THE FINANCIAL PHILOSOPHER

Socrates' Advice to Today's Greece

"I do nothing but go about persuading you all, old and young alike, not to take thought for your persons or your properties, but and chiefly to care about the greatest improvement of the soul. I tell you that virtue is not given by money, but that from virtue comes money and every other good of man, public as well as private. This is my teaching, and if this is the doctrine which corrupts the youth, I am a mischievous person." ~ Socrates

Every time I see news coverage of street protests in today's Greece or of political leaders discussing Greek Austerity, I imagine if Socrates would be there among the protestors and, if so, what he might say or do.  Would he support the protestors?  What might he say to the government leaders?  Would he approve of Greek Austerity measures?

Luxury is Artificial Poverty

Socrates never recorded any of his thoughts or ideas on paper and all that is known about him comes from the writings of his contemporaries, such as Plato.  However, it is clear from these writings that Socrates cared little about money and materiality and he certainly shared no affection with the ruling Aristocrats.  Many accounts of Socrates make him out to be something of a poor, unattractive hermit wandering the streets of Athens teaching his philosophies to anyone who would listen.  In a time when men labored for a living and spent much of their free time working for the affairs of the city and aspiring to political power, Socrates did neither.

In today's Greece, I imagine Socrates would still find himself in the unique position of standing in a corner completely his own--neither with the protestors, nor with the government.  While he might sympathize for the struggle of the Greek people against the governing leaders, he would remind the people that money is the corrupting force at the root of all of their troubles and that they would find contentment to let go of their material desires and to end their reliance on government to cure their ills.

Socrates to Greece: Die But Don't Forget to Pay 'Debt'

The featured quote at the beginning of this post comes from Plato's account of the trial of Socrates, where Socrates was accused of "corrupting the youth of Athens" and was given the choice to either denounce his philosophies or die by drinking the poison hemlock.  Socrates chose death.

His last words were reportedly spoken to Crito, where Socrates said, "We owe a rooster to Asclepius. Please, don't forget to pay the debt." Asclepius was the Greek god for curing illness.  Therefore these words are interpreted to mean that death is a cure and a means to freedom.

I would never expect a political body to take the path of a wise philosopher, but Socrates would likely say today that Greece must metaphorically die--to split from the European Union--to be cured of its ills... And, yes, don't forget to pay your debt to Asclepius...

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Related: What Would Plato Think of the Greek Financial Crisis?

Why Index Funds Had a Record Year

"The little reed, bending to the force of the wind, soon stood upright again when the storm had passed over." ~ Aesop

Living on the coast of South Carolina, I can attest that a flexible nature is required to survive the most powerful tropical storms: 

The hardest of woods break and the softest of reeds bend.

This go-with-the-flow nature extends to escaping deadly rip currents in the tide and it also applies to navigating the volatility of financial markets.

On my mutual funds site today, I wrote how Index Funds Had a Record Year in 2011.  This milestone was marked by the record amount of investor money flowing (fund flows) into index funds.  In contrast, one of the largest mutual fund families, American Funds, had record outflows.  Why is this significant and what does it have to do with reeds in the wind?

"Thus what we gain is Something, yet it is by virtue of Nothing that this can be put to use." ~ Lau Tzu

Index funds are passively managed, which means there is no fund manager or team of managers trying to "beat the market" by using their knowledge and skill to research and analyze stocks with the greatest prospects of high relative returns.  Instead, the objective is to simply match the returns of the benchmark index, such as the S&P 500 -- an example of knowledge yielding to humility.  This passive nature keeps expenses low and eliminates the risk of human error caused by emotion (i.e. greed, complacency, and hubris) and it reduces the risk of inferior returns due to a random set of unforeseen circumstances (bad luck).

Actively-managed fund managers attempt to beat the market, which is the primary reason why most actively-managed funds lose to passively-managed funds over long periods of time.  In summary, the higher expenses and greater exposure to human fallability is why S&P 500 Index Funds Beat the Pros in 2011...

Passive funds bend; active funds break.

