SEC Adopts New Rule Preventing Unfiltered Market Access

Source: SEC

Washington, D.C., Nov. 3, 2010 — The Securities and Exchange Commission today voted unanimously to adopt a new rule to require brokers and dealers to have risk controls in place before providing their customers with access to the market.

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SEC Publishes Best Practices for Senior Investors

Source: SEC

Washington, D.C., Aug. 13, 2010 — The Securities and Exchange Commission, Financial Industry Regulatory Authority (FINRA) and North American Securities Administrators Association (NASAA) today updated a joint report that outlines practices being used by financial services firms to strengthen their policies and procedures for serving senior investors as they approach and begin retirement.

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Should Brokers be Held to Higher Standards?

Source: WSJ

This question is addressed in this video from the Wall Street Journal.

Fiduciary Standard is A Complex Question 6/10/2010 1:26:07 PM

A higher standard for brokers could offer more protection for investors, but could create some limits that wouldn't be best for investors, says Arthur Laby, a professor at Rutgers School of Law-Camden.

The 4% Saving for Retirement Rule

Source: Journal of Investment Management (via Stanford Graduate School of Business News)

The 4% Rule—At What Price?

Jason S. Scott, William F. Sharpe, and John G. Watson

Saving for retirement is hard enough. It turns out, though, that spending intelligently during retirement is difficult as well. The soon-to-be-retired person has to make a range of decisions about spending that will have real consequences for as long as he or she lives.

Sadly, though, “the 4% rule,” which is the most commonly offered spending advice proffered by investment professionals and the popular press, can ultimately be harmful to the interests of people who heed it, according to recent research by Nobel Laureate William Sharpe, Professor of Finance, Emeritus, at the Stanford Graduate School of Business.

Simply put, the rule suggests that the retiree spend an inflation-adjusted 4% of his or her retirement assets each year, while keeping the balance of those assets in a portfolio that typically includes both stocks and bonds. That might be a reasonable strategy in a world where stocks aren’t risky. But they are, of course. Moreover, there’s more wrong with the rule than simply that it discounts the downside of investing in instruments that have an element of risk.

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Vanguard: The Animated Yield Curve

Vanguard has a nice animated explanation of the yield curve.

The yield curve: What it is and what it means

Is Mind Reading Inside Information?

Source: SEC New Release

SEC Charges Nationally Known Psychic in Multi-Million Dollar Securities Fraud

FOR IMMEDIATE RELEASE
2010-34

Washington, D.C., March 4, 2010 — The Securities and Exchange Commission today charged a self-proclaimed psychic who fraudulently raised $6 million after telling investors he could predict stock market highs and lows.

According to the SEC's complaint, Morton began soliciting investors around the summer of 2006 by telling them that he would use his psychic expertise to provide investment guidance to his investing team. In one newsletter to potential investors, Morton falsely stated: "I have called ALL the highs and lows of the market giving EXACT DATES for rises and crashes over the last 14 years." Morton used his monthly newsletter, his Web site, his appearances on a nationally syndicated radio show, and appearances at public events to promote his psychic abilities. Morton made numerous materially false representations relating to his psychic abilities in order to solicit investors for the Delphi Investment Group.

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Who are the Quants and Why May They Be Responsible for the Financial Crisis?

The Quants are discussed in Wall Street Journal article,  “The Minds Behind the Meltdown,” by Scott Patterson . They used mathematical models to estimate risk in the derivative market. Looking back it appears that these models may have underestimated the risks of the domino effect, how the failure of one security or investment house could bring down others.

How Seniors Change Their Asset Holdings During Retirement

From the Working Paper Series at the Center for Retirement Research at Boston College.

