Investing - what Buffett can do and you cannot

kw: book reviews, nonfiction, investing, short biographies, letters

Warren Buffett, the Sage of Omaha, is legendary for parlaying a modest fortune into billions, primarily by investing. He is considered a genius at stock picking. Warren Buffet's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor, by Jeremy C. Miller, tells the real story, at least about the first 13 years, the BPL years.

Probably the impression most people have is that Buffett was somehow prescient, and could time the market. The reality is much more prosaic. Ground Rules is about half large extracts from the Partnership Letters that Buffett wrote to his partners (initially three family members), from 1956 to 1969; and about half Miller's analysis, a valuable asset in its own right.

Buffett's style of active investment management bore (and bears) no resemblance to that of the managers of the roughly 2,000 funds of the "Growth" variety, and even of most of the 1,500 or so "Value" funds, let alone all the other categories. He was an early Value investor, but Value has a different meaning nowadays.

After working in the investment field on his own and for Benjamin Graham, the "father of Value investing", he set up Buffett Partnership Ltd., with his own money and that of a few relatives. When Graham retired, Buffett already had savings of about $175,000 (more than $1.5 million in today's dollars). BPL was set up with about $100,000, having the stated goal to beat the performance of the Dow Jones Industrial Average by 10% yearly. In those 13 years he never had a down year, and usually beat the Dow by much more than 10%. He had parlayed the $100,000, plus other funds added as partners were added, into about $50 million (in 1970 dollars; more than $300 million in today's dollars). How?

Buffett had learned deep value investing from Ben Graham. His motto was, "You don't buy stock, you buy the business." That is, even owning one share, you should think like someone running the business. He developed his own ideas upon that foundation, so that he soon had three kinds of investments in the BPL partnerships:

• General – Graham-style value stocks: with much research, companies were found whose total stock value was less than the raw asset value of liquidating the company. Stock of companies with management who had a reasonable chance of keeping the business from foundering could be purchased with almost total certainty that the stock value would increase, probably by a great amount. Such "low hanging fruit" are very rarely to be found today, nor at nearly any time since about 1970. Buffett liked a stock to not grow fast, at first, giving him time to buy a lot of it, a little at a time so as not to stir up market activity around it. Later he split this category into two based on size, particularly once BPL had much greater funding. Most General stocks represent small companies, and a million-dollar investment could buy the whole company, or totally skew the market for it.
• Workouts – Arbitrage opportunities in today's lingo: companies in trouble, or with more cash and idle capital assets on hand than the value of all shares of stock. He would obtain a large amount (10-20%) of a small company's stock, giving him leverage (and often a seat on the Board), so that he could influence company operations. He would influence, or force, company management to get rid of unprofitable operations and concentrate capital where it could do more good, both in a business sense and a financial sense. Sometimes he was vilified in the press, much as T. Boone Pickens was a generation ago, and Nelson Peltz has been in recent years. With no more than a couple of exceptions, he avoided eliminating jobs in large numbers, even at the cost of a few more percentage points in a stock's value. I don't think either Pickens or Peltz ever cared one whit how many jobs they eliminated.
• Controls – Ownership of more than 40%, and of course more than 50%, of a company's stock would give Buffett total control of operations. His last Control was Berkshire Hathaway, which he still controls. 

Does any of this sound like "timing the market"? Buffett repeatedly expressed his disdain for the very thought, and claimed he had no interest in market timing. He preferred stocks that were independent of market movements, and chose Generals in particular for this characteristic. This took a lot of research, in an era without electronic research tools.

So, whichever sort of investment one plans to make (most of us will find Workouts and Controls out of our reach!), these simple steps must be adhered to:

• Set a goal toward which you are willing to work, hard.
• Research, research, and research some more to locate publicly-traded companies that offer a great chance to meet that goal. This minimizes risk.
• Follow a disciplined plan to obtain an appropriate amount of the stock (this can take months or even years).
• When the goal is met, sell, perhaps as gradually as you bought in. The whole process is likely to take several years. Buffett didn't care for any time horizon shorter than 3-5 years.

Doing so sounds simple, but is emotionally impossible for more than about one person in a million. Buffett had an emotional detachment from the decisions he made that just might be unique. He also had the business acumen to successfully arbitrage or control a company he had bought. It is one thing to understand what he did. It is another to do any part of it. That is why there are so few investment billionaires.