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Thoughts on Taoism, Rip Currents and Market Cycles

Quotes on Contentment

Why Index Funds Beat Actively-Managed Funds

Lau Tzu Beats Wall Street in 2011

"Those who have knowledge, don't predict. Those who predict, don't have knowledge." ~ Lau Tzu

The title to this post was written with tongue only partially in cheek: The passive investor, in the spirit of Lau Tzu and the Taoist philosophy, proved once again in 2011 that going with the flow of nature most often provides the greatest results.

"Nature never hurries, yet all is accomplished." ~ Lau Tzu

Lau Tzu's Taoism is largely based upon the wisdom of applying the rythms and balance of nature to one's behavior and to one's life in general.  Humans are a part of nature and, as I often like to point out here, human nature extends to financial markets. 

As I addressed in my Angles post, going against the crowd has its merits at times both in life and in investing, but unless the investor receives intrinsic value from the act of investing, the go-with-the-flow nature of passive (index) investing is the best approach.

This passive indexing style vastly outperformed actively-managed funds in 2011. For example, the S&P 500, including dividends, was up 2.11% in 2011 while the average large blend category fund gained just 0.02%. In different words, it paid to just go with the flow of the broad market last year rather than buy an actively-managed fund. 

Index funds don't beat fund managers every year but there is certainly enough historical data to show that most fund managers do not outperform the broad market indexes on a consistent or long-term basis. As I enter my sixth year as the owner of an independent investment management firm, I've become increasingly humble as I continue to align my investment philosophies with balance and passivity (the attempt to beat the market often ends in the opposite result).

"Health is the greatest possession. Contentment is the greatest treasure. Confidence is the greatest friend. Non-being is the greatest joy." ~ Lau Tzu

Unless investing provides a significant level of non-financial reward for you, there is no good reason to ever attempt to "beat the market."  In 2012, enjoy the richness of life by applying the natural virtues of patience, moderation, contentment and simplicity.

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Related:

Angles

(Why You Need to) Get Rich Quickly

Quotes on Contentment

Nothing Is Ever 'On Sale'

"What is a cynic? A man who knows the price of everything and the value of nothing." ~ Oscar Wilde

The phrase on sale has a misleading connotation, which, in conventional use of language, suggests the price of a given product or service is below its respective intrinsic value.  In other words, the seller is implicitly or explicitly saying, "This is a good deal!  Buy it!"

Sales are insulting to the intelligence of the thinking person. 

If I didn't want the product or service before the so-called sale, a lower price doesn't motivate me to buy it now. The motivation for buying something is based upon value, not price.  Similarly, there is not always a correlation between price and value; a high price does not mean high value and a low price does not mean low value.

A thing may be for sale but it is not on sale.  There is a difference.

In extremely simple terms, the market value of anything is the price that a buyer is willing to pay for it: The basic rule of supply and demand reflects market value. If a food item at a grocery store has a two-for-the-price-of-one special today, it likely means that the particular item is overstocked and/or near the end of its shelf life.  No one bought it at the higher price.  Therefore a lower price is the best means of attracting a buyer to make the sale.  The grocer is not trying to be a nice person; they need to sell the item. 

"For some reason people take their cues from price action rather than from values.  Price is what you pay.  Value is what you get." ~ Warren Buffett

Stocks are never "on sale."  Market values fluctuate based upon the perceptions and behaviors of market participants--the buyers and sellers.  If shares of XYZ stock are in low demand because of perceived value (which does not always correlate with fundamental value) the share price will fall.

If you buy shares of stock or stock mutual funds because you believe they are "on sale," you may be disappointed when a greater "sale" occurs.  The conscious investor or any thinking person buying goods and services in the markets of the world must ignore the noise of the market place.  If a price is "marked down" or "half off," it does not indicate a bargain.  It simply means the price has fallen to adjust to market value.  Similarly, if the media pundits are all saying, "Stocks are over-priced," this is a generality and only speaks to the short-term.  It's noise.

Here is the bottom line:  Nothing is ever on sale.  In fact, the market value should not even be the primary factor in making the decision to buy or sell anything; the market value should not dictate your value.  The true value of anything, with regard to your buying and selling decisions, is what it is worth to you, not to the market.  For example, if you believe your car is worth $10,000 but the market says its worth $5,000, you should absolutely keep your car.  Similarly, if the share price of a particular investment has fallen and you believe the market value has finally reached your value, you should consider buying it.

