game, and he only scores 6 one night, he likely will revert to the mean and score 19 the next night.

What does this have to do with your investments?  It means that you can use the long-term averages for different types of investments to forecast the return of your particular portfolio.  If you have a diversified portfolio of  U.S. stocks, international stocks, and bonds, you can estimate the return for each category. You won’t be susceptible to recency bias and assume that a particular investment will always be going up (or going down.)  You won’t sell your bonds and buy foreign stocks if the internationals have an up year. And you’ll realize that if one part of your portfolio has done extremely poorly, it will probably revert to the mean and perform as expected the next few years.   And after what we’ve experienced so far this year, any reversion to the mean will be welcome.

Investing has its own rules.  When we try to play investing by the rules we’ve always used to run our lives, it doesn’t work.  One of the reasons we’re lousy investors is because we follow the rule “You get what you pay for.”  When you’re buying a car, a computer, or dark chocolate, you generally do get what you pay for.  The more you pay, the better the product.  But not when it comes to investments. You can’t tell whether a financial product is the best one just because it costs more.  In fact, often the opposite is true.

Another maxim we live by is “If you don’t know how to do something, hire an expert.”  In practice, it’s much harder than it sounds.  Just who is an expert?  We’ve all had trouble finding a car mechanic or a plumber we can trust and depend on. How in the world can we find a financial planner?  (Be on the lookout for a future post on how to find a financial planner.)

Listen to your gut.  Trust your instincts. You usually know what is right.  Sure you do.  If you’re playing Clue, you might have a hunch that it’s Colonel Mustard in the Lounge with the Wrench.  So what if you’re wrong.  You’re out of the game and go get another Pepsi.  Are you going to risk your life savings on a hunch?  Okay, I think most of us have this one down.  We don’t rely on hunches.  We don’t guess.  We actually do some research and make the best decision we can.

If Dogbert recommends Index Funds, what are you waiting for?

These cartoons are from Scott Adams’ Dilbert website.  Check it out at www.dilbert.com.  And please don’t mention the words “copyright infringement.”

Why are so many of us lousy investors?  We’ve been reading MONEY Magazine for years, keep up with CNBC, and try our best to make wise decisions.

The Bogleheads’ Guide to Investing has been on my “to read” list since it came out in 2006.  The book is a group effort by three followers of John Bogle, founder of Vanguard mutual funds.  Proponents of Bogle’s strategy of investing are referred to as “Bogleheads.”  I postponed reading the book because most of my focus has been on spending less and saving more, not investing.  The book is a comprehensive how-to guide for beginning investors.  But it’s also got a fair amount of psychology and philosophy in the mix.

The book has a great answer for why so many of us are lousy investors.  It’s because of the principles we have learned to live by.

• Don’t settle for average.  Be the best.
• Trust your instincts.
• If you don’t know how to do something, ask an expert.
• You get what you pay for.
• If there’s a crisis, do something, take action.
• History repeats itself.  The best predictor of future performance is past performance.

Applying these principles to investing will leave you poorer. *

Investing is a whole different ballgame, with its own rules.  That’s because the stock market is random and unpredictable.  The rules that we’ve lived by all our life, that have served us so well, are useless when it comes to investing.

Who is happy with being average?  Don’t we always strive to be the best?  Don’t we want the best returns on our investments?  It’s questions like these that torpedo our portfolio.  The “average” investor takes high risks to try for “better-than-average” returns and ends up “below-average.”

Bogleheads choose index funds, little risk, and are happy with “average” returns.

*The Bogleheads’ Guide to Investing by Larimore, Lindauer, and LeBoeuf. p. 76

Quick now, who is the world’s richest person? Bill Gates, right? Wrong. It’s Warren Buffett. This year Forbes magazine named him the world’s richest person. Who? He’s the 77 year old CEO and largest shareholder of Berkshire Hathaway, a wildly successful company. He is arguably the greatest stock market investor of all time. He’s known for his frugality, despite having a net worth of over $60 billion dollars. Yes, you read that right, billion. His annual salary is about $100,000 which is pretty low so far as CEOs go. He still lives in the same house in Omaha, Nebraska that he bought for $31,500 in 1958. (Most of this info is from Wikipedia. )

I’m giving you this background so you’ll sit up and listen to what he says. He knows his stuff. Last weekend he held a question-and-answer session at the annual meeting of Berkshire Hathaway. CNBC dubbed it Buffettstock ‘08.Over 31,000 rabid fans (shareholders) attended the meeting. Hence the wordplay on Woodstock. And you know Omaha isn’t exactly a major tourist destination. You can read a transcript of the meeting at CNBC.com. Here are a few of the answers he gave in that session:

Buffett says any money he’s given to charity hasn’t really affected his life because he’s given from his surplus. He admires those with much less who still give money and time to others.

How would you invest your money if you were just starting out and were not a full-time investor? Buffett’s answer: a low-cost stock index fund with a company like Vanguard.

What advice would you give to children on finances? Buffett says generally children will follow the example of their parents, and will be sensible if the parents are sensible and live within their means with an eye to the future. He says it may sometimes be best to spend money on some things when you’re young, such as a trip to Disney World that can create memories for your family. “I do not advocate extreme frugality.”

If you want to go to the meeting next year, you’ll have to buy at least one share of company stock. It’s on the NYSE, symbol BRK. Last time I checked, one share was trading at $129,990. Or a Berkshire “Class B” Share is a mere $4,500. Start saving your money.

Last night I was on Fidelity’s website researching the Contrafund. Guess what information was presented first? Past performance. 1 year, 3 years, 5 years, 10 years. 13.06% for the life of the fund. Sounds pretty good. Guess what comes next. This statement:

Performance data shown represents past performance and is no guarantee of future results.

Yeah, yeah, yeah. But past performance is important, isn’t it? That’s how you choose mutual funds. Get a fund with a good long-term track record.

Surveys show the most important factors people use to select mutual funds are past performance and level of risk.

Economic theory maintains that the most important criterion is future performance and level of risk.

Doesn’t past performance show which mutual fund managers are the best? And shouldn’t those managers’ funds outperform in the future? Unfortunately, no. There is no formula to identify the best managers. Over periods of 10 years only 3/4ths of all stock funds performed better than the market. Past performance can’t be counted on as an indicator of an above average manager. A few years of good results could be the product of chance.

A 2004 study presented a list of stocks from which brokers and portfolio managers chose which stock would do best each month from a pair of stocks. They were only successful 40% of the time, a performance below what could be expected from chance alone. The professionals reported “knowledge” as their main source followed by “intuition”. Evidently, what they “knew” and “felt” wasn’t very helpful when it came to picking winning stocks.

If the professionals can’t predict which stocks are going to perform well in the future, what chance does the average investor have?

This sounds like a great argument for index funds.

Capon, Fitzsimons, and Weingarten. Affluent Investors and Mutual Fund Purchasers. International Journal of Bank Marketing, Volume 12 Number 3 1994 Torngren and Montgomery. Worse Than Chance? Performance and Confidence Among Professionals and Laypeople in the Stock Market. Journal of Behavioral Finance, Volume 5, Issue 3, September 2004 , pages 148 - 153