O Goldman, What Art Thou?

The second chapter of my book, The 12 Investment Myths, is titled “Brokerage Firms Are Built on a Client Service Model.” (Remember, these are myths.) My intent in the chapter was to raise the reader’s awareness that, no matter how compelling the glitzy ad campaigns and glossy brochures may be, Wall Street’s big financial firms do not exist to serve you, the individual investor. They exist to move product, which they create through their investment banking activities.

Whether that product is good or bad is often beside the point because, brothers and sisters, the product has got to be moved. Otherwise it ends up on the wirehouse’s balance sheet instead of the end investor’s balance sheet, and we saw how well that worked out for Lehman and Bear and Merrill in 2008. Can’t have those toxic products on our own books, can we?

The dirty little secret that the wirehouses don’t want the investing public to ponder over is that they are really just massive trading machines that are beholden to no one but themselves. There isn’t anything wrong with this necessarily. The problem is that the wirehouses keep trying to pretend that they are actually in the business of servicing individual investors, helping them navigate through the financial wilderness and chart a path to a dreamy retirement in Shangri-La. (Or, at least, Sarasota.) They talk of planning and goals and managing risk and it all sounds so much like what a good investment advisor should say. But then you look at the part where they keep blowing up all those individual investors and getting fined billions of dollars for their egregious behavior, and it seems as though the talk is not being walked.

At bottom, this is what Goldman Sachs is really in the cross hairs for on Capitol Hill right now. The firm is being called to answer a fundamental question: What, exactly, are you? Are you an investment management firm with an obligation to do right by your clients? Or are you the mother of all trading shops with an obligation to do right by your shareholders?

Evan Newmark, a former investment banker with Goldman who now writes the “Mean Street” column for The Wall Street Journal, penned a very telling open letter to Goldman CEO Lloyd Blankfein in that space last week. Mr. Newmark lamented the demise of the old, white shoe Goldman culture he knew in the mid 1980s – before the firm went public and had to answer to profit-obsessed shareholders – and urged Blankfein to tell it straight up on Capitol Hill about what Goldman really is today:

“Goldman Sachs is a trading house, looking to multiply its capital as any trader would – and everyone knows it. To pretend otherwise, comes across as disingenuous and evasive…

…The truth is that most revenue on Wall Street comes from trading – it is 80% of yours. The truth is that you are a public company with public shareholders. And the truth is that as CEO and chairman of the board you have to put your shareholders interests first – even ahead of your clients.”

Ouch. “We put the interests of our shareholders ahead of our clients” wouldn’t sound too good as a tag line on those gauzy brochures would it?

Whatever your beliefs about whether Goldman is being justly or unjustly thrust into a negative spotlight, the truth is that Wall Street has no one to blame but itself. Historically, the wirehouses pandered to the greed in investors, but this time, in the housing bubble, they fell victim to the greed in themselves. They allowed the 30-year-old geniuses to begin running the asylum, using byzantine strategies no one understood with repercussions no one could anticipate, first using their clients’ money and then using their own.

When it all blew in the Summer of 2008, the facade blew with it. In many ways Goldman is on trial because it is the last one standing left to account for what happened. And the notion that it acted only in the best interests of its clients is as long gone as the days of the subprime mortgage.

Toyota: From Most Admired to Post-Admired in the Blink of An Eye…

A little over a year ago, Fortune Magazine published its Most Admired Companies of 2009 list. Among the criteria used to select these global giants was social responsibility, quality of management and quality of products/services.

Coming in at #3 on the list: Toyota Motor.

Ah, how fast the mighty fall. It’s hard to decide whose global brand has gone from unassailable to, um, relentlessly assailed faster in recent months – Tiger, Inc. or Toyota, Inc. Tough times for the T’s…

Since Toyota’s problems accelerated (c’mon, you know it works) over the past two months, its stock price has plunged along with its image. From mid-January to mid-February, Toyota’s stock price (blue in the chart below) plunged more than 20%, even as the S&P 500 (gold) trended downward only slightly:

Toyota’s stock price has rebounded in recent days, and it would be unwise to count out a company that has built a global reputation for quality and dependability that was unrivaled before its recent troubles. It seems plausible that Toyota’s senior management will respond to this crisis and right the ship in short order.

