Investment Pyramid: Just Wrong

For many years the personal financial industry has pushed an investment pyramid as a model. This pyramid is very similar to the food pyramid that many investors are familiar except that the sections deal with size of your risk-associated investments rather than healthy eating.

The investment pyramid has primarily served as sales tool for investment firms. One promoter is Edward Jones which wraps the pyramid into a pitch for their products. The common pyramid model has several levels with the most risky at the peak and the least risky at the base. The model is supposed to reflect the size of your investments in these type of assets.

It is becoming more apparent that this standard investment pyramid may be hazardous for your financial health. The pyramid does not take into account investment horizons and objectives very well; nor does it account for significant market draw-downs.

A better model effectively turns the investment pyramid on its right side and uses the bottom axis as time horizon. This places the most risky investments further out in time and least risky up close. However there needs to be more refinement to make this model successful than just tipping the pyramid over. Each slice needs to reflect a time period and a mix of investments; furthermore the size (or height) of the slice is driven by dollar amount of the need in the particular period. This means that the pyramid may possibly no longer get narrower in time depending on an individuals need later time periods may be larger.

Take a look at a typical family living in their first home with a couple of children. Their future needs are focused on buying a larger house in five years, saving for their kids' college education in 12 years, and their retirement in 25 years. Each of these time periods represent a slice, and each should be looked at from a perspective of the worst case draw-down and consequences based on the portfolio.

The down payment for the house in five years is probably a lot smaller than the college education bill. The down payment can not afford a large draw-down without the consequence of wiping out the families ability to move to a larger home. This investment slice may be small in size but needs to be placed in an investment portfolio with minimal risk. While the college investment slice is much larger but can support an allocation with increased risk.

A better name for this new model is Time Slice Investing or the TSI model. Each time slice needs to have a size, objective, separate portfolio, and risk modeling for an investor to be successful in the long term.

Interesting Commentary from Andrew Lo

The link below goes to a video with Andrew Lo with some interesting commentary about how the current financial crisis altered the underpinnings of investment diversification. Andrew LO is an award winning MIT economist.

http://www.investmentnews.com/apps/pbcs.dll/section?category=wealthtrack

The Ascent of Money

Earlier this week, PBS ran a special two hour program "The Ascent of Money". The program is an excellent overview of current financial crisis placed in context of other historical events. The show includes some excellent commentary and interview clips.

It can be watched online at:
http://www.pbs.org/wnet/ascentofmoney/

Fannie and Freddie

Obviously the biggest news on Wall Street this week was the Federal Government seizing Fannie Mae and Freddie Mac before both of these mortgage giants failed in a catastrophic manner. These companies have been faltering for many months while looking for lines of credit to bail them out, the government went one step further and completely took over the firms while giving top executives the boot.

The entire situation is also another example of intervention not allowing proper capitalism to play out in the market. The term “moral hazard” comes to mind in which businesses do not take responsibility for their risky behavior; this only entices other businesses to take poor risks. Especially in an environment where it appears that “gains for privatized and losses are socialized”.

While the government takeover may have buffered the mortgage market in the short term and cheered up Wall Street on Monday, the long term picture is much less clear. The U.S. tax payer is going to be stuck with the tab. The question remains on just how big the tab will be – estimates range from $250 billion to $5 trillion. The actual cost is very dependent on how the housing market and associated credit recovers. One recent article outlined how the seizure of these mortgage giant is the taxpayer’s risk (If takeover tanks, we're holding bag).

Similar too many previous government interventions, this action with Freddie and Fannie may help alleviate the short term crisis, but the toll down the road will be much greater and more painful.

WaMu CEO given the Boot

Past HingeFire articles have outlined in detail the issues at Washington Mutual and urged banking customers to pull out funds over the FDIC limit. News today shows that Washington Mutual has ousted CEO Kerry Killinger. WM stock is down over 15% in mid-day trading.

It is also interesting that Washington Mutual agreed to further oversight by the Office of Thrift Supervision concerning aspects of its operations. This demonstrates the high level of concern regarding the solvency of the institution from a regulatory perspective.

Bank Safety Ratings on the Web

Bankrate now offers bank safety ratings for free on the web. See the Safe and Sound page of the Bankrate website - http://www.bankrate.com/brm/safesound/ss_home.asp

You can search using many different criteria to find the banks you are interested in. Bankrate provides the following summary to describe the service.

