Opportunity Arriving Daily

Sir John Templeton, Jonathan Smith, and William H. Barnhardt
Douglas Airport, Charlotte, NC sometime in August 1987
Photographer: J. David Barnhardt

During the 1980’s, I had the unalloyed privilege of managing some money for the late Sir John Templeton. Every now and again, I pause to consider that one of the world’s wisest investors mentored me, with his money and on his dime, and I am profoundly grateful.

His wisdom was vast, his insights were unconventional, and his generosity knew no bounds. Sir John was always a learner and never a knower. Learners keep flexible and open-minded; knowers are brittle. When naysayers challenged his view that life continually offered wonderful opportunities, he countered that opportunities were not all gone, what was missing was preparation. Wisdom like this takes years to sink in. Some do not ever get it.

This summer, a Chattanooga friend who knows Lauren Templeton, the founder of the investment firm bearing her name, told her that years ago I managed some money for Sir John. Lauren is the wife of Scott Phillips, a principal and portfolio manager at Lauren Templeton Capital Management, LLC and the great-niece of Sir John Templeton. We three connected and talked for over an hour, a joy that reminded me of many conversations with John Templeton himself. This week, I shared my recollection of Sir John’s views on opportunity and preparation with Scott. He reminded me that Sir John once said that the very reason he went to the trouble to save half of his income was so he would have the necessary funds ready to take advantage of future opportunities, since opportunities often appear when least expected. This Scott knows, as is evidenced throughout his latest book, Buying at the Point of Maximum Pessimism, Six Value Trends From China to Oil to Agriculture.

At Jonathan Smith & Co., Investment Counsel, we recognize volatility in financial markets is high and is likely to remain high. Our experience is that volatility can be unbearably unsettling to investors, leading them to sell good companies for wrong reasons. Volatility can also paralyze investors, preventing them from taking steps that historically, over the long haul, have been in their best interests: buying quality investments whose margins of safety are high. Investors are not the only ones who must manage volatility successfully if they want to survive; read how hard pilots have it when their outlooks are horribly pessimistic:

"There's an exercise that some pilots go through late in their flight training. The student pilot gets the plane airborne, at cruising altitude. Then the instructor places a loose-fitting, thick-woven sack over the student's head, so the student can see nothing. The instructor takes the controls and starts stunt-piloting. He loops the loop. He pushes the plane, Turkish-headache-style, skyward, then flips belly-up and swoops earthward. He rollicks and spirals, careens and nosedives, tailspins and wing-tilts. He gets the student utter discombobulated. Then he puts the plane in a suicide dive, plucks the bag off the student's head, and hands him the controls. His job: to get the plane back under control." (Mark Buchanan, The Rest of God, Restoring your Soul by Restoring Sabbath, page 37)

Getting investors’ “financial planes” back under control is the JSCO Way, yet so many investors are still utterly discombobulated, their planes in suicide dives. If the instructor has plucked the bag off your head, handed you the controls, and if it feels like you are approaching earth at 17,333 feet per second, give us a call, we can put your nosedive on hold for as long as it takes to have a conversation about getting your financial plane back under control.  And if you do not want to, we will hand you back the controls while our parachutes still have time to open. 

Looking at Investing Through the Eyes of a Landlord

It seemed like a really great idea at first. And it actually was, but somewhere along the way, it turned bad, really bad. I’m not quite sure when, but it was either before or after a tenant started breeding Pit Bulls in the back bedroom . . . well, now that I say that, it was probably before. The story starts a good six years before the Pit Bulls. I was just finishing my freshman year in college. Four friends and I were looking for an apartment that would rent to five college kids, but no one would go above four (that should have been my first hint). So I hatched an idea and floated it past Jonathan (side note: I quit referring to him as “Dad” after my first day of work here). I proposed that we use my first-time homebuyer status to get a cheap loan, then buy a four bedroom condo, cover our mortgage with the rent from my four roommates, and on graduation day we’d easily sell it and voila, three years of rent free living. I was, as we say, very bullish.

