Obviously, my site features some banner ads from Google. These ads bring in enough revenue to cover the costs of the web hosting (if that). Well lately I’ve been seeing ads encouraging people to buy California Bonds at this site:

Buy California Bonds

I’ve never seen a state so aggressively advertising their bonds in banner ads. I can’t say it would put my mind at ease if I owned California Munis to see this.

EDIT: I’m not the only one who noticed this:

Bill Lockyer Goes Direct To Retail Investors With The “Terrific” Opportunity To Front Run Institutional Investors In Cali Bonds

EDIT #2: Here’s the ad that just showed up on my site:

Oh! The offer ends March 10th! Better hurry! I’m sure they’re selling like hotcakes so don’t miss out!

Over at the Diehards forum a conversation came up about the fad of Person to Person (P2P) lending.

When I first saw this idea years ago, the first word to pop into my head was “foolish.”

The first reason I knew it was foolish is because business magazines thought it was a great idea.

The second reason is why in the world would anyone make an anonymous loan over the Internet to someone they know virtually nothing about? I’d rather just donate the money to charity where it could be better used.

What’s funny though is that these sites got started for reasons of undermining The Man (being the banks) that are so mean by requiring, you know, to prove credit worthiness. How archaic! Clearly we live in a world now where deadbeats, I mean “sub-prime borrowers”, are not risky at all. We’ll just do P2P loans and sing Kum-Ba-Ya and it will all work out and we’ll cut out those greedy middlemen.

But maybe The Man had this figured out long ago as the default rate on these peer to peer loans is abysmal. Check out the graph from this blogger:

http://www.prospers.org/blogs/Fred93

Prosper Default Rates Over Three Years

Since loans that are one month late nearly always default at these sites, that’s a 20% default rate after the first year and keeps going up the longer the loan is. Ugly! Now we know why loan sharks need to charge so much to their clients to turn a profit. No real bank could survive on default rates this high.

But it seems that sites like Prosper.com are trying to clean up their image.

Clark Howard reports:

But now Prosper is back in action with a relatively low default rate of 5% among borrowers, according to Barron’s. This service and its competitors are now putting people through their paces to weed out the baddies. The company claims 850,000 members and just a little under $200 million in loans underwriting at this date.

Lending Club has a 3% default rate, meanwhile, and turns down 90% of potential borrowers in an effort to cull the herd and find the most credit worthy.

The article follows up with this salient point:

That, of course, begs the question: Why would anyone go the P2P route if you’re credit worthy?

Yeah that’s pretty much what I think, too. If someone needs a loan from P2P they are probably doing it because nobody else trusts them enough.

But what about the returns?

The returns you might get as a lender can be enticing. Prosper claims the average lender earns 7% on their money, net after expenses and charge-offs. But those who are really into this virtual underwriting boast that they can make a 12% return.

The stock market has averaged around 9-10% a year the past 80 years. And now they’re telling me I’m going to beat the market by 20% a year with 12% returns by making loans to anonymous people that can’t get a real low-interest rate loan from a bank? Sounds like BS to me. If someone claims you are getting above market returns you are taking above market risks. There is no free lunch.

If I wanted to risk a 12% return (and let’s not kid ourselves because it would be quite risky) I’d just put the money I was going to use for P2P loans into a volatile emerging market stock index and let it ride. It may be a bumpy ride, but it could pay off. Yet, I may not get 12% over time but I’m not going to lose -100% either like with a large number of P2P loans. And for 7% returns? For that I’d just put it in the Permanent Portfolio allocation and go do something less stressful with my life while earning more money.

What’s most interesting is that these P2P sites started up to give loans to people that evil banks wouldn’t consider because of the credit risk. Now they are turning into weeding out credit risks just as evil banks do because of the deadbeats ruining it for everyone. In other words they’re turning into….evil banks! The hippies must be choking on their granola at this thought.

From all of this there is a lesson to be learned and that is that banks can seem heartless at times, but they have their reasons. Ultimately, as a depositor giving them my money to help fund loans for others, I want them to be picky. When they’re not picky (or told to not be picky by government rules) we end up with things like real estate bubbles where someone earning $20,000 a year is given $500,000 to buy a house. Also, loaning money to someone who can’t pay it back just makes that person’s situation worse by straddling them with more debt. How is that fair to them? It’s an overall bad deal for everyone involved.