This reminds me, in a sideways way, of something Art Linkletter said when he was interviewed late in his life. He was asked how he had such success interviewing children for his show "Art Linkletter's House Party" (I was in the audience once, at age 8, but wasn't called up on stage to talk with him). He said, "I can tell you my secret, but you can't do it. The kids have to know you are at the same mental level." Ground Rules tells you Buffett's secrets. Bet you can't do it.

Slow and steady also wins the investing race

kw: book reviews, nonfiction, investing

Sometimes all it takes is one good, good man. In the realm of investing, Jack Bogle is that man, and the Bogleheads are his disciples. Three of them, including the one Jack calls "Prince of the Bogleheads", have written the first book you need to read to learn about investing: The Bogleheads' Guide to Investing, by Mel Lindauer ("Prince"), Taylor Larimore, and Michael LeBoeuf. I read the second edition, just out (the first edition was in 2006).

In 2007 I wrote about what I call the "P07 Prosperity Index" or PPI (see it here). It is simply the Dow Jones Industrial Average (DJIA) divided by the Consumer Price Index (CPI) and the US Population. Neither DJIA nor CPI is perfect, but these are the best we have readily available. If you look at the general trend of the DJIA after the crash of 1929, you see a general, jittery rise, with big hiccups. But the PPI shows a different story. Here is my original chart showing 1928-2001:

After the 1929 crash, which lasted until 1933, we see 5 eras:

• 1935-1954 - A generally flat, if wavy, trend.
• 1954-1966 - The post-war boom got under way after all the men on the GI bill got out of college and established careers.
• 1966-1982 - The "flat market": the DJI stayed near 1,000 but inflation and a growing population meant the true value of stock investments fell to 1/3 of their original value.
• 1982-1998 - The boom of the "Reagan Years" followed by the Dot-Com Boom, AKA the Dot-Com Bubble.
• After 1998 - Another flat market, with a modest rise in real terms (not shown here) after the crash of 2008-9 (remember, you must divide out both inflation and population growth).

The scary thing about the years since about 2000 is that there is no safe haven. Passbook savings at a 5% annual rate could be had during my formative years, and until I was 50 years old. Now, the best-performing CDs earn about 1%. So to stay ahead of inflation, one must invest. The trouble is, even though about half of American families now own investments such as mutual funds or stock accounts, few have the slightest investment intelligence. What to do?

Bogleheads to the rescue! Jack Bogle has a short list of mottoes. The two most basic are "Keep it Simple" and "Keep Costs Low". The first 16 chapters of the book cover all the basics of investing, beginning, with getting your own house in order. That means living within your income. Otherwise, you have nothing to invest. Close the book and take care of that first.

Consumer Debt is the biggest drag on a family's finances. Do you have a running balance on your credit card(s)? The highest-paying investment you can make is to pay consumer debt down until you pay it off. You are paying 15%-20% annually. For every $1,000 of your balance, you are paying $150-$200 per year. If you have the average (Average!!) of $8,200 credit card balance, you are paying between $100 and $135 every month in interest. What could you do with another $100 or so of income?

That's right. Invest it. If we could still get 5% passbook savings, and put the $100 monthly into that, it adds up over time. In a year, you'd have just over $1,200. That $1,200 would earn another $60 every year you leave it in savings. The next year's $1,200 would do so also. In 20 years you'd have saved $24,000, but your passbook balance would be nearly $40,000. Keep on for another 20 years: savings total $48,000, but your balance is now $145,000. Compound interest has added nearly $100,000 to your investment. Do you want to retire a millionaire? Starting at age 25, save $690 monthly for 40 years in an investment that earns 5%.

Getting 5% can be hard, but it is sure easier than getting the 10% or 20% that the radio personalities talk about (but you never meet anyone who actually earns that much!). The Bogleheads can show you how to earn 5%-7% with comparative safety. Nothing is totally safe. Even passbook savings during my youth might have been lost if a bank failed. FDIC insurance started in 1934, but the insured limit was pretty low until 1980, when it rose from $20,000 to $100,000 (it is now $250,000).