It worked well for the first three years. In addition to the rent working out as planned, I happened to meet my wife, Millie, who was living in the building next door (I later learned she had made the same proposal to her Mom and they owned her condo also – the serendipity!) Three years later, my roommates became my groomsmen when Millie and I married a month after graduation and, even though we couldn’t sell the condo right away, we found some decent tenants to tide us over for “just a few months.”

That first batch of tenants sent their checks in on time and didn’t scuff up the walls too badly. But as we continued to rent it out while looking for a buyer, we discovered each group of tenants brought new troubles. Our costs went up: carpets had to be cleaned after each tenant, washers broke, and rooms were painted black. And our emotional expense went up as well: lost sleep over dealing with missed rents and worry over our exit price. All the while our potential liabilities piled up: the smoke detectors went unattended, the 3rd floor porch railing was removed for an impromptu golf driving range, and of course the aforementioned Pit Bull husbandry. Thankfully, the world is full of enterprising young men with four friends who want to live together – we were lucky enough to sell our place to one such “investor” well before the housing market collapsed.

What we learned from the Doctor

Justin here. I read a great article in the WSJ this morning (here) about a movement to get more doctors to give their notes to their patients.

We have a client couple where the wife has battled through a fight with breast cancer. The husband said one of the best things about their doctor was that he would photocopy his notes after they talked and give them a copy before they left the doctor's office.  He said the transparency meant a lot to him and his wife.

We've always given some sort of recap after meetings, but it usually only involves the action points coming out ("Jim and Jane need to revisit wills.") but we didn't always send our clients the full meeting notes ("Jim and Jane need to revisit will because Jane is nervous about Jim providing too much money to his grown kids from his previous marriage.")

So, after our client told us how important it was to them in their cancer fight, we started being more intentional. While we don't copy our handwritten notes (they wouldn't be much help) we've started sending clients full recaps of the meetings. Sure, it takes some time, but we find that it adds some accountability (for us and the clients) and, like with our clients and their doctor, improves transparency. We see it as standard operating procedure.

Unintended Consequences in Aid to Haitian Woman

In February, NPR played a story about woman in Haiti, Yvrose Jean Baptiste, who basically loses her business in the earthquake. She desn’t know how she’ll go on, owes the bank $100 while selling chicken necks at the market for pennies. Then in a genuine act of kindness and humanity, NPR listeners flood her bank account with money . . . $3,860 (more than a few years’ wages).

Today, they followed up with her. She withdrew the money, put her four kids in school, bought a stand at the market and inventory. It dramatically changes her life for the better - you nearly expect Hollywood to start buying the movie rights . . . until her husband leaves her. He doesn’t know how to handle the shift in power in the marriage. Today she says she's happy but she doesn’t sleep well at night (still under a tent) fearing she will be robbed because she doesn’t have a husband to protect her.

Three lessons:

• We all have the ability to radically change someone's life through mere generosity, but
• Bailouts rarely work like we expect them to and
• Money rarely solves problems we’ve yet to encounter.

Full story here: http://www.npr.org/blogs/money/2010/07/01/128245622/yvrose

Today's headlines are rarely the same as what history's judgement is going to be

Photo courtesy FaceBook

Jonathan here: Went to Stamey's for a late lunch, all by myself. I was really looking forward to three four things: a world class hot dog all the way (that's mustard, chili, onions, and Cole slaw for you northerners), an honest-to-goodness chopped BBQ sandwich, and a tall glass of sweet iced tea (otherwise known as the wine of the South).

To tell the truth, I was looking forward to spending some unhurried alone time with my brand new 2010 US Andex chart.

Image copyright Andex/Morningstar

I love charts. I can spend an hour with a good chart and come away with having had as much enjoyment (and learning as much) as reading a well-written book (for my current new favorite, shown right).

The Andex chart shows what would have happened to $1, had it been invested way back in 1926, in a bunch of different indexes representative of tangible investments (US Small Stocks, S&P500 Total Return Index, Balanced Portfolio, World Stock Markets ex US Total Return Index, Long-Term Government Bonds, 5-Year Fixed-Term Investments, 30-Day Treasury Bills, and that darned old dog, Inflation, sorry Enzo).