How Seniors Change Their Asset Holdings During Retirement

by Karen Smith, Mauricio Soto, and Rudolph G. Penner December 2009

WP#2009-31

Abstract

We use the 1998-2006 waves of the Health and Retirement Study (HRS) to investigate how households change their asset holdings at older ages. We find a notable increase in the net worth of older households between 1998 and 2006, with most of the growth due to housing. Our results indicate that, through 2006, older households did not spend all of their capital gains. This asset accumulation provides older households with a financial cushion for the turbulence experienced after 2007. The wealth distribution is highly skewed, and the age patterns of asset accumulation and decumulation vary considerably by income group. High-income seniors increase assets at older ages. Middle-income seniors reduce their assets in retirement, but at a rate that for most seniors will not deplete assets within their expected life. Many low-income seniors accumulate fewer assets and spend their financial assets at a rate that will mostly deplete them at older ages, leaving low-income seniors with only Social Security and DB pension income at older ages.

For executive summary in PDF

For full paper in PDF

Check the SEC’s Investor.gov for Investor Education

From the website:

By visiting www.investor.gov, investors can access information in a user-friendly format that is specifically tailored to their needs. The site includes sections specifically for those just getting started investing, for those saving for a child's education, and for those planning for retirement. It also has a detailed "Seniors Care Package" section for senior citizens and caretakers.

ICI Reports IRA Ownership Remains Steady

From the Investment Company Institute

IRA Ownership Steady Despite Recent Market Turmoil

39 Percent of U.S. Households Owned IRAs in 2009

Washington, DC, January 21, 2010 - Despite market challenges in 2008 through the March 2009 stock market lows, individual retirement account (IRA) ownership in 2009 and IRA owners’ contribution and withdrawal activities in tax year 2008 were in line with recent historical experience, according to a new Investment Company Institute study.

The study, The Role of IRAs in U.S. Households’ Saving for Retirement, 2009, finds that nearly four out of 10 U.S. households owned IRAs in 2009—essentially the same as in 2008. IRA assets made up about 9 percent of all household financial assets. Traditional IRAs continue to be the most popular form, with about one-third of households owning them in 2009. The study finds that much of the recent growth in IRAs can be attributed to rollovers from employer-sponsored retirement plans. In 2009, nearly 20 million households had traditional IRAs that included rollover assets.

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EBRI Releases Brief on Target Date Funds

Investment Behavior of Target-Date Fund Users Having Other Funds in 401(k) Plan Accounts

WHY TARGET-DATE FUNDS ARE IMPORTANT: Target-date funds (TDFs) are designed to simplify retirement plan asset allocation as an “all-in-one” investment option, which automatically rebalances the account to a mix of asset classes that are more conservative as the investor ages. Because of recent legislative and regulatory inducements, they are rapidly growing as an investment in 401(k) retirement plans, and about 7 percent of all 401(k) assets are currently invested in TDFs.

MIXED TDF USERS: As TDFs grow, a new class of 401(k) investor is emerging: “mixed” target-date fund users who hold the funds in combination with other non-TDF funds in the plan menu.

LACK OF UNDERSTANDING OF TDFS: This study shows that some mixed TDF investors apparently fail to understand either the purpose or the benefit of a TDF designed as an “all-in-one” portfolio solution. However, holding TDFs with other funds could lead to an unexpected result of ending up with a potentially inferior portfolio in terms of risk/return tradeoff from more assets allocated to some sectors than the designers of the target date funds had planned.

December 2009, Vol. 30, No. 12
Paperback, 16 pp.
PDF, 707 kb
Employee Benefit Research Institute, 2009

WSJ: Considering Downside Risk

Article Link

SEC Launches Investor.gov

Agency's First-Ever Web Site Devoted Exclusively to Investor Education

FOR IMMEDIATE RELEASE
2009-224

Washington, D.C., Oct. 22, 2009 — The Securities and Exchange Commission today launched its first-ever Web site devoted exclusively to investor education, providing investors with in-depth information and "top tips" on how to invest wisely, plan for the future, and avoid being scammed.