A tale of two families: My wife and I had some good friends in the early 1980s, and we had very similar incomes. Let's call them Bill and Jane Spender. My wife and I had two cars, and each had cost about $1,000. We had a house with a $30,000 mortgage. The Spenders also had two cars that hadn't cost much, and bought a house, winding up with a $45,000 mortgage. Then they traded in one of their cars and bought a minivan. Its payment was more than half as much as their mortgage. So right away, their debt service costs were 2.25 times as much as ours. Not long after buying the van and making a couple of payments, Jane complained to my wife that they were barely making ends meet. She replied, "It was your choice. Your old car still worked." As you might imagine, the relationship was rather strained for a while after that. We moved away a couple of years later, and after another 10 years, went to visit them. They were living in a trailer in the woods. They still had the van, but fortunately it was now paid off. They were actually beginning to save a little money. The difference? We learned to live within our income a decade and a half before they did.

That's a lot, just on the message of the first couple of chapters. But if you attain the discipline to live on less than you earn, and save regularly, you have what it takes to invest the slow, steady way they Bogleheads recommend.

Keeping it simple: Diversify the easy way with a small number of mutual funds. Specifically no-load funds such as the majority of funds at Vanguard and Fidelity, and others found, for example, at T. Rowe Price. A mutual fund is already diversified, so get a stock index fund, a bond index fund or total bond market fund, and perhaps a little of a global or international value index fund. Just to track the DJI you have to buy 30 stocks. And what does it cost per trade at E*Trade?

Keeping costs low: This means investing in instruments that have very small management fees. Way too many folks go to a "financial adviser" and agree to have their money managed for a yearly fee of "only" 1.5% (more or less) of their account value. By the way, try asking the adviser if he or she will waive the management fee in any year that the balance has gone down. Not bloody likely! If the person agrees, you may have found an honest adviser!!! Anyway, this adviser is probably also a broker, and will invest in either stocks and bonds directly (if you've agreed to that) or in mutual funds. Either way, there is nearly always a commission paid, to the broker/adviser. Brokers never deal in no-load funds. For stocks and bonds the commission ranges from 5% for small purchases down to about 0.5% for larger ones. For most mutual funds, it is about 4%. If you are lucky, the adviser will leave things mostly alone and only make changes about once or twice a year. Every such change has its cost. The upshot? Your adviser is making from 3%-6% of your money. You might make some, and you might lose some. Your adviser can't lose!

The problem is, over any span of a few years, the performance of most advisers and other kinds of fund managers is below that of a stock index such as the DJI or S&P 500. For the past 20-30 years, the indexes yield in the 6% range, plus or minus a point depending on which 10-year span you choose. If your adviser can gain only 6%, and is taking 3% or more, that is not good for you. If you could gain the same 6% and your expenses were less than 1%, that's a huge difference in the long term.

Consider the example above. Instead of 5%, you earn only 3%; or, rather, your account earns 6% but the adviser takes half of it each year. In 20 years you have some $32,000 and in 40 about $90,500. Between what you paid the adviser, and the 3% that didn't compound, you've lost $8,000 over the first 20 years and nearly $55,000 over 40 years.

By the way, if you want to pay this adviser 3% to take care of your money for 40 years, and still retire a millionaire, what monthly amount must you save? $1,105/month, or about 1.6 times as much, just to account for the advisory fees and commissions and lost compounding. So you may not think 3% is too much, until you realize it eventually adds up to $415/month.

Here we find a little selling in the book, but I think it justified. The authors are not employees or affiliates of The Vanguard Group, which Jack Bogle started in 1976 with the first index fund. It became the first among many index funds, and has very low management cost. Its expense ratio is below half a percent. The "Admiral" version, for larger investors, has expenses below 0.2%. While the authors present examples using general indices, they also show how certain specific Vanguard funds would fit in, and they recommend them. So do I; I have had Vanguard as my major investment company for 25 years.