Think before you buy or sell.  To live well is to think well.

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Related:

The Greatest Source of News You Can Use

The Reason for the Market Freefall in One Word

Why There Will Be No 'Double-Dip' Recession

"Some economists are so attached to the notion of growth that they can’t let go of that word, so they refer to recession as a time of 'negative growth.'" ~ Eckhart Tolle

What is a double-dip recession?  The last recession ended in June of 2009, which means the current recovery is more than two years old now. Following the logic of economists still calling for a double-dip, why not call it a triple-dip or something more logical like a secular cycle beginning in March of 2000?  If and when we enter a new recession it won't be a double-dip; it will simply be a new recession.

I can see the reasoning of Investopedia's definition of double-dip recession, which is "When gross domestic product (GDP) growth slides back to negative after a quarter or two of positive growth."  However, assuming this quarter ends positive, the US Economy will have had nine quarters of positive growth.  That's not a double-dip recession by their definition.  (By the way, isn't all growth positive?  And why do economists use the term "negative growth?"  That's like saying, "cheeseburger without the cheese."  But I digress...)

I can also understand the reasoning of naming what may become a double-dip recession based upon the lagging employment and housing sectors of the economy.  It "feels" as if the previous recession never ended.  So one may reasonably say that any new recession that occurs after short-lived growth, and due to various economic challenges, such as layoffs, corporate cutbacks, and poor consumer confidence, arising from the previous recession, may be called a double-dip recession.  I can see the reasoning of the name but I still don't like it...

"He that knows he has no other than particular ideas will not puzzle himself in vain to find out and conceive the abstract idea annexed to any name.  And he that knows names do not always stand for ideas will spare himself the labor of looking for ideas where there are none to be had." ~ George Berkeley

Please accept my apologies for the mild symantic rant but I do not see any good use of logic or practicality of naming two recessions in relative proximity to eachother a double-dip recession.  This would be like naming two separate scoops of ice cream several inches apart a double-dip ice cream.  Even my 6-year old understands this logic.  Essentially, a double-dip ice cream consists of two scoops combined to form one oddly shaped scoop. 

If a recession occurs in the near future, it will be a new recession, distinct from its predecessor.  Therefore, we have two recessions in proximity--not one recession with a catchy name:  There will be no double-dip recession.

I do need to remember, however, that double-dip recession is simply a term generally accepted by economists and mainstream media, which makes the term conventional.  Ahhh, now I know my problem with the term--it's conventional!

What are your thoughts?

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Related:

Contrarian View: V-Shaped Recovery

Are You an Imbecile, A Pointer or Neither?

Master (or Be Masterd By) Language

Reality Check: Average Market Corrections

"Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic." ~ Charles Sanders Peirce

I'm a logical thinker, which is both strength and weakness.  With regard to financial markets, logical thinking has helped me make more good decisions than bad.  Where my logic is challenged is when faced with an irrational crowd: I have to minimize my ego that wants to ignore herd behavior and remember that the crowd is "right" more than it is wrong, at least with regard to the movement of financial markets.  Perhaps better wording is that the crowd dictates the movement of asset prices; irrationality (psychology) is at times more a factor than actual economic conditions.

"Histories make men wise; poets, witty; the mathematics, subtle; natural philosophy, deep; moral, grave; logic and rhetoric, able to contend." Sir Francis Bacon

The logical thinker, in the case of the current financial crisis, will look to history, not as a basis from which to make a decision, but as a place to begin the thought process.  The reasoning is that crowd irrationality will at times become so far removed from reality that a logical, rational investor can do quite well to recognize disconnects in stock price movement.  The challenge, of course, is to guess how long the "disconnects" will last.

Here are some historical averages, thanks to a weekly newsletter that Fidelity sends to investment advisors, that may not predict the future but perhaps may give the rational, logical investor some perspective on market "corrections."