Yeah I know there are some people that are not deadbeats in this P2P thing and could be good loan risks. But mostly I think these loans won’t lead to any additional profits vs. just doing something simpler (and safer) with the money. If you are trying to be charitable, then just donate the money to charity.

Overall, this entire idea of P2P loans reminds me of an Onion article I read a while back.

What was this stuff I kept hearing last year about the dollar crashing? In December 2009 this talk reached a fevered pitch. Here’s the dollar index over the last year and you can see how much it’s recovered since the dark days of December 2009:

You can track the US Dollar index at this link.

Since this time the Euro has taken a pounding due to the issues with Greece possibly going into sovereign default. This drove the Euro down and the Dollar was the beneficiary. I’m not a dollar bull necessarily, but I post this just to show (yet again) that reacting to news that everyone else already knows is rarely a good way to invest. The markets are random and things we think must happen may not happen for a very long time (if at all).

Best to ignore all of the financial news and just stick to a simple diversified portfolio that can take care of you whether the dollar is sinking or flying.

For our readers across the pond there is another blog that focuses on Permanent Portfolio investing. The blog by Marc de Mesel looks at investing in the Permanent Portfolio from a European perspective. The blog is in Dutch, but Google translate does a passable job for those looking for foreign analysis of investing markets:

Marc de Mesel’s European Permanent Portfolio Blog (Dutch)

Marc de Mesel’s European Permanent Portfolio Blog (Translated through Google – Click on the blog links and they will translate for you.)

Marc covers many topics affecting Europe that aren’t covered here. He runs his own Permanent Portfolio using European-centric assets (like German Govt. Bonds vs. US Bonds). You’ll enjoy it whether you live in Europe or not. Check it out.

UPDATE: Marc adds that he still has a couple articles up at this link that discuss the Permanent Portfolio. In particular, he provides an interesting analysis of how the portfolio would have fared vs. a stock/bond only portfolio during Iceland’s 2008 currency collapse:

English European Permanent Portfolio

Sure it is! And I wish I could have my home destroyed by a tornado tonight so I can support the local construction workers. Maybe I’ll luck out and get killed at the same time so the coroner has some work to do as well.

This is what’s called the Broken Window Fallacy as presented by Frederic Bastiat in his essay That Which is Seen, and That Which is Not Seen. It’s also the main theme in the classic book by Henry Hazlitt: Economics in One Lesson - An easy to read book that is required for anyone interested in understanding economics.

Here’s the jist of of the fallacy:

If someone comes and throws a rock through a window in my house, some say we should not punish this vandal but praise him. After all, now I need to buy a new window and this puts the people in the glass business to work which is good for the economy. But what about the fact that now I have to buy a new window? Maybe I wanted to spend that money on a new suit or a new camera or another product? So the glass company has work to do, but what about the other people who could have gotten that money instead?

I know this makes perfectly good sense, but many prominent (and award-winning) economists believe that doing destructive things, and having destructive things happen, is good for everyone. In this view the vandal isn’t some rogue, but some type of rock hurling employment agency.

Like the vandal’s broken window, wartime is a waste of resources. Instead of factory workers producing something more useful like computers, cars or appliances they’re making products designed to get destroyed like bombs, tanks and planes. The people in the cities where the bombs fall (assuming they survive) now have to rebuild the city structures that were leveled instead of using those resources to enhance the city further. Soldiers on both sides are slaughtered and can’t contribute to the economy in their former professions. Politicians may come up with a myriad of reasons that a country may want to wage a war, but being good for the economy certainly isn’t one of them.

I really wish this fallacy would die. But sure as the sun will come up tomorrow, you’ll hear this dumb idea get trotted out after the next major disaster or war as if these events are some type of benefit to society. Next time you hear someone using this line of reasoning for justifying destructive acts, do me a favor and relay the story of the broken window and fix their thinking.

I was going through some old investing books today getting ready to dispose of them to make room on my shelves. When paging through the candidates for removal, I saw so many complicated investing strategies. Some of the portfolio recommendations held 10 or more different mutual funds as part of their allocations! I bought these books early in my investment career and during that time they convinced me that only a complicated investment strategy could deliver diversification and performance.