In the second part of the book we find strategies to get investments on track and keep them there. The discussion of portfolio rebalancing in Ch 17, "Track Your Progress and Rebalance When Necessary", made so much sense I finally decided I'd better make rebalancing a habit. I made a simple model of two Vanguard index funds since their inception late in 2001. One tracks the S&P 500 and the other tracks the "Total Bond Market". The S&P has, like the DJI, gyrated all over the place. The Bond index is much more stable, though it has had periods of loss. Over the past 13 years the stock fund's average rate of return has been about 6%, and the bond fund's return has been 4%. That includes the market crash 6 years ago, when stocks fell by 40% and even bonds fell a little.

As you might expect, a 50:50 mix of bonds and stocks fell right in the middle, about 5%. It still gyrated a lot, but much less than stocks alone. But with rebalancing, things were a little different. The gyrations were a little less while the return rose. Specifically, using a starting investment of $10,000 (what fund prospectuses always use) and rebalancing every January except the first one in 2002, with or without rebalancing there was an early dip to about $8,650 in Fall of 2002. The crash of 2008-9 dropped the "no rebalance" portfolio from $13,513 to $10,085 and the rebalanced portfolio from $13,719 to $10,265. $10,000 in the S&P by itself would be well below this, at $7,341. The power of rebalancing occurred during the early long (4y) rise followed by a long fall that took 16 months. Rebalancing in January of 2008 and 2009 shifted money from bonds to stocks even as stocks grew cheaper while bonds continued rising. During the prior 4 rebalancings, money from rising stocks had been shifted to bonds. This captured a portion of the stocks' profits. By the rebalancing of January 2010, stocks were again outpacing bonds, and the shift back toward bonds resumed. As of August 2014, the now badly unbalanced portfolio (56% stocks and 44% bonds) totaled $19,195 while the yearly rebalanced one was $20,880. The difference is $1,685. In the past 2 months both portfolios have lost about $400. The effective yearly earnings come to 5.2% for the unbalanced portfolio, and 5.7% for the rebalanced one. I think it is worth my while to make simple rebalancing adjustments once yearly for the sake of $1,700 per $10,000 invested.

That is just one useful thing I learned from the book. I also find that their recommended asset allocation for someone like me in early retirement, with perhaps 20 years to live, is half stocks and half bonds, like the portfolio I modeled, with a dollop (10% of the total) of international stocks included. My own investments are a bit bond-heavy, so I might benefit from adjusting that also.

Being financially conservative, I've been right in line with many of their recommendations, but I believe many worried investors will find a great many helpful principles within these pages. Now if only I'd had the insight to start putting away $690/month at the age of 25!

I am almost ready to hire this guy

kw: book reviews, nonfiction, investing, retirement planning

Ric Edelman is heard on the local radio station, sometimes advertising and sometimes hosting a talk show about investing. His advice and approach seem sensible to me, so I was glad to run across his book The Truth About Retirement Plans and IRAs. His advice compares well with that from Peter Lynch in a book he wrote just after retiring from managing the Magellan Fund. Both make the point that long-term, stocks perform better than any other investment (except perhaps high-end real estate, if you have billions to invest).

Based on the Lynch book, I invested heavily in stock funds while I had a 401(k) available, then reallocated as I neared retirement. It turns out, I'd have done the same had this book been available 30 years ago! The difference is, Ric Edelman advises investing in everything available to the small investor. Here is an asset allocation model generated by the "GPS" tool at www.ricedelman.com:

Count 'em up: 18 asset classes, plus Cash. I ran the tool several times, for both myself and my father, in his 90s. This model is for someone about 10 years before retirement with a pretty good tolerance for risk. If you add the international bonds to the "International" category, which is for stocks, global exposure is 18%, a surprisingly aggressive stance. And although he mentions gold or precious metals a few times in passing, I see none in this model, nor any discussion in the book. I suspect that is due to their double risk: gold went from $1,800/ozT a couple of years ago to $1,200 early this year, and is creeping back up at best. In real terms gold has yet to reach values it had during the Reagan presidency. Such fluctuations are risk type 1. The second type of risk is, you either pay for a custodian to guard it, or you take custody and risk being robbed. If anyone is paying attention (someone usually is), you are vulnerable when it is in your possession, before you get to your safe deposit box.