"Bankrate.com's Safe & Sound® service is a proprietary system designed to provide information on the relative financial strength and stability of U.S. commercial banks, savings institutions and credit unions. The system employs a series of twenty-two tests to measure the capital adequacy, asset quality, profitability, and liquidity (CAEL) of each rated financial institution. Individual performance levels are determined from publicly available regulatory filings and are compared to asset-size peer norms, industry standards and key absolute benchmarks. Combined results form the basis for our Composite CAEL and Star Ratings, which are described below. When possible, the system also produces a report that provides a detailed explanation of our findings, for each rated financial institution."

Earlier we had warned everyone to get their money over the FDIC limit out of Washington Mutual. It is interesting to note that WaMu recieved the lowest possible ratings, for both the Bankrate star rating and CAEL rating. - http://www.bankrate.com/brm/safesound/thrftmm.asp?fedid=1000508551

Gas at the Pump

A HingeFire survey early this summer asked readers about the projected price of gas at the pump on August 1st. The results showed the following:

Over $4.50 23%
Between $4.00 and $4.50 43%
Between $3.50 and $4.00 17%
Between $3.00 and $3.50 13%
Below $3.00 2%

The actual nationwide average price was $3.84 at the beginning of August. Congrats to the 17% who selected the $3.50 to $4.00 price range (I actually believed it would be above $4.00).

The good news for consumers at the pump is that it appears that the short term speculative bubble associated with oil has burst over the past couple of weeks. This will help both the market and your wallet when filling up the tank. As a note, 68% of readers in the most recent HingeFire survey believed that oil was in a speculative bubble. At this point, many analysts would say this perspective is correct.

Is your online bank account safe?

A recent report by researchers at the University of Michigan demonstrates that bank & brokerage websites are plagued by security flaws. These widespread design flaws make it easier for accounts to be compromised. According to Finextra, an examination of 214 bank websites revealed that more than 75% have cracks in security that hackers could exploit to access customer information and accounts.

‘Says Atul Prakash, professor in the department of electrical engineering and computer science: "To our surprise, design flaws that could compromise security were widespread and included some of the largest banks in the country. Our focus was on users who try to be careful, but unfortunately some bank sites make it hard for customers to make the right security decisions when doing online banking."’

This should be a cause for concern for all banking customers, the prospect of going online and finding your account cleared out is a nightmare. Security remains the top concern for banking institutions, and regular steps have been taken to improve the situation. The state of affairs is not as dire as outlined by researchers because many of the security flaws are difficult to exploit.

The real issue with the banking industry is the lack of a systematic defined approach to security testing their websites. There needs to be a single standard that all online financial institutions are tested against.

Cisco has some excellent initiatives such as SAFE that improve the security of customer deployments by defining configurations and testing steps that reduce vulnerabilities. The company also has service-focused teams of specialists that aid customers in securing their networks.

During my time at Cisco, I drove an initiative called SITE (Security Integration, Test and Evaluation) which defined a structured process for evaluating potential vulnerabilities, performing boundary & penetration testing, and evaluating the results in a logical matter. This approach was incorporated as part of the quality system and utilized across the company in testing multiple product lines. The process could be scaled from “light” to “heavy” based on the needs of the team performing the evaluation. The use of automation tools for “fuzzing” (sending in deliberately mal-formed packets) and other security testing was crucial for meeting tight deliverable schedules within the framework of SITE. Over the years, the original SITE initiative has evolved and now is included within the scope of other security enhancement programs (run by some real sharp engineers) that raise the standards to even a higher level.

What does the banking industry lack? Basically the online financial industry needs to define a SITE type of initiative and a set of common standards for securing their websites. The problem is not the inclusion of vulnerabilities (which will always pop-up), but the lack of screening for vulnerabilities in a structured manner. Banks do not have a methodical approach to find the vulnerabilities, nor a structured system for ranking and resolving the issues. Most banks are flying blind to what potential vulnerabilities currently exist on their websites because testing has only been performed piecemeal over time.

Banks and brokerages have a lot at stake; losses from compromised accounts continue to mount. It is time to raise the bar in the financial industry and reduce the exposure faced by customers. This requires a change in direction for security practices, and includes a need for information services cooperation between competing institutions. The best approach would be to create a focused team with IT representatives from multiple banks to define a central testing standard utilizing a structured approach for evaluating the security of online banking websites. After adoption, the methodology would need to be driven as a requirement across the industry.