As if that wasn't enough, the chart also shows: median PE ratio, minimum wage, the price of a first class stamp, gold, the price of oil, prime interest rate, and inflation. That's not all: dotting the nearly 85 years of time were hundreds of events, panics, assassinations, wars, crises, bombings, collapses, deficits, unemployment, Watergate burglars, hostages, bailouts, bankruptcies, market closings. It shows the day the first international mutual fund was introduced in the US and the day John Glenn orbited the earth.

All of the above is not the half of it, you need to get a copy of the chart for yourself or drop by our office and spend an hour or two with it.  In the words of Jack Bauer, I promise you, it will lower your blood pressure and your heartbeat; two numbers that I imagine have been higher than they really ought to be. Why, because it gives you a 30,000 foot view of things and lets you know that today’s headlines are rarely the same as what history’s judgment is going to be.

It was after 2:30 when I gathered up my belongings (today's News-Record, my PDA, and my new friend the Andex Chart, when I noticed several waitresses and busboys and one cashier, who apparently had just spend the last half hour or so gawking at some guy in a Seersucker suit, eating a hot-dog and a BBQ sandwich and pouring over a chart with as many squiggly lines (and as big) as a road map. The cashier became their spokesman, she took a step toward me and peered at the chart: "I saw the market was up 175 points this morning, what it is gonna do?" "By when," I said pleasantly and sincerely, hoping to draw her out. "Oh, I don't know, I guess by when I retire," she admitted, seeing I was for real. "We have a 401(k) plan, you know."

Judging she had at least 15 more good working years on her side, I said, "Keep your head down, your heart up, and take advantage of buying more shares month in and month out." "Thanks, she said, that's just what I thought I'd do." She added, "And that's just what our guy says to do, too. You know he comes to see us when the market us up and he comes to see us when the market is down, and he always tells us the same thing. I don't know how people without an advisor do it."

"I don't either," I replied, "Put an extra scoop of ice-cream on his peach cobbler next time he comes in. And thank him for telling the truth.”

If all this volatility has you down, drop us a line, give us a call, or come by and see us.  We'll talk about risk and return and how we're guiding investors through this mess, how to turn this crisis to your advantage.  It never hurts to have a second set of eyes, especially in this environment. 

And then we can go to Stamey's and enjoy a hot dog and a BBQ sandwich and a sweet iced tea.

You Think You're Paying Too Much In Taxes?

Justin here. For all its quirks, it's hard to find a better (and cheaper) place to easily track what you spend that at www.mint.com. On top of that, the Mint blog does an equally great job at relaying financial concepts in easy to understand methods; today's post doesn't disappoint.

Note that the y-axis numbers are misaligned with the chart for some reason, but the meat of the chart is still right (for those of you who don't remember, the "y" axis is the vertical axis, also known as the "yo-yo" axis because it goes up and down . . . how about that?)


Personal Finance Sofware Mint.com

Congress Waivering on Fiduciary Issue

Justin here. An article last week from WSJ's Jason Zweig highlights what fiduciary duty means to Joe Investor. The element of how congressmen play into the reform is interesting. After seeing how Senator Colburn trades his account, it seems a lot like letting my two year-old decide her bedtime . . . or if she has to hold my hand when she crosses the street (depending on how important you think fiduciary duty is.) Full article here.

In a recent interview with the Journal's Brody Mullins, Sen. Tom Coburn (R., Okla.) said that most of his money is managed by a professional adviser. The senator explained that his portfolio is heavy on oil and natural-gas stocks because energy is big business in his home state of Oklahoma.

Sen. Coburn added that he has his own account at TDAmeritrade, valued at about $70,000. He said he trades actively based on tips he gleans from Jim Cramer's "Mad Money" show on CNBC.

In 2008, Sen. Coburn traded Transocean four times in less than a month on Mr. Cramer's advice. "I lost my shirt," the senator said. He fared better with Tyson Foods, which he bought on Nov. 20, 2008, and sold less than three weeks later. "I bought it and got out because it went up," Sen. Coburn said. He added that he regretted selling Tyson so quickly, because its price kept rising after he sold.