But for investors in Toyota, that may be little solace. Audi suffered a similar problem back in the 1980s with its vehicles seeming to zoom forward even when the brakes were applied. It was later determined that the cars weren’t the problem – the drivers were. Specifically, drivers who were depressing the accelerator when they believed they were depressing the brake pedal. It was a simple fix for the carmaker – it just moved the pedals farther apart and made them substantially different in size. But it was too late for Audi as a brand; its sales plunged more than 75% over the next decade, and it has only been in the past 10 years or so that Audi has cleansed its reputation with the car-buying public.

The sudden and unanticipated problems at Toyota are a great example of the dangers of security risk – the risk that something goes fundamentally wrong with a company that causes its stock to tank. Security risk is completely different from market risk, which is the risk all investors take on when they invest in the stock market.

All equity investorshave to live with a certain amount of market risk, as we all experienced first hand in late 2008 and early 2009. But security risk is easily avoided simply by being in a broadly diversified portfolio. If you have a well constructed portfolio with exposure to thousands of securities in dozens of market sectors, you don’t have to worry about what happens at Toyota as opposed to, say, Nissan. You own both companies and thousands more, and no one stock accounts for more than a fraction of a percent of your portfolio. Easy come, easy go.

On the other hand, an investor concentrated in Toyota – or any other stock – is taking on a tremendous amount of security risk. There are myriad examples of the dangers of security risk from the wreckage of 2008 to look at: Lehman and Bear, Fannie and Freddie, GM and GE, and on and on.

Most investors don’t set out to concentrate large chunks of their net worth in individual stocks. They acquire those positions in three principal ways: Inheritance, company stock in a retirement plan, or options received as executive compensation.

But however those blocks of stock are acquired, my experience is that investors are loathe to let go of them. Those concentrated stock positions seem to emit a mystical quality for those who hold them; way down deep, the stock holders know they should diversify, but they just can’t bring themselves to part with positions that have generated returns far in excess of the broad market for them over the years – especially if it involves paying capital gains taxes.

Until the day you wake up with the likes of a Delta or Enron or WorldCom in your portfolio, once venerable companies and now nothing more than a $50/share cost basis and zero value on their investors’ brokerage statements. Then the risk will seem far outsized to whatever gains you may previously have enjoyed.

It doesn’t have to be this way; diversification easily solves the dangers of security risk.

Pity that so many investors have to learn that lesson the hard way.

Back to the Future, Part I…

When I started this blog in April of last year, I did so with a singular purpose: To offer a counterpoint to the Tsunami of dread the media was ginning up for investors on a daily basis. I had grown very tired of turning on CNBC and being inundated with the latest crop of stories about how the End of the World was nigh upon us and everyone with any money at all should run screaming for the exits. So I set out to offer a different, which is to say calmer, perspective on investing in these turbulent times.

It is an ambitious kind of thing when you start a blog that has no readers and you are attempting to counter the Jim Cramer’s of the world, who reach millions of viewers every night. But righteous was my indignation, strong was my purpose, and cheap is it to start a blog. And so “The Tranquil Investor” was born.

As you will see in my prior entries, I am not a fan of market timing. But I must admit I did time one thing very well as it relates to this blog: I began offering my counterpoints to the doom-and-gloomers almost precisely when the market began its jaw-dropping turnaround after its low in mid March. In fact, since I started TI (my acronym for “Tranquil Investor” – all the cool blogs do it, you know), the S&P 500 has gained north of 40%.

Yes, there’s nothing like a 40% market gain to make you look like an investing genius. If I had any sense at all I’d turn this into a subscription-only site and charge people $300 a year for my “secrets to how I correctly called a 40% market gain in only nine months!!!”

But that, of course, would be wrong (and by “wrong” I mean “the way Wall Street does it.” Isn’t it funny how easily interchangeable that is?) The truth is I was telling my clients, friends and family not to lose faith and flee the market in October 2008, too, and I sure didn’t look like a genius for the next five months.

Anyway, by the time last November rolled around, I must admit I found myself a little stuck for material for TI. The market was up nearly every day, the media had lost its apocalyptic story line and was reduced to focusing on things like earnings (zzzzz), and the mood of investors was just so, well, tranquil that I wondered if maybe this blog had served its purpose of guiding folks through an epic market crash and it was time to put it to bed. No more windmills to tilt at, as it were…

In truth, of course, I knew those halcyon days wouldn’t last forever. And they didn’t: January rolled in and the market tide began rolling back out. Triple-digit market swings once again become more the norm than the exception, and in the past few weeks the Dow has dropped about 800 points from its 12-month high and then gained back nearly all of it.

