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Showing posts with label Stock Market. Show all posts
Showing posts with label Stock Market. Show all posts

24 June 2017

Dave Ramsey Lie #5

#5 In Dave Ramsey's Continuing Series Of Lies

This is an excerpt from promotional material attempting to (illegally1) sell people the poor advice of one of Dave Ramsey's "Endorsed Local Providers"

"When Dave says you can expect to make 12% on your investments, he’s using a real number that’s based on the historical average annual return of the S&P 500. The current average annual return from 1926, the year of the S&P’s inception, through 2011 is 11.69%."

Let's take it one lie at a time. First, "He's using a real number that based on the historical average annual return of the S&P500." - True but intentionally deceiving.

This is one of many, many examples of Ramsey using the average person's ignorance against them. The statement itself is true. The deception comes in his use of the words "Average Annual Return". 
Knowledgeable financial professionals know the term is meaningless, and they know what Dave really means, but can't say, is "Compound Annual Growth Rate"


Let's look at it more closely;

"Annual Return" is, well, the annual return. If you begin the year with $100, and at the end of the year you have $110, you annual return is 10%. Simple? Yes. 

January 1       - $100
December 31 - $110
Return (or increase) - $10  *There can't be an "Average Annual Return", since there is only one year


Now, suppose at the end of the second year, you lose money and you end the year with $100 again. 

January 1       - $100
December 31 - $100
Return (or increase) - $0 

What is your total return for the 2 year period? 

ZERO. 

You started with $100 and at the end of two years you have $100. Your return is ZERO.
Every literate person can understand this.

But....

According to Dave "Liar" Ramsey, you made 5%.

He says your year 1 return was 10%. Your year 2 return was 0%.

10+0= 10 

divided by the number of years (2),

10/2 = 5

And viola! you have a "Average Annual Return" of 5%. 

Where is this $5 Dave? 


The Truth

Dave Ramsey is intentionally substituting the meaningless term 'Annual Average Return' for Compound Annual Growth Rate (CAGR). 

The CAGR is the number legitimate Financial Advisers use, and, with accurate informational input, can give you realistic numbers to use in making major life planning decisions. 

Ramsey knows when he says 'Average Annual Return', most people will think 'Compound Annual Growth Rate', even though they don't know the term. "They will think Dave Ramsey said I can expect to gain 12% per year, every year."  


Addendum

The Compound Annual Growth Rate of the Standard and Poor's 500 Index for the period 1929 to 2011 is actually 2.43%2, a huge difference from Dave's 12% Lie, and the real-world difference between a comfortable retirement and abject poverty. 




1- Securities Law, including the Securities Exchange Act of 1934, make it illegal to profit from the sale of securities unless one is licensed. Dave Ramsey is not a licensed securities professional, but receives "kickbacks" from members of his ELP scam

2- Adjusted for Inflation

14 March 2017

Stock Market Asymmetry and It's Implications



The dirty little secret of mainstream financial gurus.

Do you consider yourself an investor? Do you have a 401K or Defined Benefit retirement plan? Many people’s retirement funds are professionally managed and invested directly in stocks and bonds. Even if you never directly participate in the markets, you are affected by them, and your money isn’t as safe as mainstream financial advisors would have you believe.

Everyone knows you can take a loss in the market, as we have all been reminded the past few years. The critical omission is that this is guaranteed to happen. This post focuses on stock market asymmetry and what it means for the average investor.

Below is a chart I created plotting expected performance of the stock market versus actual for the past 80 years. The chart shows the total number of years the market was within 1, 2, or 3 standard deviations.


 


The chart illustrates the positive bias of the stock market. More importantly for this discussion, is the “fat tail” at the -3 sigma point. Normal Distribution would predict a -3 sigma event 1.8 years out of 80. However, there were actually 3 years when the market lost over 29.9% (3 standard deviations). Statisticians would argue this sample is not statistically valid due to the small sample size, and this argument is correct. However, it has been shown (by others) that this asymmetry holds no matter the time period. It is true for daily, minute and even tick values.

The stock market more closely follows a Power Law distribution rather than a Normal Distribution, but almost all common stock market tools, including the Black-Scholes option pricing model, use the Normal Distribution, ignoring the greater-than-expected risk of substantial losses. This is the dirty little secret of mainstream financial gurus.

 

The fact that the market does not follow Normal Distribution (the Bell Curve), has several important ramifications.

1.    In order to realize something near the 10.95% mean, market timing must be correct. Retirees do not have the flexibility of waiting +/- 15-20 years to achieve optimal entry-exit timing. If the market is in a much-greater-than-expected slump at retirement time, you lose. Survivors of the 1929 crash had to wait 40 years to recover their losses. Who can  postpone retirement an extra 40 years?

2.    The stock market is MUCH more unpredictable than commonly acknowledged or accounted for.

3.    Most investment mangers lose more money for their clients than they make. This sounds incredible but is true. Managers make a little bit of profit each year until a >3 Sigma event occurs (at a rate much higher than expected due to Power Law distribution of the market) and they lose more for their clients than they have ever made for them. I will try to elaborate on this proof in a future post.