Grantham on Bubbles

Justin here. I'm fairly certain that all the 1000+ hours I spent studying for the CFA and CFP exams might have been better served taking a class on "How to Speak with a British Accent." Jeremy Grantham is brilliant (see his bio here, and latest commentary here) but his accent adds a good 20 points in perceived IQ.

The following short (6 minute) video discusses bubbles, how to spot them, what purpose the serve, and how "bloody mad" you have to be to buy into one. Y'all enjoy.

http://link.brightcove.com/services/player/bcpid71778049001?bclid=69928231001&bctid=79128759001

When Emotions Get the "Worst" of Us

Dan Ariely is the James B. Duke Professor of Behavioral Economics at Duke University and author of the New York Times bestseller Predictably Irrational. And to my delight, one fortunate night last year, he was a friend who just happened to stop by my house for dinner. We sat around the dining room table with my wife, our son Justin, his wife and their one-year old daughter. We talked about, among other things, the irrationality of stock prices, the packaging of laundry detergent, and the sleep schedules of toddlers. Take solace that Ariely, a highly intelligent professor and author with doctorates in marketing and psychology, could figure out complex problems involving emotions and economics, but was still trying to get a toddler to sleep through the night.

Ariely and I met at a lecture two years ago. I was intrigued by the focus of his studies: how people behave in the marketplace compared with how they would behave if they were completely rational. His interests span a range of ordinary behaviors: buying, saving, ordering food in restaurants, pain management, procrastination, dishonesty – all under different emotional states.

In a recent Harvard Business Review, Ariely explained how he and research partner Eduardo Andrade set out to prove how one’s past emotional decisions can negatively influence future decisions. Participants were divided into two groups: Group A saw a five minute segment from the movie Life as a House, a clip known to irritate and annoy its viewers. Group B watched a five minute segment of the popular TV show, Friends, known to evoke happy feelings. After that, they played the Ultimatum Game in which the “sender” (Ariely) has $20, and offers the “receiver” (the movie watcher) a portion of that money. Sometimes the offer was fair (you get half and I’ll get half) and other times it wasn’t (you get $5 and I’ll get $15). If the receiver rejected the offer, both sides got absolutely nothing. To make a long story short, the agitated group rejected more offers than the happy group. Even though it was highly irrational behavior, the agitated participants preferred to lose free money in order to punish Ariely for making an “unfair” offer.

Now the really interesting part: after Ariely and Andrade gave the receivers time for their emotions to settle down, they played the game again. The previously annoyed group, now no longer irritated, still rejected far more offers than the happy group, who was now no longer glowing from watching Friends. Why? Because the members of each group had tapped the “memory” of decisions they made earlier, without any regard to whether they were under the influence of being annoyed.

All too often, we see aggravated emotions creep into markets like a fog, turning seemingly easy decisions into difficult ones. If that weren’t enough, we see that the lasting effects continue to obscure the judgments of many, even when the aggravation is long gone. A few years ago, investment banks became frustrated by the low returns offered in the market. So they invented financial products and increased their leverage, sometimes loaning out their capital 30 times over. In effect, these banks were fearfully wrapped up in the potential for lost future profits and made the irrational choice. Sadly, this “experiment” didn’t carry the warning “Don’t Try This At Home!” Homeowners became increasingly irritated by their neighbors, brothers-in-law, and people from TV shows like “Flip That House” making loads of money. That aggravation propelled them to put on the blinders, assume home prices would rise forever, lie about their income, borrow more than they could ever afford, and put themselves squarely in harm’s way.

Likewise, at the end of 2008, Joe and Jane Investor were staggering under the weight of their irritated and annoyed emotions. Every time they opened their statements or turned on the TV, they saw a smaller “number” than the day before. It was hard to see the rational point of view: that the world wasn’t going to end, that P/E multiples were historically low, that stocks were extremely underpriced and that US Treasuries were fairly overpriced. Just like in Ariely’s experiment, investors seemed to be offered $5, free and clear, but turned it down because of emotions rather than rationality.

