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Financial and Real Assets
By William Parmenter, editor
Roger Shaar, M.S., spoke on Combining Financial and Real Assets to Achieve Superior Diversification and Profits at the July 17, AAII Los Angeles chapter meeting at the Skirball Cultural Center.
Shaar is a past president and program chair of AAII, Los Angeles, with over 15 years of service on the board of directors of the chapter. He has been investing in both the traditional stock market and income properties in Los Angeles for more than 40 years. He retired from Lockheed Martin after a 30-year career in both engineering and marketing.
In his talk, Shaar discussed how investing in real assets diversifies your traditional portfolio, and how asset diversification lowers volatility and uncertainty. He pointed out that real assets can zig when the stock market zags.
He began by reviewing vocabulary that is common with investing in financial assets, such as stocks and bonds. Investors need to understand such terms as: portfolio, portfolio risk, earnings, P/E ratio, cycles of all kinds, and asset allocation. Other terms include: diversification, stocks, bonds, cash, time horizon, risk aversion, various indexes (such as DJIA, S&P 500 and Nasdaq), foreign and domestic investments, recession, bull and bear markets.
Then, Shaar reviewed vocabulary associated with real assets, such as real estate. Investors need to understand terms such as: bank loans, interest rates, ROI, ROE, leverage, refinancing, debt to equity and down payment. Other terms include: loan terms and conditions, balance sheet, appreciation, depreciation, amortization, cap rate, taxes and tax shelters.
The virtuous cycle of the American dream occurs, Shaar said, when depositors earn 3 to 4 percent interest, banks charge 6 to 9 percent interest on loans, investors earn 15 to 20 percent on returns on their investments, governments obtain sufficient taxes to cover their expenditures, and the general public enjoys free and competitive markets.
The American nightmare occurs when a cash-strapped public finances its expenses with Visa, Amex and Mastercard credit cards paying fees, and interest charges ranging from 10 to 25 percent.
Changes in the American scene have been substantial in the last 42 years, between 1967 and 2009. During that time, the annualized inflation rate has been 4.53 percent.
Between 1967 and 2010:
ü Population has increased from 200 million to 307 million.
ü Nominal GDP in billions has gone from $832 to $14,250.
ü The nominal GDP ratio has gone from one to 17.13.
Table of ContentsFinancial and Real Assets……Roger Shaar……..……p.1
Animal Spirits…….Akerlof and Shiller………………p.3
Investing in Physical Gold……Scott Mickelson…..….p.4
Investor Education…………Dr. Don Gimpel...………p.6
ü The real GDP ratio has gone from one to 2.66
ü The nominal per capita income has gone from $4,188 to $46,371.
ü The nominal per capita income ratio has gone from one to 11.07
ü The real per capita income ratio has gone from one to 1.73.
Return on real investments (or business), which is ROI or ROE, consists of: 1) investment income (cap rate equals NOI/Price or /market value. NOI is net operating income. 2) financing (C.R. minus interest rate) (Debt/equity), leverage equals D/E, 3) appreciation (appreciation rate) (1 + debt/equity) Leverage equals D/E, 4) taxation
Taxation considerations include the following, but may not apply in all cases (see your CPA):
· Capital gains: may be deferred if 1031 exchanges are used.
· Interest on loans: is usually a deductible expense.
· Depreciation: is deductible, but lowers the basis and affects capital gain upon sale.
· Capital improvements: may be depreciated per schedule.
· Refinancing: generally is not a taxable event.
The ultimate tax loophole occurs upon death and could provide tax savings.
Shaar presented both in chart form and graph form information on return on real investments (before taxes). The conditions involved variously: zero, 50, 67, 75 and 80 percent debt to equity. Under each of those conditions the cap rate was 10 percent.
The finance percentages (additional income) were respectively 0, 3, 6, 9 and 12 percent.
The appreciation percentages were respectively: 3, 6, 9, 12 and 15 percent.
The above figures cumulated in a return on investment respectively of: 13, 19, 25, 31, and 37 percent. (To view the graph and chart, go the Chapter website www.aaiilosangeles.org. then on the left side of the blue panel click on Presenter’s Slides, then click on the title of Shaar’s presentation: “Combining Financial and Real Assets to Achieve Superior Diversification and Profits” and scroll down to slide 7 .)
The question of the household balance sheet versus portfolio risk was addressed. Whatever the household circumstances, there needs to be an assured household income.