• Average Frequency of Market Corrections: 5% corrections occur 3 times per year, 10% corrections once per year, and 20% declines occur once every 3.5 years.
• This is the first 10%+ correction of the year.
• The market is 11.3% off its recent peak and 12% off its cycle peak
• Can we go down further? Yes, but big corrections (>12%) are normally associated with recessions or markets that are overvalued.
• The debt ceiling crisis has passed.
• 75% of companies beat earnings estimates.
• Oil is back under $90.
• Car sales are up 5.8% year over year.
• Signals from the bond market: Credit spreads are currently holding in well and all recessions have been preceeded by a flattening of the yield curve (relation between the interest rate and the time to maturity of the debt for a given borrower), which is not currently the case.

For added perspective, this information came from a source (Fidelity) that has an incentive to incourage investors to put money back into the market.  The key takeaway from this is that investors, reflected by current stock prices, are "anticipating" recession.  If the crowd is "right" we will re-enter recession.  If investors begin to see evidence that the US economy will avoid recession, stock prices will climb again.

In summary, irrational behavior can create the event that was initially not "real"--a self-fulfilling prophecy.  This is where neither logic nor emotion are useful for decisions; it is perhaps a time for another imperfect decision source--intuition.

"Those who have knowledge, don't predict. Those who predict, don't have knowledge." ~ Lau Tzu

My intuitive thought is that this is a severe but short-term correction.  With that said, however, I am mostly a passive investor; I believe the best reaction in extreme conditions is no reaction at all.  Therefore, I never make predictions.  The best decisions are made in the planning stages prior to the emotional event.

What are your thoughts now?  Is this a short-term and classic case of crowd irrationality compounded by a fast-moving and ever-present media?  Is crowd behavior creating a self-fulfilling prophecy (e.g. falling stock prices worsens consumer spending, which harms the economy)?  What are you doing now? 

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Related: The Rhyme of Irrationality

Guidance From Dead Philosophers

Whenever a timely milestone, such as this new calendar quarter and the second half of the year, is reached I do my best to resist the tiresome looking-back-and-looking-forward ritual.  To remove myself from the timely chatter, I indulge in the timeless words of philosophers from another age.

Who better to provide the greatest unbiased perspective on today's world than those who are not living in it?  Who would you prefer -- today's politicians, technicrats and mainstream media?

As we move into the third quarter, consider this guidance from dead philosophers:

...those who wish to know in what direction they are going would do well to give their attention not to the politicians but to the philosophers, for what they propound today will be the faith of tomorrow. ~ I.M. Bochenski (1902-1995)

Even if someone knew the entire physical history of the world, and every mental event were identical with a physical, it would not follow that he could predict or explain a single mental event (so described, of course). ~ Donald Davidson (1917-2003)

We do not, in fact step out of the movement of things, ask 'What am I to do' and, having obtained an answer, step in again.  All our actions, all our questionings and answerings, are part of the movement of things, and if we can work on things, things can work on us... ~ John Anderson (1893-1962)

All human situations have their inconveniences. We feel those of the present but neither see nor feel those of the future; and hence we make troublesome changes without amendment, and frequently for the worse. ~ Benjamin Franklin (1706-1790)

A crust eaten in peace is better than a banquet partaken in anxiety. ~ Aesop (620-560 BC)

And as imagination bodies forth the forms of things unknown, the poet's pen turns them to shapes, and gives to airy nothing a local habitation and a name. ~ Shakespeare (1564-1616)

A hidden connection is stronger than an obvious one. ~ Heraclitus (c.536-470 BC)

It is the mark of an educated mind to rest satisfied with the degree of precision which the nature of the subject admits and not to seek exactness where only an approximation is possible. ~ Aristotle (384-322 BC)

When the mind is in a state of uncertainty the smallest impulse directs it to either side. ~ Terence (195/185 - 159 BC)

Reasoning draws a conclusion and makes us grant the conclusion, but does not make the conclusion certain, nor does it remove doubt. ~ Roger Bacon (c.1214-1292)

It's quite true what philosophy says, that life must be understood backwards. But one then forgets the other principle, that it must be lived forwards. A principle which, the more one thinks it through, precisely leads to the conclusion that life in time can never be properly understood, just because no moment can acquire the complete stillness needed to orient oneself backward.~ Soren Kierkegaard (1813-1855)

The crowd is untruth. ~ Soren Kierkegaard (1813-1855)

Stubborn and ardent clinging to one's opinion is the best proof of stupidity. ~ Michel de Montaigne (1533-1592)

If you do not change direction, you may end up where you are heading. ~ Lau Tzu (fl. circa 600BC)

Do any of these thoughts align with your philosophies? If so, which one(s)? If not, how would you describe your overall philosophy of money and investing? Also, who do you listen to/watch/read to get the information that forms your philosophies and, hence, your actions?