The irrational behavior continued into 2009 and by all measures appears to still be present today. The Vanguard Group reported that January 2010 was the first month since January 2009 that more money flowed into their stock funds than their bond funds. And according to the Investment Company Institute, it seems that most of the rally was the result of mutual fund managers putting their large cash reserves to work, rather than new investors entering the market. Meaning, when stocks were cheap, investors plowed money into bonds, but once stocks got more expensive, investors decide to buy again. It’s not surprising that Joe and Jane are once again aggravated. They have missed most of the rally and seem willing to buy any stocks, regardless of the business quality or dividend yield.

So, how do Joe and Jane avoid making irrational decisions? Let’s go back to Ariely’s study. Imagine if the aggravated subjects were allowed to consult their most trusted advisor and even let that person make the decision for them. It doesn’t matter if the advisor was their pastor, hairdresser or bartender, as long as they were very rational (i.e. they weren’t affected by the aggravating movie clip), highly qualified (i.e. they knew that $5 was better than $0) and held to a fiduciary responsibility (i.e. they were solely devoted to making sure the subject made the right choice). I can almost guarantee than the instances of irrational behavior would plummet, hopefully to zero. In essence, that’s our job. Our mandate is to think and act as that most trusted advisor for our clients – giving rational, qualified, fiduciary advice and direction.

Then how is Jonathan Smith & Company making rational decisions in this market? As we’ve mentioned in recent commentaries, investing rationally today involves: buying high-quality stocks with correspondingly high-quality dividend focuses, owning corporate and high-yield bonds with less inflation risk than treasuries, and aligning our clients’ overall expected risk and return with their respective stomachs and wallets. Perhaps the most meaningful way we’re making rational decisions is by knowing our clients well and helping them navigate their financial lives in a personalized way. We ask everything from “what will you regret on your deathbed?” to “what’s your credit card debt and interest rate?” We inquire about their history of investing and the things that keep them up at night. And we try to impart our experience and knowledge by addressing issues from “how commodities act as a diversifier” to “how to pass on financial wisdom to your kids.”

And if that doesn’t work, we always have a DVD queued to a clip of Friends. For some reason, that usually seems to put everyone in a good mood.

Asset Allocations, Starting Points, and Diversification

Justin here. I ran across this great (short) video from Roger Ibbotson (the unofficial father of market research) about asset allocation, starting points, and diversification. At JSCO, we talk a lot with clients about how much an investor's return depends on valuations when they start. Investing last year when all valuations were low was a no-brainer. Investing today, when valuations are inflated, takes a bit more precision (throwing darts at the WSJ won't do.) Ibbotson brings up a good point when he mentions bonds' relative historical starting point.

See it here: http://www.morningstar.com/cover/videocenter.aspx?id=328583&sr=wt0110

Why Financial Plans Are Worthless

Carl Richards is a CFP Professional who blogs about financial matters at his own site, Behavior Gap, and on the Bucks portion of the NY Times online. He really understands what's important with plans, planning, and the whole process. And for those of us who think in Venn diagrams (can I see a show of hands? One, two, . . . ok, so all two of us) he usually has a treat like the one below.

His newest post "Why Financial Plans are Worthless" is especially good.

Warren Buffett on Gold

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Top 10 Investment Tips from the Ancient Texts of Classic Rock ‘n’ Roll

Justin here. I found this absolute gem of a article on the CFA Institute's website. Written by Thomas Collimore, CFA, (Director, Investor Education for CFA Institute) it has some great tips and might even make you hum some classic rock. Here's a sample:

8. “Lady Madonna,” The Beatles (1968)

“Lady Madonna, children at your feet,
Wonder how you manage to make ends meet.
Who finds the money when you pay the rent?
Did you think that money was heaven sent?”

Plan, plan, and then plan again. Committing yourself to a realistic investment plan requires understanding your resources and obligations as well as the essential attributes of your future desired lifestyle. As you plan your investment strategy, leave room for investment underperformance. Committing your plan to writing may force you to address issues that you might otherwise glide over.

Go here for the full list of tips inspired by hits from bands like The Eagles, Led Zeppelin, Rolling Stones, and Aerosmith touching on topics such as Expenses, Longevity Risk, Taxes, and Professional Designations. It's rare to find something worth reading that's this easy to read. Good work Mr. Collimore.