Investments and savings can be divided into risk-free assets and risky assets.
Risk-free assets are those of reward, but no risk, and include: tier one and two cash, cash equivalents, and quasi-liquid assets, with the watchword being liquidity.
Los Angeles County Meeting ScheduleWestside Computer Group – Don Gimpel, 310/276-9875 . Veterans of Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City, Ultra FS User Group at 9 a.m.; then., Twenty Great Internet Investing Sites, at 10:30 a.m. both on Saturday, Aug. 7.
Pasadena Group – Meets at 7 p.m., at Pasadena Main Library, in the David Wright Auditorium, at 285 E. Walnut St., Pasadena. (Meets third Tues. of the month, except for August and December.) Contact, Ivan Wong at (626) 446-2486, .
Mutual Fund Group – Gunter Hagen 310/457-7404, . Topic and date TBA, at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. The meeting is free to the public
Stock Selection Group—Norm Langhout, 310/391-6430, . Fourth Wednesday of the month at 7 p.m. Using IBD, CANSLIM stock selection method at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. Topic TBA
Los Angeles Chapter Skirball Center at 9 a.m, Sat. Sept. 11, 2010, Jim Goldberg, President Goldberg Economic Advisors “How will the Gee Forces – Greece, Goldman Sachs, Gulf Oil Spill, Gov’t and Growth affect returns on stocks and bonds”; and Gil Morales and Chris Kachar, Managing Directors, Moka Investors LLC on “New Ideas in the O’Neil Methodologies – The Pocket Pivot Buy Point”..
Desert (Palm Springs area) Group Usually meets from 10 a.m. to noon, second Saturday of the month at Sunset View Club House, Sun City, Palm Desert. For more information, contact Patricia Gammino, .
Option Special Interest Group, meets Saturday, 9 a.m. to noon at Westside Pavilion, Community Room A, 10800 W. Pico Blvd. (corner of Westwood Blvd.) Time and topic TBA by leader Robert Morgan, .
Risky assets include: financial assets, real assets, other assets, and the watchword is diversification.
Shaar’s last topic was to enumerate the factors that could trigger a double-dip recession. (See the article in the U.S. News and World Report of July 1, 2010). These factors included: unemployment, housing, expiration of the stimulus, spending cuts, tax hikes, sagging consumer confidence, depressed consumer spending and the European debt crisis. Intensification of these factors could lead to a second dip recession.
In the question and answer period, Shaar cited a book by George A. Akerlof and Robert J. Shiller, Animal Spirts (2009, 264 pp.) that describes how emotion drives world-wide financial events. Investing is not scientific, because it is too much based on emotion. (See the following article for a book review.)
Shaar recommended getting rich slowly, as one does with real estate investments, and that way the investor avoids too much risk.
Currently it is not the best of times to get into the apartment house market. The investor has to be careful. Especially avoid neighborhoods where tenants are losing their jobs.
Animal Spirts
By William Parmenter, editor
Animal Spirits is the title of a 2009 book that emphasizes the role of emotion in investing and the financial world. It was recommended by Roger Shaar during his presentation at the July 17 AAII meeting at the Skirball Cultural Center.
The book cite is: George A. Akerlof and Robert J. Shiller, Animal Spirits, How Human Psychology Drives the Economy, and Why It Matters to Global Capitalism (N.J.: Princeton University Press, 2009), 264 pp., $24.95 cloth.
The global financial crisis has made it clear that powerful emotional forces are threatening national wealth. Emotions (animal spirits, of the title) drove ever-rising housing prices and falling confidence in capital markets. In this book, two noted economics professors challenge the wisdom that got the economy into a mess, and put forward their plan to restore prosperity and to transform economics.
Shiller and Akerlof assert the necessity of an active government role in economic policymaking by recovering the idea of animal spirits (a term John Maynard Keynes used to describe the gloom that led to the Great Depression).
Akerlof and Shiller contend that managing animal spirits requires the intervention of government, as simply allowing the market to act will not restore prosperity. They build a case for a more vigorous, behaviorally informed Keynesianism.
The authors detail the effects of animal spirts in contemporary economic life, for example on: confidence, fear, bad faith, fairness and corruption. They also discuss the stories people tell themselves about their economic fortunes. They show how Reaganomics, Thatcherism and the rational expectations revolution do not speak to the current economic malaise.