With the return of volatility to the market, my material has returned as well. The very same pundits who told you to run for the hills a year ago are now staring at you from behind their anchor desks, earnestly wondering which sector of the market you should be in. (It makes me want to tap on the glass on my TV screen and say, “Hello? If I’d followed your advice I’d be sitting in cash earning 1% right now. Remember? What about the 50% gain I missed out on? Can we talk about that???”)

Still, in my hiatus from this forum since last fall, it occurs to me that there is so much more to talk about than just mustering up your courage to stay the course in tough market conditions. I don’t want to be a one-track Pollyanna, after all. And in the wake of the near collapse of the global financial system in 2008, the world is undeniably different now; as a result, there are a lot of interesting and important things to talk about in the financial world these days. Not to mention a lot of things that are just plain humorous. (Exhibit A: Merrill Lynch’s analysts recently upgraded Bank of America’s stock rating to a “Buy.” Meanwhile, BoA has made it clear it does not believe that Merrill was such a good buy. Oh the irony!)

So we’ll go forward from here secure in our belief that staying the course in a well-diversified portfolio is always the smartest move even in tumultuous times. And we’ll focus on some other interesting things along the way.

And, above all, we will continue to rattle Wall Street’s cage until they heave to and stop their insatiable thirst for turning the investing public’s dollars into tax-loss carryforwards.

(That last part may take awhile, fyi…)

Understanding What Your Mutual Fund Costs

(Editor’s Note: Following is a guest submission from Greg Retzloff, publisher of the well-regarded financial blog Workingman’s Dollar.)

By Greg Retzloff
www.workingmansdollar.com

Fund companies continue to post their total return figures in ads, carefully pulling together lists of funds that together compose what looks like a winning team. Morningstar ratings are often paraded along with these return figures as though Morningstar ratings have any real predictive power. Rarely mentioned in these stellar lists are sales fees, fund expenses, trading costs and taxes.

Professional investment advisors and informed individual investors know of the cumulative long-term effect of these costs on the real performance of mutual funds. But often both professional investment advisors and individual investors gladly ignore these costs as though they are just inconvenient reminders of the otherwise exceptional performance of the fund that they either currently own or want to buy.
 
Costs are important – very important! Even the best index funds from companies such as Vanguard and Dimensional Fund Advisors (DFA) have them, and actively managed funds will have added costs because of the expenses associated with active management and more frequent trading. 
 
It is unfortunate that investors are not provided with the cost-adjusted returns of funds in a single figure. These figures make a critical difference in the final investor returns. Neither the mutual fund industry nor the SEC require an actual “investor return” figure demonstrating the return an that investor would have received after all costs are deducted from total-return figures. So-called total-return figures do factor in management fees, but do not generally include trading or tax costs.

For example, the Dodge & Cox Stock fund (DODGX) posted a 10-year total annualized return of 5.51% according to Morningstar. This number factors in the expense ratio, but does not include the tax costs associated with the fund’s trading. The fund’s tax-adjusted return was just 4.04% for that period.

John Haslem wrote an interesting paper in 2006, “Assessing Mutual Fund Expenses and Transaction Costs.” In the paper he proposes an all-inclusive expense ratio that would include the following: regulatory expense ratio (management fees, 12b-1 fees, and other expenses), brokerage commissions, and implicit trading costs (generated by portfolio turnover). Together these would constitute a total expense ratio. This number would help an investor determine the true historical returns of a mutual fund. 

In the Meantime

The single total expense ratio suggested by Mr. Haslem doesn’t yet exist, but there is a good way to get a handle on the historical return of a mutual fund with a figure that does exist.   

The tax-adjusted return figure as provided by Morningstar is close to the actual total return figure we are looking for because it provides us with something resembling actual investor return over time. This figure indicates the total return of a fund less taxes and sales charges. You can find this number on Morninstar.com for a given fund based on three-, five- and ten-year time periods.

A fund that has been a consistent performer and kept costs and taxes low in the past is likely to be a good performer into the future. But, as always, past performance is no guarantee of future results.

It’s Caveat Emptor Time In The Market Again

There is a downside to all this recent upside in the market, I’m afraid: The performance pushers are crawling back out of the woodwork, armed with dazzling numbers and whispering of magic.