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Related: The Greatest Source of 'News You Can Use'

Your Mutual Funds Guide: My New Writing Gig

"If a man is proud of his wealth, he should not be praised until it is known how he employs it." ~ Socrates

As most of you know, I am an investment advisor and financial planner by trade but this is just one function of the thinking and writing aspects of my life.  Recently I was honored to receive an invitation to write on the subject of mutual funds for About.com, an online publication owned by The New York Times. I gladly accepted.

My writing here at The Financial Philosopher will not change in any way but, for those of you who would like to expand your knowledge of investing with mutual funds, I extend an invitation to join me at the About.com Mutual Funds site, which is a combination of timeless educational content and timely market commentary. 

Here are some recent examples of each:

Educational: 5 Things to Know About Mutual Funds

Timely: Why Investors Like Dividend Funds Now

Something for Everyone

For those of you who read The Financial Philosopher for reasons other than financial, I say take a look at the mutual funds site anyway.  You just might take away something useful that you've not seen from mainstream financial publications.  Also, I will inject my philosophies into the investment and mutual funds content; therefore it may be a useful balance of finance and philosophy for you.

Those of you who are traders, I believe you can receive value from the mutual funds site because I will periodically post information that will serve your interest, such as fund flow analysis and the general state of capital markets from the mutual fund perspective, which can be valuable for any kind of investor.

And for those of you who are my investment advisory clients, this new writing gig only takes a few hours of time per week and I'll continue to expand my investment knowledge for your benefit!

Mutual Funds Newsletter

If you want the easiest and most valuable access to my writing on mutual funds, subscribe to my mutual funds newsletter, accessible in the upper-right corner of the mutual funds site.  What you'll get is a weekly email on timely market news and some useful investment information from the perspective of the mutual funds investor.

I look forward to continuing our growth together in both philosophy and finance!

Does it Matter if America is Second to China?

"Wealth and rank are what people desire, but unless they are obtained in the right way they may not be possessed." ~ Confucius

As soon as 2016, China may replace the United States as the world's leading economy.  Does it matter?

On the first day of macro-economics class, one of my favorite graduate school professors asked the class which of these two scenarios is best for the United States economy:

1) US Gross Domestic Product (GDP) is 3.0 and China's GDP is 1.0.

2) US GDP is 4.0 and China's GDP is 7.0.

Most of the students raised their hands to vote for scenario #1.  After a 10-second pause (which seemed like an eternity of silence) my economics professor slammed his hand down on his desk and yelled "NO!"

As every student stared at him in stunned amazement, he calmly followed, "Why would you think a lower GDP is preferable?  It doesn't matter if China's GDP is higher than ours, as long as our economy is healthy and growing."

I was reminded of this lesson recently when I read an article, IMF Bombshell: Age of America Nears End.  I thought of my economics professor and thought, "So what?"

The article highlights a report from the International Monetary Fund (IMF), an international organization of 187 countries working to promote global economic growth, forecasting that China's economy will surpass that of America's "in real terms" by the year 2016.

Here are some select excerpts from the article:

...the Chinese economy will expand from $11.2 trillion this year to $19 trillion in 2016. Meanwhile the size of the U.S. economy will rise from $15.2 trillion to $18.8 trillion. That would take America's share of the world output down to 17.7%, the lowest in modern times. China's would reach 18%, and rising.

Just 10 years ago, the U.S. economy was three times the size of China's.

We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else. America overtook Great Britain as the world's leading economic power in the 1890s and never looked back.

The rise of China, and the relative decline of America, is the biggest story of our time. You can see its implications everywhere, from shuttered factories in the Midwest to soaring costs of oil and other commodities.

