Another dumb investment idea

[Ted]

This Sunday, the "business" section of my local newspaper (the St. Louis Post-Dispatch) had a full page ad that began with the headline "Historic 2003 Striking....WORLD'S FIRST $100 SILVER PROOF."

Below the headline, spanning the width of the page, was a picture of a shiny replica of a $100 bill.  (Below, in small print, it says that the actual size is 6" x 2 1/2".)

Then, "The Washington Mint Announces the Limited Mintage Striking of an Extraordinary Silver Proof -- the New United States $100 Bill Struck in Pure Silver Bullion.  Discount Price $99"

Wow! A silver hundred dollar bill for "only" $99!  But you better buy now, because, we are told, the price of this "Giant Silver Proof" will soon be increased to $125.  And "the earliest orders will receive the lowest registration numbers."  But orders are limited to twenty units for "just $1,698"  (which works out to $84.90 each, not counting the shipping and handling charge).

A great investment idea?  I doubt it.  

The ad boasts that a "proof" contains "over one-quarter pound (4 troy ounces) of pure silver."  Sound like a lot?  Well, silver is selling for approximately $5.10 per troy ounce, so the value of the silver in one of the "proofs" is about $20.40.  If you bought one and then sold it at a coin dealer, you would probably get a little less than that because of the dealer's mark-down.

So if you want to buy one of these "proofs" as a trinket to decorate your desk, that's your choice, but if you do it as an investment, you are a sucker  .

 

[Michael]

Hi Ted,
I will stay away from those proofs.

What do you think of silver, gold, and other commodities at the present time? Monday's Barrons had an article showing why Richard Russell liked gold's prospects. BTW, does anyone know if Warren Buffet still owns the silver he bought a few years ago?

http://online.wsj.com/barrons/artic...ns/30day&vql_string=russell<in>(article-body)

 

[Ted]

Hi Mike,

Historically, gold and silver have been rotten investments -- except perhaps in countries with unstable governments where they are a hedge against collapse of the currency. It seems that the U.S. dollar is widely used throughout the world in that role now.

However, even the dollar is susceptible to inflation, as the Federal Reserve (properly IMO) keeps creating new ones at a fast pace to keep short term interest rates low and finance part of the federal budget deficit.

With the prospect of an economic recovery that will spur demand for industrial commodities, coupled with inflation, I think that industrial commodities are attractive investments and hedges against inflation. Some time ago, I suggested holding long-term futures contracts on crude oil, which I have been doing all along. Lately, I have also acquired a long-term contract on natural gas, and short-term contracts on copper, lumber, and the Japanese Nikkei index.

My experience with futures is that I make a lot one year and lose a lot another. It is inherently very risky, and anyone who participates should follow certain rules:

1. Ideally, invest for the long term, in a way that hedges against price increases in commodities that you will need in the future. This particularly applies to crude oil and natural gas. In my case, it also applies to lumber because I expect to build a new house in a few years (although lumber contracts are only available for a few months into the future).

2. Put stop loss orders on your positions, unless you are financially and psychologically prepared to hold onto them no matter how low they go. (When futures contracts lose value, you must deposit collateral with your brokerage firm to cover the loss. Conversely, when they gain value, you may withdraw funds.) My failure to do this in the past is the reason I lost a lot of money some years.

Like gambling, futures are essentially a "zero sum game" for investors as a whole. Only the brokers are assured of making money. For various reasons, most people lose substantially and a few people gain. Right now, I'm somewhat ahead and feel that this is an exceptional time to own futures contracts. But I'm not recommending it for everyone. As with gambling, it's possible to get "hooked" and lose your shirt.

 

[Michael]

Thanks Ted. For diversification, and simplification, I was thinking of something like the Rogers International Commodities Index. They are planning to introduce generally available shares (minimum 10K) soon.

http://www.rogersrawmaterials.com/page2.html

http://www.financialsense.com/editorials/rogers_why.htm

http://biz.yahoo.com/smart/030618/20030618theproshop_11.html

 

[Ted]

I hope that it is not significant that this discussion is under the heading of "Another dumb investment idea."

I hadn't heard of the Rogers index, and from a brief look at the links I couldn't tell what the terms will be of the public "shares" that Rogers plans to introduce.