Despite the choppiness in the stock market over the past week, large cap stocks are still up more than 50% since the market bottom in March, and small stocks have gained north of 70%. That means a money manager who made some well-timed, risky bets earlier in the year could easily be sporting year-to-date investment performance approaching triple digits. Sales reps fairly fall all over themselves when they come across managers that have those kinds of gaudy gains, knowing they can attract droves of assets by just selling the numbers.

Recently, one of my clients forwarded me an email from a broker who was doing just that. He claimed to have found a new money manager who had generated huge returns this year by:

“…focusing on short-term returns from stocks in beaten down sectors by buying the top 8-10 stocks in the sector when a signal is given, then managing the risk by exiting the position in 4 days if not profitable but holding for as long as 5 days if profitable. The year-to-date return is 70%.” 

I love the part about holding for four days if not profitable and as long as five days if profitable. I guess the 24-hour interim is the manager’s idea of “The Long Term.”

I also couldn’t help but notice this “advisor” is a Certified Financial Planner. I wonder what his financial plans looks like for his clients if five days is the long side of his holding period? If you put that kind of trading activity into your financial planning software it would have about the same effect as putting a fork in a wall socket.

It’s been so long since we had a run of big gains in the market – second quarter ’09 was the first positive quarter in two years – that it’s easy to forget the tactics that the performance hawkers use when times are good. It’s always about the numbers, and it’s always a trap. Remember that these are the same folks who were shilling dot.com stocks a decade ago.

The bottom line is that it’s definitely caveat emptor time in the market again…

Beware the Faux Media

This summer I joined the cool crowd and purchased an iPhone. (My daughter Georgia says this doesn’t automatically gain me admittance to the cool crowd, but I guess it’s a start. It’s got to be cooler than my old bag phone.)

Anyway, the iPhone came with an app (FYI, this is what cool people say when they mean “application,” becoz we R busy and don’t have time for 4 syllables) that tracks the performance of the major stock indices. At the bottom of the screen are links to a variety of news stories related to the market and finance, and after a few weeks I began to notice a curious thing about the headlines I was seeing.

Most of the stories were links to generic, market-related articles from well-regarded news sources such as Reuters, Associated Press, etc.  But sandwiched in between, I kept seeing headlines scroll by that were both dire and sensationalistic:

Are We On The Verge of Another Black Monday?

Welcome to History’s Biggest Sucker Rally

Why the Dow Won’t Close Over 10,000

(Ha-ha on that last one, BTW.)

These links always went to obscure web sites that I didn’t recognize. Initially I assumed they were just opinion pieces written by news sites I wasn’t familiar with, and I didn’t pay any attention to them. But one day curiosity got the better of me and I followed the link to the story about how the market was about to take a 90% swan dive. And as soon as I started reading I felt like “History’s Biggest Sucker” myself, because three paragraphs into this “article” about how Armageddon was upon us there was the pitch:

“At my XYZ Fund Timing Newsletter we correctly called the 2008 market crash. Subscribe for just $149 a year and learn how to protect yourself from the even bigger crash to come!”

It wasn’t an article at all – it was an infomercial for a market-timing newsletter. It never ceases to amaze me that people fork over good money for these things, because of the gaping hole in the logic: If the guy knows what the market is going to do and knows how to profit from it, he should be able to make a couple billion dollars just by flipping stocks, right? So why does he need your measly $149?

I assume these are paid-placement links in the stock-market app, but I really don’t know. Maybe the people who compile the links are just gullible enough to think these web sites are legitimate news sources instead of charlatans in journalists clothing. Whatever the case, it was sandwiched right in there with all the legitimate market news of the day from the mainline media.

That is the problem for investors today: In the cyberworld the lines between real media and faux media are fuzzier than a Congressman’s expense report. At traditional media outlets you have editors who double as gatekeepers, but there are no editors on the Internet – only compilers, aggregators and advertisers.

Investors have never had access to more information than they do today, and they have never been more on their own to sleuth out the real news from the faux news. And that is a very precarious situation, because one of the great ironies of successful investing is that too much information is often a bad thing, because investors become overwhelmed and can’t sort out fact from fiction. Real articles from fake advertorials. So they fall victim to the one guy who claims he absolutely knows what to do and where to be. Alas, that is the absolute last guy you want to listen to.

And that’s the way it is in today’s world of mixed media. We miss you, Walter Cronkite.