Back to the model. Non-bond non-cash totals 65%, about right for someone about 55. There is a joke hidden in the GPS. To answer one question, you have to choose one of 5 levels of risk, from zero to a scary graphic of zigging up and zagging down. If you choose the zero-risk tab, you are admonished that risk is never zero, and if you really have no tolerance for risk, you're on the wrong planet (that's how I'd word it; Edelman's webmaster is more tactful). So there are really 4 levels of risk tolerance. Then there is another question that evaluates the same trait in a different way, a few about objectives, your age and how much you'll be allocating, and you get your model.

The book has three parts. The first 7 chapters discuss retirement plans in all their variety, with frequent exhortations to take full advantage of any plan you're offered. In fact, if you don't at least have a 401(k) with some amount of company matching (AKA free money), he recommends changing employers. Of course it is also a good idea to fund your IRA every year also. Chapter 5 is titled "How to Save for Retirement When You Think You Can't Afford it". In a sidebar he mentions a study that found people making less than $13,000/yr spend about 9% of their income on lottery tickets. That's more than $90/month. For everyone who didn't win the lottery, it is lost money. If you have a way to put $90 into a passive stock fund, that is, an index fund tied to S&P 500 for example, after 40 years you'll have invested more than $43,000 and it'll be worth $200,000 to $300,000. That is the slow way to win the lottery!

He writes a lot about compound earnings. A halfway decent bond fund earns 4%/yr. Depending on market fluctuation, the index stock fund will gain 7%-10%. Let's pick 7% to be conservative. The first $90 you invest will grow to $1,350 in 40 years. Ninety dollars invested for 20 years will grow to $348. Each $90 investment grows for a different period, but they all add up to more than $260,000 over the total 40 years. Compare that to the lottery. One in 1,000 tickets wins a few hundred bucks in a "pick 3", one in 10,000 wins a few thousand dollars in a "pick 4", and one ticket in 100 million (or more) wins the millions at Powerball or a similar game. Everyone else has simply put a few bucks into a piece of paper they can throw away. This is why the lottery is called "a tax on people who can't do math."

The second section of the book consists of 5 chapters that discuss all the investment options (but as I wrote above, precious metals are not discussed only mentioned in passing). The 18 asset classes in the GPS model are all mutual funds or ETF's. Edelman doesn't recommend buying individual stocks or directly owning T-bills or other bonds. He has unearthed a marvelous principle for picking a fund: go for the lowest Expense Ratio, and of course, one with no "loads" (A load is the commission paid to the broker who sells you the fund. It is typically 4%, and some funds add another load when you sell, though it is a lower percent). The expense ratio is a management fee for choosing and trading the stocks or bonds or whatever. A study by Morningstar found that the performance of a mutual fund was better, the lower its expense ratio. Actively managed stock funds have ER's of 1% or more, averaging 1.4%. Bond funds may be lower, but usually exceed 0.7%. If a stock fund's basic performance is 8%, but you pay the manager 1.4%, your real performance is 6.6%. A passively managed (index) fund typically has an ER of 0.15% or less. One of those I own is at 0.05%. That is because these are easy to manage, and the fund company doesn't have to hire a highly-hyped "power manager". And they perform better. Even if my fund were to earn "only" 7.5% (it earns more), if I only pay 0.05%, the rest, 7.45%, is mine, and grows compounded!

Ah, compounding. It has been called the Eighth Wonder of the World. Over 40 years, $1,000 that earns 6.6% will become $12,891. But at 7.45%, it will become $17,711. That active, "higher returns" fund actually costs $4,820 per $1,000 you originally invested!!

OK, once you get to the third section, you have the meat of the book, 14 "best way" chapters that cover every situation leading up to retirement, living in retirement, how to (financially) handle life events such as divorce, and the best way to care for your heirs, should you see fit to leave something for them. I touched on a few items he covers in the discussion above, so I won't belabor. The 14 "best ways" are truly comprehensive, and of course, he advises seeking his services to get into more detail about your particular situation.

If you have no other book of such advice, or even if you have several, be sure to get this one and read it all. Even if you think you know everything in the first two parts, read them anyway, for the grounding, and to get used to the author's writing style: breezy, cheerful, and relentlessly right on the money!

A boon to day traders

kw: investing

I stumbled across this chart in Yahoo Finance some months ago. It expands the "compare to" function to include up to five stocks and indices. To generate this particular chart, for the current day and time, click here. Click on the chart to see a full size version.