Boy, was I wrong.

After looking back over the many years when I first bought these books it showed me this: Despite the complexity of these various strategies, not a single one of them added anything significant to investor diversification over this time. Owning a bunch of stock funds does not make you diversified. If anything, these approaches were tremendously risky for what you got out of them. Yet, the approaches hid those risks by making you think you had diversification because you owned so many different stock assets.

Well, stocks share the same market risks by and large because of the deep interconnections that exist between them all. Just because an investor owns some small company stocks, large company stocks, foreign stocks, etc. is no guarantee that a bad bear market can’t come up and bite them all at once. I didn’t go back and run the performance numbers, but my quick look predicts that over the period I owned the books they wouldn’t have done any better than a simpler portfolio. With the additional trading and management costs involved, there is a chance they did worse than a simpler approach.

This just reminded me how important it is to keep investing simple. Complicated investment schemes can hide many risks and expenses. The simpler you keep investing, the less chance you have of making a mistake. Investors don’t need to follow complicated investment plans to get good results.  Indeed, I’ve found the simpler you keep investing the more likely you are to turn a good profit and not face any wicked surprises.

After 2008 many people swore off stocks. “Too Risky!” they say and then tell you about their hot new investment in a multi-level marketing scheme or their Uncle’s new franchise opportunity. Isn’t it funny how whatever assets you don’t own you always think are “too risky” when someone else owns them? I’m as guilty as the next guy on this. For instance, I don’t touch junk bonds and emerging market debt. It’s too risky. But I think I can make a better case for this position than people who don’t own any stocks for the same reason.

I own stocks and I admit it. I feel comfortable with stocks in my portfolio because they represent an ownership stake in the productive capacity of my country. Every time someone buys a Coca Cola, a computer or any other product they hand me money through the profits. When I’m awake they are handing me money. When I’m asleep they are handing me money. They are handing me this money 24 hours a day and seven days a week across the planet as they make their purchases.

Stocks have risks. Sometimes these risks show up in big price declines. But sometimes these risks cause the prices to climb far higher and faster than any other asset you can own. Over time, stock dividends reinvested can grow capital by large amounts through compounding. This makes it different than assets like gold which cannot grow on its own as it pays no dividends.

While market risks can impact a company’s stock over a period of time, I also realize that most companies are resilient and can adapt to changing economic conditions and survive. Not all of them can do this, but most do. This is why I own a broadly based stock index fund. Such a fund may own over 5,000 individual company stocks. This means any one of company going bankrupt has an insignificant impact on the entire portfolio. Not only this, but stock index funds are cheap. Every penny an investor saves in management fees is another penny in their pocket each year to compound and grow.

I know the markets have proven to be efficient over time. This means it’s almost impossible to outperform the market averages as everyone else on the planet receives the same information you do almost instantly. I recognize that sometimes the markets are not 100% efficient all the time. But I also recognize that it’s close enough that debating the point is academic because rebalancing between assets eliminates these risks.

I admit that all the brokerage houses receive news of major events within seconds and have computers and people that will trade positions just as fast in reaction to it. Therefore, I don’t try to compete with these people by out trading them because someone like me is always the last to know. Instead, I just hold on to my boring index fund that owns everything and profit from the thrashing the professional and amateur traders are doing underneath. Over time, my index fund will beat in excess of 95% of all of them.

The markets are random. The price movements are not predictable day-to-day or even each year so I balance my stock ownership with assets like bonds, gold and cash. I don’t own just stocks because owning 100% in stocks is extremely risky and not guaranteed to bring any more success than a diversified portfolio. I know there have been protracted decade-plus stretches where stocks have performed poorly in real terms (such as the 1970s and 2000s). Therefore, I reject the idea that stocks are the only asset any investor needs. Instead, I diversify just in case the next decade of under-performance happens to be during a period of time when it could hurt me.

I understand that portfolios which do not have any stock exposure face the risk that they will not be able to grow faster than inflation over time. So I accept that stocks have risks of loss in order to ensure I have the chance to take advantage of gains when they present themselves to grow my money. Although assets like gold and bonds by themselves are useful to diversify against certain market risks, I know they may not be enough to beat inflation and grow the portfolio alone. That’s why I own stocks.