By visiting www.investor.gov, investors can access information in a user-friendly format that is specifically tailored to their needs. The site includes sections specifically for those just getting started investing, for those saving for a child's education, and for those planning for retirement. It also has a detailed "Seniors Care Package" section for senior citizens and caretakers.

GM Dropped from the DJIA

Few of us ever thought we would see the day when GM would no long be included in the Dow Jones Industrial Average. On June 8 two new components will be added to the DJIA: The Travelers Companies Inc. (TRV) instead of Citigroup Inc. (C), and Cisco Systems Inc. (CSCO) instead of General Motors Corp. See the WSJ, Here's Why We Changed The Dow.

The DJIA includes 30 large capitalized stocks selected by the editors of the Wall Street Journal. The prices of the 30 stocks are added and then divided by the Dow divisor. The divisor is continually modified to account for stock splits. The DJIA is one of more than 13,000 market indicators published by Dow Jones. You can find information on all of the indexes at the DJIndexes.com.

Interactive Asset Allocation Chart at Bankrate.com

Bankrate illustrates three asset allocation portfolios from aggressive to moderate. As you slide your mouse over a slice of the pie chart a window pops up with a brief description of the assets in that category. The chart is accompanied by a brief explanation of portfolio theory.

Page link

Run a FINRA Broker Check on Bernard Madoff

Interested in your brokers professional history? You can run a broker check at FINRA. Try one on Bernard Madoff.

Joint ICI/SIFMA Survey Finds Ownership Driven by Growth of DC Savings Plans

From Press Release

Washington, DC, December 15, 2008—Nearly half of U.S. households owns equities or bonds, a significant increase during the last two decades. But ownership of these investment assets has declined since 2001, as increasing market volatility has reduced Americans’ tolerance for risk, according to a new joint study released today by the Investment Company Institute and the Securities Industry and Financial Markets Association.

Based on a survey of more than 5,000 households, researchers at ICI and SIFMA calculate that 54.5 million households participated in the market through equity or bond ownership in early 2008. This represents 47 percent of U.S. households—up from 39 percent in 1989, the first year for which directly comparable survey data are available.

The two-decade rise in equity and bond investment was fueled by the rapid growth of defined contribution (DC) retirement savings plans, such as 401(k) plans, the researchers conclude. Between 1989 and 2004—the latest year for which comparable
data are available—the number of participants in private-sector DC plans nearly doubled, from 36 million to 65 million. The ICI/SIFMA survey shows that at every income level, working-age households are much more likely to be equity or bond owners if their employer sponsors a DC plan.

The Impossible Economics of a Ponzi Scheme

Bernard Madoff will be the Guinness Record Holder for running the largest Ponzi scheme. However, he will not hold the record for being the best Ponzi schemer of all time. To be the best, you need to time your exit and get out of town before the inevitable collapse. The economics of this house of cards is illustrated in the following table. It is linked to a spreadsheet that estimates the best time for grabbing your passport and making a hasty exit.

The numbers in the table are based on the following assumptions. You can change the growth rates in the linked table and see how the date of inevitable collapse changes.

• The beginning contribution is $1 million. Each year thereafter the amount contributed by the unsuspecting investors increases by 5%
• The expected amount that investors think they have in the fund each year is equal to the amount from the previous year compounded at the fictitious return (12%) plus contributions less withdrawals for the current year.
• Withdrawals each year are equal to 5% of what investors think they have in their accounts based on the assumed fraudulent returns.
• The actual amount in the fund consists of net contributions for the given year plus last years real balance compounded at the after-Ponzi rate of return. For example, if the actual amount earned on the fund is 3% and the Ponzi manager takes 6% then the after-Ponzi rate is -3%.
• The criminals take-home pay is equal to a given percentage of the actual amount in the fund in the previous year. In this case a 6% Ponzi tax is assumed.

