Investments and taxes

To be honest, it's more an academic discussion for me, as I don't play the markets like I used to, and when I do, I follow astute managers who happen to have similar philosophies on markets--and life. When my philosophies are congruent, I don't allow myself to second guess my decisions, and to me, second guessing has been my achilles heel when it comes to investing. I've lost far too much money when I let emotions, politics, and other people influence me unduly. That's one of the reasons I disdain politics: like the talking heads on CNBC, I follow it with mild interest, but only to get a beat on the general consensus, and I use it as a contrarian indicator. Because let's face it, when it comes to investing, most people get it wrong. The average 35 year old American has a net worth of $15,000. We are taught from day one to go to school and how to get a job, but we have had zero training on personal financial management. And the mortgage crisis just happens to be one big symptom of that mentality.

My whole investment methodology turns conventional wisdom upside down, but in reality, I am merely a good plagiarizer--I just follow unpopular strategies that the majority of the population is not exposed to, but are readily adopted by the wealthy. Even some of the brightest and best investment managers aren't privy to these strategies--or their emotional makeup doesn't allow them patience to implement them. They're great at picking stocks, and a few are even good at market timing, but they don't understand asset optimization--the optimization of ALL assets.

Dawgbytes is 100% correct--Wall St. money managers like to brag that the long-term returns of equities is between 8-12% historically (depending on the time window), but that's only if dividends are reinvested. Without that boost, the Dow and S & P's returns are closer to 2-3% or less, underperforming inflation. And since divies are taxed as earned, it ends up being a losing game.

And because we are humans, with emotions, the average investor thinks they can time the markets, when in reality, they are terrible at it. Owning stocks between 1983 to 2000 was the best time to own equities in the history of mankind--the annual rate of return for the S & P was over 12%. Guess what the average investor earned? 2.3%. They suffer from the casino delusion--that somehow they can beat the house.

So what does that mean? You better pick the right stocks for long-term appreciation and income--or pick the right money manager. Which means you eliminate 96% of the mutual funds out there, as they underperform the Lipper averages and indices. That's mainly due to exorbitant trading transaction costs, as well as the more unscrupulous window dressing. The gentler explanation is that the funds are "actively managed", and yet clients have to pay a 3% load to have it actively managed. It's unbelievable what many of these managers get away with. So cheat with my wife, and stick me with the hotel bill while you're at it.

Then there's the indexed method of investing which I espouse, as the loads are lower, but even in that case, there are hidden transaction costs as indexed funds get re-balanced as companies exit/enter the index and market caps vary. But at least clients get a semblance of earning the averages, which 80% of active money managers can't even meet. And then there's the taxation.

People have no idea how taxes hurt investment portfolios. They think they do, but they have no idea of the magnitude.

An individual earns an income, and gets taxed on that income. After paying expenses, and he/she is disciplined enough to save enough money to invest, and lucky enough to earn a positive rate of return on that money, they are taxed again (hopefully at the lower capital gains rate). Dividends are taxed as earned. Tax what I make, tax that same money short-term, and long-term. That sounds like a triple tax to me.

That's why tax-free accumulation and income is so crucial. $1 doubled 20 times ends up being over $1 million. $1 doubled 20 times, but taxed as earned at 27%, nets a little over $50,000. I'd rather have the million.

Today's entry, a year later...

Today's entry:

I've never made money following the crowds. I've always made money going against the masses. If I were to hire someone to manage my money, I'd rather them have a background in crowd psychology and mob theory, instead of degrees in econometrics. People tend to rely too much on numbers on things not necessarily controlled by numbers. It works for designing innovative technology; it does not work for predicting behavioral finance. In other words, when they win, it's because of their savviness and acumen, and when they lose, it's due to bad luck. It is analogous to a reknown physicist claiming he will find the next treatment for certain types of cancer, using stem cell research. The interviewer decried his attempts, asking how a physicist could solve a problem that was clearly a medical and a biotech one. He curtly replied that biologists and people who study medicine don't know numbers. Metastasis is a compounding problem, an uncontrollable geometric growth of malignant cells. The drug discovery process itself is a numbers game. He was spot on in his approach. OTOH, behavioral finance is more behavioral than economic models, and mere numbers. Market participants are human, not drones who predictably turn like electrons. I've had very long and interesting discussions with some of the brightest minds on and off Wall Street, and many of them think the number-crunchers are deluding themselves into thinking they can outsmart markets. And the road kill of some very smart people only confirms my suspicions. It's like a casino: the players keep playing as long as they win, but as soon as they lose, they get washed out for the next group of gold speculators to arrive. The key is to manage OPM, as the managers make money no matter what their performance is, and they last as long as they can get away with it (underperformance). The clients underperform the index averages 80% of the time. And the top 10% managers are so good that they can outlast their peers, and make a killing over their life times. I've reached a stage where my clients and I can't afford to take a hit like the tech bubble, and the recent subprime mortgage crisis. It's about capital preservation, efficient (i.e. low-cost) diversification, risk mitigation, asset optimization (all assets, not just investable liquid assets), and guaranteed floors (the last two are why I win). Lots of people can claim the first 3, but few can deliver the last 2.