Important: Funds over the FDIC limit at WaMu

If there is one post to sit up and pay attention to this month - This is the post.

Get your funds over the FDIC limit out of WaMu now! There appears to be a run on the bank forming and one likely end-game will be the FDIC seizing the bank; similar to the situation with another large bank, IndyMac, recently.

Knowledgeable investors have been removing funds for several weeks and now the situation has caught the attention of the mainstream press. A recent report by Gimme Credit cited liquidity concerns with Washington Mutual.

"We won't use the phrase `run on the bank,' but we would be remiss if we did not observe that many creditors have quietly been pulling funds,'' wrote Shanley, based in Chicago. Their actions are "presenting an increasing funding challenge,'' she wrote.'

The bank disputes the findings stating that 7 billion cash infusion led by TPG Inc, cost reduction plans, and a lack of need for commercial paper will help Washington Mutual ride out the storm. Many analysts are skeptical. These restructuring actions are helpful but will not enable the bank to survive a crush of depositors withdrawing funds from an institution that is increasingly looking like a house of cards. Standard depositors are likely to follow the lead of savvy unsecured creditors over the upcoming weeks as more bad press continues.

The second day of WM stock in free-fall is a more telling sign about the challenges facing the institution. While some would state that withdrawing your funds over the FDIC limit does not help the stability of the bank, the other side of the coin states that why should your be out of your funds from a personal finance perspective because you did not take action in the early stages while the crisis was unfolding.

Crushing the American Family

Once in a while a cartoon comes along which really drives home a point. Despite political pundits waving their arms and claiming that we are not technically in a recession, the circumstances facing American families are so dire these proclamations are nearly meaningless.

The credit crunch, housing market, gas prices, job losses, and rising food costs have left consumers in a tough position. Families are having to cut back many activities and purchases simply to cover necessities - this is not good news for the two-thirds of the economy dependent on consumer spending.

Well for the good news - At least we are not technically in a recession!

Is Your Bank Next?

A slew of mainsteam press articles a month back stated that the credit crunch was over. Not so fast! As outlined in articles on HingeFire in May (see Is the Financial Crunch over?) the financial sector is ripe for continued turmoil.

The top headline news today outlined the shares of U.S. banks plummeting amid stability fears. Sizeable regional banks such as Wachovia, WaMu, and National City are near the top of the list that investors believe have the likelihood to fail.

‘"It's the cockroach theory. You don't just have one bank failure -- when you have a big bank go under, there's always more than one," said James Ellman, president of hedge fund Seacliff Capital, who is short some financial stocks.’

The failure of IndyMac in many ways was a standard run on a bank. Panicked depositors lined up outside the doors pulling out $100 million a day causing what regulators called the second-largest bank failure in U.S. history. It was clear to regulators, politicians, and investors that IndyMac was in trouble, leaving only the question of degree. This type on depositor driven panic could easily happen to other struggling regional-type banks.

'One woman leaned on the locked doors, pleading with an employee inside: "Please, please, I want to take out a portion." All she could do was read a two-page notice taped to the door.'

At some point the FDIC will not be able to handle the level of defaults. While the FDIC has staffed up expecting more failures, the federally sponsored insurance agency is primarily focused on merging banks in trouble. The FDIC does not have deep pockets to bail out a chain of sizeable cascading failures.

Regional banks are not the only concern. Fannie Mae and Freddie Mac are in deep trouble. To avoid total financial market panic, the White House administration has ask Congress this past weekend to approve a plan that would provide a credit line of some $300 billion to the troubled GSEs and buy their stock. The Fed passed measures to allow both Freddie Mac and Fannie Mae to borrow at its discount window. Clearly, the government's hand was forced by a $3 billion Freddie auction scheduled for today that would have revealed the extent of the disaster without government intervention.

Is your bank next?

Will you be lined up at the door of your local institution begging to get your money out while the door is slammed in your face?

This is a time to carefully evaluate the safety rating of your local bank where you have deposited your money. If the bank looks the least bit shaky then your should get your funds out before a wide-spread panic develops.