These stocks are a portion of a portfolio I follow, of dividend-paying stocks. I had used the stock screener to find stocks with high dividends, then the history function to find out which of those has had stable dividends for the past decade or more. Then a tool like this allows me to pick a momentary low spot, which boosts the effective dividend yield.

I am not a day trader, but I do try to time my entry into an equity. Almost any stock will vary by 5% over a few weeks' time. Suppose I am interested in one that is very stable, and is currently yielding 5%; not only that, it has very seldom reduced its dividend despite large variations in the overall market. This makes it a good income stock. If the day the screener program showed its yield as 5.1% it was selling at $25, and has a very steady $0.32 per quarter, I'll watch it for a few days. A downturn in the market could drag it down to $22, at which point I might purchase it. The dividend isn't likely to change, but now the effective yield is 5.8%. And the company's underlying value is the same, so it'll be back at $25 before long, and may grow substantially from there.

Whether it does or not, every 100 shares purchased gains nearly 6 shares a year in reinvested dividends. Give it ten years, and I'll have 176 shares where I had 100. If the stock has also risen, that's an added bonus when I am ready to sell. By the way, I only trade stocks inside my IRA, so I don't pay ongoing taxes. The tax bill will be high enough when I take money out of the IRA anyway!

Market timing futility

kw: observations, investing

Look at this image for a while and let it sink in. It shows the correlation between the market change of AT&T stock on one day with that on the day following.

It was produced thus: At Yahoo Finance I entered the symbol T to get a stock quote, then in the navigator on the left I chose "Historical Prices" (the 4th item). In the page that comes up I set it for daily and used the default time span (from some time in 1984 to present). At the bottom of the page is a button for downloading an Excel worksheet; I clicked that.

In Excel, I copied the "Close" column (NOT "Adjusted Close") to a new sheet and labeled the column "Day1". I copied it again, starting at the second value, to the next column and labeled that column "Day2". This sets up the basic correlation. I highlighted the two columns and made an X-Y chart, then changed the symbol color to dark red. I set the scale on X to -3 to +3 and that on Y to -2 to +2, so the plot is approximately square. There are several data points in the range of 30 to 70, where the stock split. This scaling gets rid of those from the view, and focuses on the day-to-day variations in the range of a few percent or less, which is 99% of all the data.

Just for fun I performed a regression using Excel's Data Analysis package; the correlation coefficient was 0.0003, which is even closer to zero than I expected. Consider this visual proof that no matter what the stock did today, it has no bearing on what it will do tomorrow. Any slice of these data in any direction whatever is a random distribution, centered on zero, with heavy tails, meaning that larger jumps are more common than for a Gaussian distribution.

The only "market timing" technique that works is to hold a stock for a very stable company for a long enough time that the general rise in prices will bring you a gain, then perhaps watch it for a day-to-day variation that will snag you an extra percent or so, then sell. Of course, at that point, in what will you invest now? All the other stocks in the market have been going up also. So the basic method of "buy when you can, sell only when you need to spend the money" actually outperforms any "technical" scheme.

The P07 Indices of Investment and Prosperity

kw: opinion, finance, population, investing

One investment guru I listen to is Peter Lynch. In One Up on Wall Street, published in 1989, he wrote (I paraphrase) that in the thirteen decades since the financial markets were founded, stocks outperformed bonds in every decade except 1921-1930. Therefore, he reasoned, don't "diversify" by buying both stocks and bonds; a long-term investor ought to diversify into different kinds of stocks.

As it happens, it is a little hard to find out just what "different kinds" of stocks there are. Of a dozen or so indexes out there, the only one that significantly differs from the others, long-term, is the EAFE index of "world non-US" stocks. I have found it better to diversify by looking for mutual funds having differing stated strategies, as found in their prospectuses ("prospectus" is Latin, but irregular, or I'd pluralize it "prospecti").

However, as an aside for the purposes of this post, I've had a long, hard look at the Dow Jones Industrials index (Symbol ^DJI in Yahoo Finance). This chart, from Wikipedia, shows the index from 1901 onwards, on a logarithmic scale (so you can see the first 60 years above the axis).