A couple thoughts:
1. A substantial part of the index is in agricultural commodities. I don't speculate on these because the price is largely a function of the weather and international political events that are totally unpredictable. (International politics also affects the price of oil, but in the long run it is likely to keep rising because of the underlying supply/demand relationship.)
2. Before investing in the Rogers index shares, check the expense ratio. I would expect it to be pretty high. In contrast, if you invest in futures contracts directly the transaction costs can be fairly modest, if you approach it on a long-term basis.

 

[proud_texan]

As I move into ER, I'll be rolling my 401K over into a traditional IRA. I'm certainly interested in diversification, but really, what kind of returns can one expect from commodities and futures? Most of us in ER will depend a steady cash flow from our investments.

Wouldn't a portfolio of primarily stocks and bonds have the most consistent returns?

 

[Cut-Throat]

PT,

Yes, I agree with you. The basic mixture of Stocks and Bonds. And don't forget some Cash!

 

[JG]

As was mentioned above, futures are mark-to-market, meaning the margin requirement is calculated at the end of the day (at least for equity indexes it is). It's very risky IMO but the leverage is there if you need it.

There are also oil and gas royalty trusts, if you want direct exposure to petroleum prices. They're traded on the NYSE and pay out dividends. They've about doubled in the past year and the dividends are still about 10% but, again, they're risky. When the price of oil or NG drops, so does the unit price and so do the dividends. Note that the taxes can get messy with the field depreciation and tax credits. You'll be filing on Schedule E, as I recall.

 

[Ted]

Wouldn't a portfolio of primarily stocks and bonds have the most consistent returns?

Absolutely! If a person wishes to trade futures contracts, the money that they deposit with the brokerage firm as a margin requirement should be no more than maybe 5% of their assets. And they should put stop loss orders on their contracts that will prevent them from losing more than they can tolerate.

Also, beware of "professional" futures traders who claim to be able to "beat the market" with various trading formulas. In truth, most of their profits come from the management fees that they extract from gullible investors.

 

[unclemick]

Mentally I wouldn't even include furures money as part of my ER portfolio - perhaps more under my gambling/entertainment budget. Have never bought futures but do have leftover 'stuff' I never count as assets:
-timberland in Oregon(can you spell spotted owls) - gold coins (1970's) -10% of a non-working gold mine in Colorado(1970's), and probably some old buy/sell slips from the 60's, 70's and 80's of gold funds and mining shares. The school of hard knocks has lead me to low cost balanced index funds and cash.

If I ever 'do' futures - it will be with mad money that I can 'mentally' afford to lose.

 

[Michael]

A good investment idea.

Ted wrote:

I hope that it is not significant that this discussion is under the heading of "Another dumb investment idea."

Mike replies:

No, I was just too lazy to change the subject heading. I will certainly carefully examine the expense ratio before deciding. My thoughts are that Alan G seems to be determined to create inflation, and I believe him. A small portion of my portfolio in various inflation hedges seems prudent. I already own REITS, and am looking at commodities as a potential further hedge. Thank you for your thoughts on the subject.

JG wrote:

There are also oil and gas royalty trusts...

Mike replies:

I will examine these also. I have much study to do before I take any action in this area.

 

[Ted]

Mentally I wouldn't even include furures money as part of my ER portfolio - perhaps more under my gambling/entertainment budget. ...
If I ever 'do' futures - it will be with mad money that I can 'mentally' afford to lose.

I basically agree. Futures trading tends to be more like gambling than investment in the sense that a futures contract is essentially a "bet" that a particular commodity or index will rise in price (or fall in price if a person is "short" on the contract).

Initially, the contract has neutral value -- it gains or loses value as the market price changes. You actually don"t "buy" a contract -- the money that you must deposit with the broker as "margin" is yours and comes back to you if you liquidate the contract (plus any gain in value; minus commissions and any loss in value). So you "invest" nothing, and your "expected" (most probable) gain/loss is zero (except for commissions).

Your odds of "winning," however, are better than with gambling, and the feature that makes futures contracts a useful part of the financial system (unlike gambling) is that futures contracts can be used to hedge, thereby actually lowering a person's overall financial risk.

 

[unclemick]

I agree with the theory that commodities can lower overall risk. But the skill level/leaarning curve for futures is too steep for me.

 

[Ted]

To have a reasonable chance of success at futures trading certainly does require a lot more "active management" than "normal" investing, and that is an important reason why most people should not do it.

As I said elsewhere, women often are more successful investors than men because they are more inclined to simply invest money (in stocks and bonds) and leave it there, without trying to "beat the market."

I like to try to modestly "beat the market" with a portion of my investments largely because it's my competitive nature But in discussing possible ways to do it, I try to acknowledge why it is impossible for the majority of people to do it, and why not everyone should try it.