The Fallacy of Extrapolation

The two-year period from 2007 to 2008 saw an epic drought seize the Southeast. Streams dried up, water usage in some areas was rationed (not restricted, mind you, but actually rationed) and crops turned to dust in the fields. It got so bad in these parts that at times you began to feel like you were living in a Steinbeck novel.

For residents of North Georgia, though, the most unsettling part of it all was watching our primary water source, Lake Lanier, dwindle day by day, literally going down the drain and evaporating into thin air simultaneously. During the worst of it, in December 2007, the lake’s level dropped 21 feet below full pool, and the Army Corps of Engineers estimated that Atlanta had a three-month supply of water remaining. People in other parts of the country began to tell me they were praying for me when they learned I was from Atlanta. I think when people you don’t know tell you they’re praying for you that’s a pretty good indicator your situation is dire.

Dire it was. The experts said that it would take years – perhaps a decade – to refill Lanier, and that was assuming we got a decent amount of rainfall. Some of the real doom-and-gloomers posited that the South was in a permanently drier climate now and doubted that Lanier would ever again reach full pool.

 “Lake” Lanier in late 2007

I mention this because, over the past week in Atlanta, we have received between 15 and 20 inches of rain, depending on where you live. It has been the kind of rain you would expect to run across in, say, the rainforests of Borneo, but not in Atlanta. The rains spawned an epic flood – perhaps greater than a 100-year flood – in a year that was already well above average in rainfall. Having already come up more than 12 feet this year, Lake Lanier has now come up another four feet in only a week. By the time all of the runoff from this week’s deluge makes its way into the basin, the lake will be almost full.

In less than a year.

Lake Lanier in September 2009

This is a great example of the fallacy of extrapolation; the tendency of layman and expert alike to take the recent past – the known – and project it into the unknown future as if events are already a foregone conclusion. We can see that we are in an epic drought, we can see the implications of that drought, and we project that into the future and see that it will be many years before the lake is back where it needs to be. What we can’t possibly see is that the weather patterns are going to change faster than anyone thought possible and fill the lake back up in months instead of years.

Extrapolating is an innate human tendency, something that tugs on all of our emotions as we try to get out ahead of events, whether to prepare for them, avoid them or profit from them. We look at things as they have been, and as they are, and we convince ourselves that that is how they will be, too. And yet, more often than not, our foregone conclusions are really false assumptions.

The tendency is pervasive in nearly all human endeavors, none more so than investing. (As an aside, that was 558 words before I got the investment angle in – a new Tranquil Investor record!) I have had thousands of meetings with investors over the years, and in nearly all those meetings I have found folks have a powerful tendency to extrapolate the present into the future, and a keen desire to make investment decisions accordingly.

In the past two decades, I have heard that Japan is the only logical place to invest. I have heard that Blue Chips are going to rule the day forever. I have heard that we are in a New Era and earnings don’t matter. I have heard that bank stocks are “safe.” I have heard that the market is broken and we need to get out before we lose what money we have left. I have heard all these assertions and many more, and they all proved to be wrong.

Presently the extrapolation that I am hearing at every turn is that gold is the only logical place to be because the government is printing money left and right, and it is a foregone conclusion that hyper-inflation is not only likely, but actually inevitable.

I am here to tell you, folks, that there is no such thing as inevitable when it comes to investing. An event observed is an event altered. When millions of people begin making investment decisions based on an assumption such as, “We are going to have high inflation in the future,” their very actions begin to alter the event. If, say, a few hundred million people run to gold in anticipation of high inflation, wouldn’t you think that might impact the price, and thus the future expected return, of gold? And simultaneously create value in the very areas of the market that are being shunned?

You can provide me all the foregone conclusions you want, with all your supporting documentation, and you will not convince me that your scenario is inevitable. You may convince me that such a scenario is possible. Maybe even probable. But never inevitable.

And that is an important distinction, because “possible” and “probable” are hardly compelling enough words to bet one’s life savings on. If you need proof, just find someone who bet last year that $200 a barrel oil was “inevitable.”

They can testify for you…

Things are calmer. Now what?

“I’ll just wait until things calm down, then I’ll get back in the market.”