Assuming there are no expert financial analysts who might get suspicious, and given recent history that seems unlikely, this scheme could last 26 years. You can try out your own parameters and calculate your own get of of town date. One interesting insight is that a higher promised return can reduce the cumulative take-home pay for the criminal. A promised return of 20% will break the bank in the 19th year and and almost cut in half the cumulative profits. Because of a wealth effect created by the higher fictitious return withdrawals increase, cutting the life of the scam. Given that too high a promised return will also decrease credibility, the best promise seems to be an above normal but not exorbitant return. This is likely what Madoff promised.

The obvious factors that hasten the collapse during a recession include a decline in contributions, an increase in withdrawals, and a reduction in the underlying real rate of return.

Google Spreadsheet

Greed is Good, Trust is Bad

The first rule for arms control agreements and personal investing is inspect and verify. You may trust you friends and family, but don't trust your broker. Ponzi schemes need greed, but they only succeed because of trust. Bernard Madoff was the founder and former chairman of Nasdaq and an esteemed member of prominent country clubs. the Palm Beach Country Club and Boca Rio Golf Club. Who wouldn't trust a man like this? He was such a nice guy. He even tried to pay his employees their Christmas bonuses. As reported, "he wanted to pay certain employees portions of the $200 million to $300 million dollars that was left." Wait a second! Weren't those Christmas bonuses other peoples wrongfully taken money?

Trust is an expensive virtue that will likely cost investors over $50 billion. In the days ahead we will hear from investors who say that Madoff never fully explained how he was able to generate a steady stream of profits in these uncertain time. Everyone said he was a financial genius and others had profited. Given trust, there was no need to inspect and verify.

The second rule of investing is don't invest in something you don't understand. Madoff's investors probably received fancy looking reports on expensive paper with ambiguous explanations for past returns. But did any of these financial gurus that channeled clients funds to Madoff really inspect the books? Could any of them explain just how those returns were generated? Madoff would get upset with people that probed too much. They were probably told that they didn't have the financial skills to understand the advanced trading strategies that Madoff was engaging, such as the sideways arabesk or the perambulated put. Brokers closed their eyes, earned their commissions and put their trust in the man. His employees say he was "cryptic" about his business investments. According to one news report, financial consultants "couldn't figure out how he managed to produce steady returns, month after month, even when everyone else was losing money -- and leave almost no footprint while moving billions of dollars in and out of the markets."

Fraudulent schemes flourish in good times. If there is any benefit from a recession, it is that bad times expose fraud. If Madoff's investors didn't need to withdraw funds to cover other losses he could have continued his sham for many more years racking up even more losses. Recessions purge the system, exposing cancerous frauds and driving out failing firms and dying industries. They leave the body weak but intact. Joseph Schumpeter labeled this "creative destruction." You can't have creation without some destruction and if you are not willing to put up with the destruction then you must forgo the creation. It is the necessary preparation for future growth and recovery.

Stocks as Lottery Tickets

When you purchase a lottery ticket you pay a small price for the possibility of a large gain. Gerald P. Dwyer Jr. and Cora Barnhart in Returns to Investors in Stocks in New Industries surmise that investors are doing the same when they purchase stock in new untested companies. This may be especially relevant when the firm’s product might generate network effects. Network economies exist when the productivity of a product is positively related to how many consumers purchase it. Based on their empirical analysis of selected industries they conclude the following:

Adjusted for risk, expected returns are not particularly high for firms in new industries.

Our evidence is consistent with new industries having distributions of payoffs across firms that are highly skewed. In this sense, new industries are similar to lotteries. As is well known though, this can be quite consistent with a log-normal distribution and our data across firms generally are consistent with a log-normal distribution of the cumulative values across firms.

Our evidence uniformly indicates that the expected return to owners of traded stock in new industries is positive and substantial. This is consistent with a supposition that investors receive expected returns that can be interpreted as compensation for the risk they bear. We do not address whether that compensation is consistent with a model of market equilibrium at the level of individual firms.