4.    When mainstream financial experts claim you can expect x% return in the stock market over time, they can only mean one of two dishonest things; either “over time” really means an unknown (and unknowable) variable amount of time, or; they are citing a mythical Normal Distribution market.

5.    It is interesting to note, that in the financial gurus make-believe ND stock market world, Black Monday 1987 and the 2008 market meltdown are statistically impossible. Their models do not allow for these events yet they happened.

6.    Day trading is generally considered risky and perhaps much like gambling. The main reason is because optimal market timing is so important and it is infamously difficult to achieve. For investment and retirement funds the time period is the only difference. The importance of timing is exactly the same. Therefore, investing in a long term equities fund is fundamentally no different than the shadowy world of day trading.

There are better ways to invest that greatly decrease risk.



05 May 2016

Why Dave Ramsey is Wrong (Dave Ramsey Lie #1)






Many financial "gurus" like Dave Ramsey advise their clients to "Buy and Hold"; buy investments regardless of current market conditions and hold them for a long period. My personal favorite flavor of Buy and Hold is Dollar Cost Averaging where you pretend you didn't overpay for a particular investment.
Other advisers say to invest in actively managed portfolios with the (poorly thought out) idea of beating the market. Still others recommend investing in indexes that attempt to follow one or more of the popular markets and take advantage of the market's positive bias.

They are ALL wrong

They are wrong because they are either intentionally dishonest, or more likely, willfully ignorant.

 

What does a hedge fund manager do?

 

Imagine someone has a million dollars in stock. They want to protect their million dollars. So they "hedge" their million by buying an investment whose value is inverse to their stock. They could buy a Put option on their stock, and if the stock goes down, the option goes up. They can exercise the option and gain roughly the amount they lost on the stock. But the option itself has a cost. The hedge fund manager conducts these transactions for the stockholder, and in many cases they are the "Market maker"; the one who sells the stockholder the option.
This scenario IS a Zero Sum Game. Someone gains, someone loses. It sounds like a bad deal for the stockholder (it is), but more importantly, it's a very dangerous game for the hedge fund. Sooner or later,  hedge funds collapse. 
In the real world, hedging is not limited to options, futures, and futures option. The Now Even Bigger too-big-to-fail firms create derivative instruments so complex even they can not decipher them at times.*


The Financial Sector

 

There is no doubt some people make money in the financial sector. We all hear of the success stories. But we seldom hear of the millions who lose. That's just human nature, the winners are celebrated and the losers are forgotten. But the winners all have one thing in common - they have an edge or angle. Where does the wealth of the multi-billionaire hedge fund managers come from? Does it come from growth? Added Value? No, the majority comes from the losers. That isn't to say the economy is Zero-Sum; it isn't. But economic growth can not account for all of the wealth accumulated by the top winners.


The Unpredictable Market

 

The US stock market has dropped in excess of 40% five times in the last 80 years. None of these declines were predicted mathematically. In fact, According to the models used by financial advisors, those declines were impossible. Impossible as in even one of them could not happen in billions of years. But they happened. I explore the reasons why in other posts.


As a result of this phenomenon most (all?) successful managers destroy more wealth than they have ever created.  

This wealth destruction happens because investors entrust successful managers with more money as they become more successful. The few managers who make money do so not because they are highly competent, but because they are simply lucky with favorable timing.


Why Dave Ramsey and most all other so-called experts are wrong.

  

Financial experts fail their clients by not taking into account or informing their clients of the true nature of risk. Whatever their favorite advice, they always discount risk. They happily plod along, advising their naive clients, and some of them make outstanding returns. Then something like Black Monday happens and all the gains they previously made are wiped out. But, the expert shrugs his shoulders and says that's life, no one could have seen that coming. 

No one could have seen that coming. 



And that's exactly the point. Because they can not properly quantify the risk, they ignore it. Because of this omission, investors are guaranteed to always lose unless their execution timing is exactly right. We know that is impossible. 

This exact phenomenon has been recurring over and over since markets have were invented. And it will continue.

There is a better way. 


* This was an aspect of the so-called Housing Bubble in 2008. Investment banks fraudulently created derivatives so complex they could not decipher them. The government stepped in, and they nor the contractors they brought in could not decipher them. In the end, taxpayers paid off the investment banks and their insurance companies the amount they claimed to have lost. A real-life example is a poker game, where one person wins all the money on the table. Then the government comes in and repays all the losers whatever they claimed to have lost -with no proof.










05 April 2013

Economics Is NOT Rocket Science - Stages of the Economic Cycle



This blog was created to simplify the alchemy of economics. Economics is not rocket science, . I maintain that it isn't even a science at all. Behind the facade of formulas, theories and schools, the underlying principals are relatively simple. 

The issue is separating economics from business and investing. Both are essentially the study of people. In economics, if people do a, the result is x. If they do b, the result is y, and so on. The problem in business and investing is trying to predict if and when people will do a or b. Of course, this can be impossible, and is the reason business and investing is difficult....and complex. 