(Click on any image to see a larger version)The biggest visible feature is the 1929 crash, which actually took four years to play out. The single biggest drawback to this image is that each datum is in current dollars. Thus the following image is the DJI divided by the Consumer Price Index (CPI). The downloadable data I was able to get dates from October 1928, when the DJI was finally settled on thirty stocks.

After 1934, we see five generation-long trends:

• 1934-1950 – A "flat" market, with lazy swings in a 2:1 range. This is what pink noise looks like. These are the Roosevelt-Truman post-Depression years.
• 1950-1966 – A rising trend with more structure. The intervention in Viet Nam began early in this period, but was unknown to most. The Eisenhower highway system and other infrastructure creation set the stage for "the good life" that ended during the Johnson adminstration.
• 1966-1982 – Dividing by the CPI shows that these "flat" years were actually a slow market fall of magnitude equal to the 1929 crash. Johnson, Nixon, and Carter each failed in his own way to reverse the slide. America was now alert to Viet Nam, and prosperous enough to focus more on the war than on the economy. The somewhat structured look continued; it was during 1950-1980 that the concept of a "business cycle" was developed. Such cycles vanished after 1984 (just when you think you've figured it out...).
• 1982-1999 – A strong rising trend, interrupted briefly in late 1987, with the sharpest (i.e. quickest) downturn ever. Reagan prosperity, which the policies of Bush "41" and Clinton could not reverse. Note the "cycles" are absent. This is now white noise.
• 1999 and later – A 3-year downturn and a 5-year recovery. Is this a return to 1932, or even 1966? No way to know. The Baby Boom generation is getting ready to retire, so their (our) narcissism will drive everything.

What do we make of it? I call this the P07 Investment Index, because it shows when it has been favorable and unfavorable to invest in stocks. Had you owned a lot of stock in 1966, by 1982 your portfolio's dollar value would have been just about the same, and you might have reaped dividends, but its real value became a third of what it had been.

Now, if somebody could have foreseen the strong upticks in 1967, 1970-1, and 1975-6, they could have made enough to stay closer to par, or perhaps show a minor profit. Back to Peter Lynch. He managed the Magellan Fund from 1977 to 1990. He had enough success prior to 1982 to stay on board, and after that, only an idiot could have lost money managing a mutual fund...and many idiots did! This era spawned the rise of index funds. Today an index fund is considered more of a hedge than as a way to make buckets of bucks.

There are two other factors to consider about the DJI. The increasing popularity of mutual funds after 1980 greatly increased the amount of money invested in the markets. There was also a great increase in population, which required more "stuff", and that drives an economy all by itself. I can't easily quantify the popularity factor, but I can get population figures. The following chart shows the US population and the DJI/CPI together.


Without further comment, let us divide these two. The following chart shows DJI/(CPI*Pop), scaled by taking the population in millions into my Investment Index. The result I call my Prosperity Index.


Why do I call it a Prosperity Index? It is a rough measure of the total value of the 30 DJI companies per capita, normalized to inflation. It is quite revealing. We've had three major "good times" periods since 1900: the 19-teens-20s, the 1950-60s, and the early 21^st Century, since about 1985.

What does this mean for an investor? There are two relevant factors. From 1950-1966, the Depression-era, now prosperous, parents of the Baby Boom generation spent gobs of money raising their kids and sending them to college. Huge numbers of new schools, colleges and universities were built during this time. Then the combination of Viet Nam's second phase (overspending and increased inflation) and the bad feelings (especially anti-establishment) of that era made everyone over-cautious, and actually reduced, for the first time in history, most people's economic focus. Money wasn't the only bottom line for a generation, and it showed.

After 1982, many Boomers had become the establishment, and began spending gobs of money, not only on their kids, but on their "lifestyles." I don't recall ever hearing the term "lifestyle" when I was young.

Now, although the "Bush years" have been America's most prosperous period in history, there is an increasing "feel bad" atmosphere and huge numbers equate the Iraq war with the Viet Nam war, though the analogy is atrocious.

My father had the bad luck to spend his 40s and 50s trying to invest profitably, in a time when it wasn't possible. Had he known what would happen from 1966-1982, he'd have bought land. I had the good luck to invest profitably when it was easy to do so. I think I need to reconsider my strategy. 2007 looks too much like 1966 for my comfort. Stay tuned.