This was the refrain I heard from one investor after another from September ’08 through March ’09. Some folks who said this to me had already bailed out of the market. Others were contemplating it. And in all cases, it was based on the following assertion:

It is clearly so different this time – so much worse, so much more dire – that any fool with eyeballs can see it. And it would be complete insanity to stick around in a stock market that is clearly just, well, broken, when I can save what money I’ve got left and hide out in my money-market fund until there is some evidence that the ship has been righted.

Truly, it all seemed so logical in the emotion of the moment, when the best thing about weekends was that the stock market wasn’t open.

So today, brothers and sisters, it is my great joy to bring you good news! Almost one year to the day after the collapse of Lehman Brothers…

THINGS HAVE OFFICIALLY CALMED DOWN!

I do not base this on mere opinion. In fact, the news today was a veritable cornucopia of items that make the case, to wit:

• The widely followed Empire State Manufacturing Survey’s business conditions index came in at 18.88 in September, the highest level since late 2007, from 12.08 in August. That’s up from a low of -38.23 in March.

• Fed Chairman Ben Bernanke essentially declared the recession over in a Washington Speech.

• The Libor-OIS Spread, a gauge most experts think is the best indicator of credit-market health, returned today to 0.11, its five-year average from the period before Lehman collapsed. (For comparison’s sake, it peaked last October at 3.52)

• The CBOE VIX index of market volatility fell to 23, a level last seen before the failure of Lehman. (For comparison, it peaked at 82 last October, a level best described as “widespread panic.”)

So I think we can all agree that things look a lot better today than the dire straits that drove millions of investors from the market from September through March.

Now, though, for those who bailed out of the market, I am afraid I must also be the bearer of some bad news:

While you were waiting for things to calm down, the Dow Jones Industrial Average gained, from its March 9 low through September 14, let’s see, um…

Fifty percent.

 

Hold on, it gets worse: The Russell 2000 Index of small U.S. stocks gained…

Seventy-six percent.

 

It’s not like this took years to unfold. It took, in fact, a mere six months. Six measly months to recover what would ordinarily be a half-decade’s worth of returns. Six skinny months from what conventional wisdom told us was the brink of financial Armageddon to, “Eh, not so bad…”

Thus, while things are calmer, they sure aren’t any clearer for those who bailed out of the market and are wringing their hands trying to figure out when to get back in. In fact, for those on the sidelines, things today are a lot less clear than they were back in March.

So…what to do? If you are one of those folks who is stuck in the mud trying to decide when to get back in the market, my advice is to quit focusing on the market and start focusing on yourself. Don’t worry about where the market is today compared to where it was when you got out and where you are afraid it might be in another six months. That is the mindset that got you into this mess in the first place, and your paralysis will only increase with each passing day no matter what the market does.

Focus, instead, on what your goals are – your long-term investment objectives – and where you stand today in relation to those goals. Perhaps you find that you really don’t need as much growth to sustain you in your golden years as you once thought, in which case you needn’t plunge all of your money into the stock market anyway.

On the other hand, if you still need a healthy dose of stock exposure to achieve your goals, then…plunge away. You may be wrong in your timing – you may well get back in just in time for another downturn – but in the long run you will have removed the single biggest impediment you have to successful investing (your own emotions) and will be back in the market knowing that, sooner or later, you’ll be glad you got back in.

(And you will stay in this time…right?)

DSL vs. Fiber Optic: A Lesson In Creative Destruction

A few days ago I learned that the phone company is now offering fiber optic Internet service into my neighborhood, something that will increase the download speed at my house more than tenfold over our current DSL service. I signed up without a second thought, and then called my DSL carrier to break the news that I was leaving.

“But sir,” said my phone rep, “Greg,” in his lilting Indian accent, “you have been with us for 10 years!” He sounded like I was breaking up with him.

“I know, ‘Greg’, but whattayagonnado?” I said, doing my best Tony Soprano impression. “Something better has come along.” 

“Well what can we do to keep you?” he asked, moving to step #2 in his “What To Do If A Customer Tries To Cancel” procedure checklist.

“Increase my download speed to 18mb a second like I’m going to get from the fiber optic line,” I told him, knowing he had about as much ability to do that as my dog does to meow.

“Well, we can’t do that, but we can increase it from 1.5mb to 3mb a second!” he said, as though coming in at 1/6 the connection speed of fiber optic was going to be a lot more compelling than 1/12.

“Sorry, ‘Greg’,” I said. “I’m cancelling.”

“But sir, you’ve been with us for 10 years!” he said again. “We value our relationship with you and want you to stay!”