This week’s trite “that’s obvious” personal finance article

Every week a slew of personal finance articles appear in the mainstream press across the county. Many of these articles don’t go beyond what should be obvious to even what a consumer with a very low IQ should intuitively understand. You would hope that the “hard-hitting” financial news media would be able to provide useful information with some depth instead of the junk that is put out as meaningful financial reporting in this era.

In a world ruled by 30 second sound bites, it is easy to understand why not all articles are lengthy. At least consumers could hope that they could make points that are not obvious even to the most dimwitted.

With the continual pile of trite articles put out each week, maybe there is a need to establish an award for the most useless personal finance article of the week – sort of an Ig Nobel prize for personal finance. As long as they don’t name the trophy after me I would be quite content to see this happen.

This week’s winner would be a gem from U.S.News & World Report titled “Tips on Selling an Unloved SUV”. The article makes the obvious points of:

• Sell to individuals, not dealers.
• Don’t strip the bells and whistles from the SUV.
• Lower your price.
• Wait for winter to sell.

Where is Captain Obvious when we need him?

Sticking it to investors: SEC does not want to hold Credit Rating agencies accountable for their ratings

So what does a regulator do went they find out that the credit ratings applied to money market accounts are basically meaningless? Do they:

A) Get tough with the credit rating agencies and demand that they properly evaluate and grade interest bearing instruments.

B) Open the credit rating market up to new companies, hoping that the competition fosters an improvement in credit ratings.

C) Propose reducing reliance on credit ratings, including proposing to eliminate a requirement that money market funds hold highly-rated securities.

If you selected C then congratulations - you are a winner. The SEC is moving forward with a policy of weaning investors and Wall Street institutions from over-reliance on credit ratings, instead of fixing the credit rating firms. While the proposal does require that fund managers assess a security's liquidity and inform investors, we have seen quickly a formerly-liquid credit market can lock up. The major focus is to deemphasize credit rating agencies and effectively get them off-the-hook for the terrible job they have done in terms of properly rating securities. There is no need for the agencies to reform their processes.

Worst yet, investors are now basically being told that they are on their own when if comes to evaluating the safety of money market funds and interest-bearing funds. This is setting the table for a future crisis. At some point in the future there will be a large number of grandmothers spread across the nation who will be quite unhappy with this change in regulatory mindset.

SEC proposes reduced reliance on credit raters

How come Mutual Fund Managers don’t invest in their own funds?

Once again, an article highlights that the majority of mutual fund managers avoid their own funds. Why would a customer want to buy fund when the manager won’t touch it?

Maybe the manager knows that the expense fees in most mutual funds eat you alive over time, and most knowledgeable investors are better off investing directly in stocks. John Bogle, the former chairman of Vanguard group, talks about this trend in his discussion about the “The Battle for the Soul of Capitalism”.

Morningstar reported that 47% of the managers of U.S. stock funds reported no ownership in their own funds. 61% of the managers of foreign stock funds and 66% of taxable bond funds do not own their funds. Similarly 71% of the managers of balanced funds will not include the funds in their holdings.

Do they know the funds are so toxic or poorly run that these managers will not even pick up a small number of fund shares – maybe this would be a good display of confidence.

Once again this is a dismal reflection of the mutual fund industry, and demonstrates that many managers do not believe their “gimmicky market-driven funds” are designed for the long haul. Investors should focus on low fees when investing in mutual funds and take a look if the manager actually holds shares.

Is the Housing Crisis at its apex?

The news cycle continues a downward cycle on housing. Homeowners can not open a newspaper, turn on the news, or browse online without immediately getting hit with the latest negative housing commentary.

On the front page today, US foreclosure filings surge 48 percent in May. The continuous stream of downbeat real estate news may be a sign that the housing market has finally hit the bottom. In the same way, that the endless stream of news on how to get rich speculating on real estate in 2005 marked the real estate market peak. Interestingly, the spin today is how to get wealthy buying real estate foreclosures.

There is continuing statistical evidence that indicates that housing has turned the corner. In many markets, the number of days on the market is falling, along with the amount of unsold inventory. Coupled with the rate of price decreases slowing as buyers and sellers come into alignment of the new expectations regarding the proper value for a house now that the speculative bubble has burst.

The mortgage situation is also easing, as banks have returned to traditional lending standards. Financial institutions now have an improved comfort level for underwriting and re-selling proper quality loans – the credit crunch is slowly moderating.