 

[haha]

Lately, I have also acquired a long-term contract on natural gas, and short-term contracts on copper, lumber, and the Japanese Nikkei index.

Hi Ted and others. Nice to see that there some cowboys on this forum.Ted, your list above is interesting. I have many of the same investments, oil and gas through royalty trusts and a production MLP. timber through an interesting hybrid investment in British Columbia called Timberwest, and Japan through Japan i-shares and some individual stocks, ordinaries and ADRs.

All except Japan are pure inflation plays. My only reason for Japan is that it seemed the only place in the world that was well organized and highy productive, that nevertheless had a cheap stock market. My question is, is the Nikkei in a new bull market, or is this another temporary jump? I have no clue how I will decide whether to hold or fold down the road-I guess this may be a job for Technician-Man.

Sometimes when I know something is definitely cheap and think it is due, I don't try to get maximum gain, just some of what I think is likely a low risk proposition, given patience. I think it has always worked, if I stick to "basket stocks"-ie. I am not going to put a lot of money into GM common no matter how cheap it gets. It will probably work out, but I can see a world without GM easier than I can see a world without Japan.

Overall I think this eclecticism is safer than S&P 500 at 1000, and 4% bonds. A lot safer, IMO. On most retirement oriented forums you get shouted down for saying this, but I have been more or less retired for 20 years, and in that time I raised 2 kids and had a non-working wife. Mostly I did it by monkeying around in nooks and crannies of the investment world. It appears riskier now, there were some real no-brainers over the last 30 years that I can't find anymore- but that will change. We just need to avoid big losses, and always look for value, not for "returns". Which I believe are the after-the-fact face of value.

Before the current cycle is over, INDEX will have become a four letter word.

Mikey

 

[unclemick]

Hey Mikey
You have the Warren Buffet malady - you know what you know by doing it a long time. I once read a book by an olympic skier but still had to put on the slats and go downhill - never got past intermediate before leaving Seattle.

Greaney is still stock guy. I still have my side money (/hobby stocks') but am not past 'intermediate' yet.

 

[Ted]

Before the current cycle is over, INDEX will have become a four letter word.

My approach is to put the majority of my investments into "stodgy" stock index funds and low-cost bond funds. Over time, this portion of my portfolio is virtually certain to produce a higher return than most other investors will experience, because of the lower "leakage" to expenses.

With that in mind, I can "gamble" with a small portion of my assets, knowing that if I lose money on that portion, it won't be financially devastating. It is a good way for anyone to reconcile their "logical" and "competitive" instincts.

Incidentally, TIAA-CREF has "pitched" this idea of "enhanced indexing" in its advertising for its main stock fund, calling it "brilliant" etc., etc. Although I think this fund is a good investment because of its low expenses, it hasn't been as "brilliant" as advertised in that it hasn't outperformed the index.

To me the story that best illustrates the difficulty of outperforming an index involves the first index fund, which was created, I believe, by Wells Fargo for its pension accounts, in the late 1970s. It consisted basically of the S&P 500 stocks, but to be "prudent," a few companies that were experiencing financial stress were omitted. I recall that one of these was Chrysler.

So guess what happened. It turned out that the fund would have performed better if these "out of favor" stocks had been included! The point is that the "dumb" investing involved in index investing is actually pretty smart 8) .

 

[unclemick]

YES BUT! Before the but, let me say that i'm a die hard Boglehead balanced index kind of guy since 1994. But I have these ? widows & orpans?, dividend income? bought via DRIPs since the early 90's. Electric,gas,water utilities, oils, a REIT,banks, telephone, drug, etc.- the taxible dividend stream is approaching half my pension.

The mental BUT is to view them as a fall back income stream when I run FIREcalc. They aren't going to behave like the index 500. So yes index funds in my ER portfolio and dividends(inflation indexed) as negative withdrawal. I will 'never' go 100% dividends - BUT as fall back insurance? Any thoughts, comments?

 

[Mr._johngalt]

I would never go 100% dividends either. You know,
my financial affairs are very simple to me, but would be
Greek to others upon my untimely demise. To make matters worse I am a lousy record keeper. in spite of many years as an accountant. But, I digress.

Even though I own no common stock, I think my total
pile is pretty well diversified. Also, I've taken into
account all of the various disasters that might befall us,
and have a plan to deal with each. I think that is all
that anyone can do. The rest is up to the financial
gods.