I thought back on my deep relationship with my DSL carrier over the years. I couldn’t seem to recall any golf outings, or steakhouse lunches, or gambling trips to Vegas. Heck, I couldn’t even see the thing I was paying them for. The only thing I had ever gotten from them was a monthly bill and an invisible portal to the World Wide Web.

After “Greg” tried the remaining nine steps on his checklist to no avail he finally gave up and put me through to the cancellation department. When I got off the phone I couldn’t help but think of the experience as a lesson in “Creative Destruction” – the notion that companies are at their most vulnerable right when they seem to be at the pinnacle of success. Once a company becomes a world dominator, goes the theory, they lose their edge and appetite for risk – the very things that made them successful in the first place. Inertia sets in, and then new technologies come along that suddenly render them obsolete or irrelevant.

That is certainly the case with my old DSL carrier. When I first signed up with them a decade ago DSL was the hottest thing around – a blazing gateway that blew my old dial-up connection out of the water. The company was one of the darling stocks of the New Economy, poised, it seemed, to dominate the new virtual landscape forever. Now, a scant decade later, their stock price has been sliced by eighty percent and they stand helpless as a new technology is steamrolling over them, unable to offer anything even remotely competitive. They are learning that, when what you offer is a commoditized service, there is no such thing as customer loyalty – only customer inertia.

What’s happening to my DSL carrier is a story as old as capitalism, and it is happening with blinding speed in today’s technology-driven world. That’s why investors today can’t afford to bet their money on the fate of just a few individual stocks, as investors thirty years ago routinely did. No matter what the analysts want us to believe, there is simply no telling who the winners and losers are going to be in any industry in the long term, as investors in such formerly venerable companies as Enron, AIG and Wachovia have found out firsthand. In fact, if you buy into the notion of Creative Destruction, then piling into what conventional wisdom tells us are today’s hottest stocks may well lead us right to tomorrow’s losers.

There is an easy way around this. When you create a broadly diversified portfolio, you are buying, in effect, the global capital markets. You are buying the whole shooting match, and you can sit back and let the phone company and the cable company and the DSL provider slug it out over the years without having to worry about who the winner is going to be, because you own them all, and thousands of other companies in hundreds of other industries to boot. You can let Creative Destruction run its course and not have to worry that, one day, you’ll end up with all your money riding on a company that is stuck with a technology that is heading the way of the VCR.

 Sorry, “Greg.”

A Tale of Two Road Signs

 Last week I was driving through the mountains of North Georgia when I passed an aging, hand-painted sign along the road in front of a farm.

“Land values in this area are increasing 20% annually!” said the sign, which then provided a phone number to call for information on how get in on this golden opportunity.

About two miles later I passed another farm with another sign – this one larger, fresher and professionally lettered.

“Farm for sale: 57 acres,” said the sign. “Reduced 50% from original asking price.”

I couldn’t help but laugh at the irony. The story of an epic asset bubble, told in a couple of farm signs two miles apart.

Bubbles are like that, aren’t they? Always so obvious, but only in retrospect.

Every third piece of mail I received in 2006 was a pre-approved credit card or checks for a home equity line I never asked for. I applied for a mortgage in 2007 and when I tried to provide income verification the mortgage broker told me he didn’t need it because it would just “gum up” the underwriting process.

I look back on those days and shake my head, amazed and appalled at the way so many different entities and institutions conspired to create a massive real estate bubble that took the whole economy – and very nearly the whole financial system – with it when it popped. But I only see it now. I didn’t see it then, in real time.

We think we know, but we don’t. In fact, what we think we know is often dead wrong. A year ago oil prices were sitting at almost $150 a barrel, and commodities from wheat to copper to grain were soaring in price. A commodities fund seemed like a no-brainer. And then, out of nowhere, commodities prices suddenly plunged, a harbinger of things to come in the economy.

We think we know, but we don’t.

It is an innate part of human nature that we are massively influenced by the current environment we are in, and by the mass media that reports it to us all day, every day. This is why a disciplined investment strategy is a must – one that is based on long-term fundamentals, and is never, ever altered based on short-term market conditions. That is the one, sure way to navigate through the manic/panic dynamic that is inherent to all bubble events.

It’s how we avoid getting caught up in the group think that plagues investors in every day and age.

It’s how we avoid having to hold a half-off sale for our farm that was increasing in value at a 20% yearly clip when we bought it.