The summer of 2008 may mark the actual bottom of the real estate plunge on a national level; some markets will face further price correction. However the path out of the crisis across the country will still be lengthy and painful, extending well into 2009.

Saving on Food: Avoiding the checkout coronary

The cost of food keeps going up. Most customers cringe when going through the checkout line at their local grocery store these days. Coupons are back in vogue, and many people are comparison shopping between brands and stores to save money.

One problem is that the most standard items like milk, eggs, and bread that have risen in price significantly don’t normally have coupon discounts. One way our family is saving is by going to big wholesale discount centers such as Sam’s to buy these items. Milk at Sam’s is cheaper than any of the local groceries. Until recently we were not focused on using discount centers for food purchased; when I used to think of Sam’s it was for cheap electronics, office supplies, and other stuff. Times have changed – thanks to the rapid inflation in food prices.

On an interesting financial note, regulators are proposing to increase the margins for agricultural products in the commodities markets to curb speculation. This step was recently enacted for energy futures to reduce volatility, apparently it has not worked out very well – Oil jumped $10 today.

One recent article outlined “How to Save $400 a Month on Groceries”. The piece outlines some of the websites and strategies for finding coupons that will help you save in the checkout line.

Vote Now: Gas Survey

Over the recent holiday weekend, millions of U.S. drivers fretted about the price of gasoline. There are two days left in the poll about gas. Take the survey now.

Where will Gas at the pump be on Aug 1st?

Found at the top left corner of the blog.

Phishing risk rises

Banks and brokerage firms continue to have problems with sophisticated phishing schemes targeting their customers. Many brokerage firms have released records on the amounts that they had to pay back to account holders who have been cleared out electronically. The numbers persistently grow at a staggering rate each year.

Recently a large international cybercrime ring was taken down. These crooks used the internet to facilitate the theft and misuse of credit and bank card numbers. Spam that sent account holders to fraudulent websites was the common starting point in clearing out the victims accounts.

Two recent articles discussed the situation. The Information week article provides a list of impacted institutions; if you have credit cards or accounts with these firms then you should be on alert. The SC Magazine article focuses on technical measures such as SPF, and DomainKeys which can be used by the industry to reduce the problem.

International Cybercrime Ring Busted

Hot or Not: Winning against the phishing assault

Get Coupons on the Web

With the prices of food and basic necessities rising weekly, the importance of saving money has risen to a new urgency in many families. Coupons – a normally ignored component of Sunday’s newspaper have now become an important part of the family budget.

Even so last year only 1% of coupons were redeemed. This rate is expected to rise this year. One issue with the low redemption rate is that many paper coupons are for articles not normally purchased by families. One bit of good news for consumers is that manufacturers are offering more coupons this year for commonly purchased items, even as they raise prices.

One resource for coupons is the web; there are a number of free and paid sites that offer coupons. It is no longer necessary to limit your search to the Sunday paper. A recent Wall Street Journal online article provides an overview of the “The Best Sites for Coupon Clipping”.

Countrywide Chairman tells Homeowners they are Disgusting

Countrywide Financial Corp. Chairman Angelo Mozilo reaped $132 million as the mortgage lender got hammered in 2007. It appears this wad of cash has not made him appreciative of his customers; he views homeowners as “disgusting”.

Apparently Mozilo does not know the difference between the reply and forward buttons, setting the stage to send an absurd email response to a homeowner. It does reveal the contempt that the executive holds for homeowners seeking help with unaffordable adjustable-rate mortgages, loans that were pressed on them due to Countrywide’s inappropriate business practices.

As outlined by the government and consumer groups, the mortgage giant has a history of focusing on loans that generate the maximum fees even if they were totally unsuitable for the homeowners, while not properly explaining the terms of the loan. Furthermore many loan agents, as shown in this case once again, made “promises” about refinancing and other loan attributes that would defined in most courts as fraud.

Despite these mortgage companies claiming in Washington that they are taking steps to alleviate the pain of homeowners; the email exchange underlines the stark reality that the mortgage giants actually could give less than two hoots about these mortgage-holders.

Mozilo on distressed borrower's appeal for help: "disgusting"

Countrywide Financial Chairman Angelo Mozilo's e-mail sets off a furor