The U.S. Treasury market continues to operate on the assumption that it will always remain the global benchmark of money. Business schools still teach students, for example, that the interest rate on the 10-year Treasury bond is the "risk-free rate" on money. And so it has been for more than a century. But that's all based on the Age of America.

Are there any real concerns about America's becoming second economic fiddle to China?  Certainly there are speculative concerns that can be raised.  For example, if the global perception of US dominance fades, the US dollar could be weakened as doubt increases that it can remain the world's currency.

"There is no calamity greater than lavish desires. There is no greater guilt than discontent. And there is no greater disaster than greed." ~ Lau Tzu

But how serious can economic consequences be for a strong but second place America?   Does the world really need one dominant, hegemonic economic power?  Why wouldn't a balance of East and West be ideal?  A knowledgable person could spin the argument in any direction but our energy is best spent on our own well-being than to stumble as we look over our shoulder.

"It's not whether you win or lose -- it's how you play the game." ~ Grantland Rice

One of the things I love about America is our competive spirit.  However our achilles tendon may be that we care too much about winning the game.  If we want to apply our competitive spirit, let's focus on the fact that our country has arguably the greatest overall quality of life on the planet.  We are a free, capitalist, diverse society; China is not.

The big picture view, however, is that we are all citizens of the world.  A rising tide raises all ships; economics is not a zero sum game where there can only be one "winner."  If and when China becomes "number one world economy," let's pat them on the back and go about our day -- loving life. 

The true winners are those who are indifferent to winning or losing.

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Related:

How Ego Hurts You (& How to Overcome It)

Quotes on Contentment

Framing Market Cycles: Speculators, Skeptics & Suckers

"The crowd is untruth." ~ Soren Kierkegaard

Two years ago, stock prices hit their lowest point of the current market cycle.  As the investor herd wonders how to make money in year three of the Bull market, I thought it prudent to observe the herd from a distance and frame the market cycle in a different way.

I like to divide the investor herd (and market cycle) into three segments--Speculators, Skeptics and Suckers:

• Speculators jump into stocks in the late stages of a Bear market and into the early stages of the Bull market; they are the gamblers; and they are willing to accept higher relative risk to capture the largest price movements that occur later, when the Skeptics and Suckers are buying in larger numbers.
• Skeptics wait for the Speculators to make the first move and to see real evidence of economic recovery before buying into a Bull market. Skeptics don't jump in; they move in increments; and they usually miss the biggest price movements, both up and down. Put simply, Skeptics make their money when neither fear nor greed are at peak levels.  There is also a sub-category of Skeptic, which are the Contrarians, who are skeptical to the degree that the most prudent position is the opposite of the herd.
• Suckers will buy or sell at any point during a market cycle but tend to buy more at higher price levels and sell more at lower price levels; therefore, as a whole, Suckers are the last to join a Bull market and the last to abandon it.

These are generalizations and most investors will exhibit characteristics of all three types at various points of a market cycle.  For example, at the market cycle extremes--the highest and lowest points--many Speculators and Skeptics become Suckers.  Also, there are hybrid forms (e.g. Speculative Suckers, Skeptical Speculators, Perma-Suckers, and so on).

At the present moment, I believe the market cycle is somewhere near the mid-point, where most Speculators have made their biggest gains; at least half of the Skeptics' assets are in stocks; and the buy high/sell low Suckers have yet to jump in.  In other words, uncertainty about the near-term direction of stock prices is higher now than at the easy-to-recognize extremes: The Bull market has room to run higher but short-term corrections are inevitable; and any investor armed with five-minutes' worth of gathered information could make a believable case on either side of the Bull vs Bear market argument .

"Ever more people today have the means to live, but no meaning to live for." ~ Viktor Frankl

If there were to be a fourth 'S' for investor types, it would be the Sages:  These are the investors who do not predict, categorize, or apply heuristic models; they place self-knowledge and self-awareness above financial knowledge and market awareness; and they use money as a tool for life rather than following the herd's general behavior of using life as a tool for money.

Where do you think the market cycle is today?  When do you think the current Bull market will end?  Are you a Speculator, Skeptic or Sucker (or Sage)?

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Related:

Thoughts on Taoism, Rip Currents & Market Cycles

Investor Sentiment: Stepping Back to Hope