In economics there are "laws" or "rules". Economics doesn't follow the Austrian School some of the time and the Chicago School some of the time. This is ludicrous, despite the fact there is a huge industry of producing and employing economists and researchers. The Federal Reserve itself employs over 300 PhD level professionals. 

So in the interest of offering people a clear view into the obfuscated world of economics, I am re-posting an article from a couple of years ago outlining the true stages of the economic cycle. This cycle has been repeated over and over throughout the history of mankind, and despite of, or perhaps because of, our technical progress we are still subject to the same cycle. Because we are now in stage 11, it is important to know the truth.


True Stages of the Economic Cycle 

1. Hard Money. A form of currency is established to facilitate commerce. In order to gain acceptance the currency is backed by something of intrinsic value such as precious metals. This is known as Hard Money.

2. Debasement of the Currency. It is immediately evident that “free” wealth can be created by Debasing the Currency. In its most fundamental form this involves the practice of charging interest (or usury, the meaning has been exactly the same throughout history up until recent times).

3. Enactment of Legal Tender Laws. Without Legal Tender laws, implied values are self correcting and always closely match true value. Legal Tender laws greatly facilitate the debasement of a currency. The Founding Fathers knew this, Thomas Jefferson wrote: 

"If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered".
 
The U.S. Constitution, Art. I Sec. 10 Cl. 1, states: 

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts;"

The Supreme Court ruled in U.S. Supreme Court - Wheaton 1827; 

“The prohibition in the constitution to make anything but gold or silver coin a tender in payment of debts is express and universal. The framers of the constitution regarded it as an evil to be repelled without modification; they have, therefore, left nothing to be inferred or deduced from construction on this subject.”

4. The Accumulation of Debt is unavoidable with legal tender laws in general, and especially in a Central Banking scheme such as our current Federal Reserve, in which the perpetual increase of debt is an essential component.

5. An Illusion of Economic Prosperity is created by the accumulation of debt. This is no different in principle from a person going on a spending spree with credit cards. They have the illusion of being very prosperous, but in reality they are destined for a reckoning when the debt cannot be paid.

6. Monetization of the Debt. As the accumulation of debt becomes unmanageable, it become necessary to monetize the debt. The debt grows so large it cannot possibly be paid. There are a few ways to “resolve” this. 

  • The most obvious way is through taxation, but this is never politically acceptable. 
  • Another way is by directly devaluing the currency. This has been done many times in history, but is also not very politically acceptable.
  • The third, and easiest (for leaders at least) is hyper-inflation. In simple terms hyper inflation erases debt by transferring wealth from individuals to government.

It is apparent that all three solutions have one thing in common – all transfer wealth from individuals to government, or more accurately, to the central banks.

7. Dilution of Currency Value The process of monetization directly causes a Dilution of Currency Value.

8. Loss of Confidence. In essence Consumer Confidence is a measure of how well the taxpayer is being fooled into thinking all is well. The dilution of his buying power caused by the dilution of currency creates a Loss of Confidence.

9. Inflation. As buying power decreases, the consumer tries to make up the difference by charging more. The merchant charges more for his goods, the laborer demands more for his services. This is classic Inflation.

10. Inflation Stabilizes as government  implements inflation control measures, but does nothing about the underlying problems, causing a:

11. Return of Inflation, quickly followed by:

12. Hyper-Inflation, which effectively erases the debt. If the U.S. experiences the level of hyper-inflation similar to Hungary in 1946/7 (42 QUADRILLION percent per month), the entire national debt could be paid off with less than a penny. This may sound like a good thing to some, but the truth is, wealth is simply transferred from private individuals to the government. This is the stage of Reckoning. It is obvious that there was no real wealth created in phase 2. This is the essence of my argument against the “Economy creates wealth” proponents. Economic trickery does not create wealth. It never has and it never will.
The wealth transfer causes:

13. Depression, which leads to:

14. Reorganization of Government. It is only at this point that a significant number of people understand the inextricable link between wealth and real money. This enlightenment leads to:

15. Return to Hard Money, and the cycle repeats.


These phases are exponential in nature. The time from the debasement of a nations’ currency to the loss of confidence in that currency can be measured in decades or even centuries. The time between the loss of confidence and inflation however, may only be weeks or months. In the later stages of hyper-inflation the loss of a currency’s value and the accompanying price increases can double in days or even hours.[1]
It should also be noted that inflation is not bad for everyone in equal measure. It is actually a good thing for those people of means who are in a position to borrow to purchase property. The reason is the same; the repayment of debts, is made in currency that is worth less than the currency originally borrowed. This is also the reason working people cannot prosper during times of inflation or hyper-inflation. Wages are generally not indexed to inflation and always lag price increases. Even in the case of the relatively few people whose wages are indexed to inflation, the adjustment is always done after the fact. Loses accumulated from the previous adjustment are never recovered.


[1] In the Weimar Republic in 1923 workers demanded, and were paid three times a day in order to be able spend the money before it lost further value.