The book offers a road map for reversing the financial misfortunes afflicting the U.S. today. They prescribe that leaders channel animal spirits to transform economics and restore prosperity.
Louis Uchitelle called the book a milestone that took its case to both economists and the general reader, in the New York Times Book Review.
George A. Akerlof, an economics professor at University of California, Berkeley, was awarded the 2001 Nobel Prize in economics. Robert J. Shiller is an economics professor at Yale University.
Another book by Akerlof is Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being.
Other books by Shiller include: Irrational Exuberance; The New Financial Order: Risk in the 21st Century; The Squam Lake Report: Fixing the Financial System; and The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It.
Using Physical Gold to Manage Risk
By William Parmenter, editor
Scott Mickelson spoke on Using Physical Gold to Manage Risk at the July 17 meeting of AAII Los Angeles Chapter at the Skirball Cultural Center.
Mickelson, a senior consultant at American Bullion, Inc., is an expert on gold and how to invest in gold. He is a graduate in finance from Iowa State University.
He told the audience why they should invest in gold as a hedge against inflation, and explained how to invest in physical gold.
The dollar is in deep trouble. We have already seen collapses in the housing and stock markets. Later on, we will see collapses in the dollar and in debt.
Every time there is an over-evaluation it is followed by a collapse.
To make his point, to an audience already riveted by his challenging assertions, Mickelson gave some examples of national debt collapses: Mexico in 1982; South Africa in 1985; Asian tigers at the end of the 1990s, Russia in 1998, and the hyperinflation in Zimbabwe. He showed a picture of a 100 trillion note from Zimbabwe.
(Editor’s note: when I was in Zimbabwe in 2009, the billion and trillion dollar notes were being hawked by vendors to tourists as Zimbabwe had shifted off its national currency and onto the South African Rand. That had stabilized the economy and brought the price level down somewhat.)
Prime candidates for a currency collapse today are Greece, Spain and about one half of the European Union, said Mickelson.
The United States is a prime candidate for a currency collapse. The question is, will the collapse be a fizzle or a pop? After the housing collapse there was capital flight. Long term interest rates will be pushed up to double digits.
Venezuela provides an example of a currency collapsing via a fizzle. Compared to an ounce of gold, Venezuela’s money sold for 240 in 2001; for 1,200 in 2005; and for 3,500 in 2009. Over a nine-year period the currency declined to 14.6 percent of its previous value.
An example of a currency collapse with a pop was provided by Argentina in January, 2002. Compared to an ounce of gold, the Argentine peso went from 240 to one, to 620 to one within two week.
The case of Brazil is instructive. People thought their currency could never collapse. Surprise. Brazil put a moratorium on debt payments. That was followed by capital flight. Then the currency was devalued. The stock market at the end of 1989 dropped 90 percent. Anyone who jumped ship preserved their capital.
In 1998 when the Russian currency collapsed, the stock market lost 75 percent of its value. Pensions were eroded to a fraction of their value, and retirees had to move in with their children.
Germany’s Weimar Republic in the 1920s was another example of hyperinflation. Saddled with war debt reparations that the government could not meet, the mark went from around $1 to four marks in 1916, to $1 to 50 million marks in 1923.
Gold fluctuated in value, but was more stable than the currency. People who owned currency got wiped out, but people who owned real assets preserved their assets.
A big problem in the United States is unfunded liability, including Social Security, Medicare, Medicaid, military pensions and civil service pensions. Altogether it comes up to around $107 trillion.
Debt as a percentage of GNP has fluctuated but currently is high. In 1946 it was 121.7 percent; it fell to 32.5 percent in 1981, and in 2011 is expected to be 99 percent.
The easiest thing for the Fed to do is to inflate the dollar, by printing money. The dollar that was worth a dollar in 1925 inflated such that it was worth seven cents in 2000. Between 1971 and 2009 the dollar lost 81 percent of its value, with an annual rate of inflation of 4.43 percent.
Money is now staying on the sidelines, as people are afraid to spend, so they are saving. The problem is, it is bad to hold dollars. It is not a source of wealth. The U.S. is deep in debt. If you hold a currency that is deep in debt, the currency is not backed by real assets.
If you want to buy gold, what kind should you own? Mickelson recommends holding gold that you have a legal claim to. You need to have the legal ownership of the metal, and documentation that you hold the gold in an account.