The Tough Love School of Life…

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You have read the numbers. Half of all Americans do not have $1,000 to $2,000 in savings for an emergency. Forty percent of Americans do not have a retirement account and the same percentage, 40%, do not pay off their credit card every month. The balance on these cards not paid off monthly is about $9,000 and at an average interest rate of 18%, interest alone is $135 a month before you even make a dent in the principal.

You could sit down and rationally explain to people that they need a detailed budget and they need to stick to it. Its simple, spend less than you earn. Sounds sensible, sounds logical… but close to impossible for many. The thrill of spending and the persuasive power of American advertising is just too great. Some folks need a more radical, tough love approach. Dave Ramsey has made a career of preaching tough love in finance, both through his radio show and through books such as his “The Total Money Makeover” (2003) which has sold 5 million copies.

What’s his solution? It requires going cold turkey (see below), cutting up your credit cards, paying for everything in cash and if you don’t have cash, don’t buy. Focus immediately on building an emergency savings account of $1,000. Then start the ‘debt snowball’. List your debts in order from smallest to largest and attack the smallest first, making minimum payments on the rest. Then when the smallest balance is paid off you attack the next smallest debt. This is not conventional wisdom which recommends paying off the highest interest rate debt first, then the next, and so on. Ramsey argues that people need to see small victories to stay on course so going after the smallest balance first makes sense.

After your consumer debt has been paid off you build an emergency cushion equal to three to five months of expenses, you invest 15% of your gross salary in a retirement account (no compromising here) and finally move on to the longer-term issues on the list.

How effective is this program? Like losing weight and stopping smoking, it is tough. Some can do the Baby Steps on the first try but others will have to try again or try something completely different. Consumer debt (including college debt) is a real problem today. A significant number of Americans have not had an inflation adjusted pay raise in ten to fifteen years. Life is indeed tough. What’s your plan?

What’s in Your Wallet?...

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Just when you thought you could forget about Bitcoin…it’s back. Bitcoin is a digital currency that is free from any influence by central banks. Libertarians like it for it’s independent, secure and untraceable features. But for a whole slew of reasons Bitcoin has not taken off as a medium of exchange.

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One problem is volatility. The price of Bitcoins soared in 2017 only to crash a year later. When you have crypto currency in your ‘wallet’ and you are ready to buy something, you want it to have a stable value. It doesn’t. Facebook will use the proceeds from selling ‘Libras’ (its cryptocurrency) to purchase Government securities insuring the full backing of the currency and tying its value to a basket of world currencies. The cost to make purchases or transfer funds should be much cheaper than the 2-10% you pay Western Union or MoneyGram today. Facebook touches about a third of the entire world population today and the prospect of Libra users ‘facebooking, instagraming, what’s apping’ and then, shopping and transferring money, all on one site, is a business worth drooling over. The Chinese have already designed a system like this (Tencent’s WeChat and Alibaba’s Alipay), where users stay all day, texting, surfing the internet, playing video games and shopping. Facebook wants its share of the action.

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Banking the unbanked has also been a success in places you might not expect. In Kenya, the phone companies saw plenty of commerce but few ways to move money around. So, they designed M-Pesa where you load balances on your cell phone and text money to creditors who can convert to cash at small convenience shops or send the money on to other creditors. The phone companies suddenly become banks. Facebook is looking to do the same.

This is a slam dunk, right? Not so fast. Big hurdles await Mr. Zuckerberg. The first is the issue of privacy. The public is not too excited about all the information Facebook has accumulated already and sold to others. Do we really want to give them more information? Secondly, governments around the world are not too excited about an alternate monetary powerhouse developing. Is it a bank, is it a payment system (ala Visa or Mastercard), and since it is anonymous, what about the criminal money transfer aspect to the platform?

We don’t know if Libra will get off the ground, but disruption is coming quickly to the money business. Commerce will get cheaper and more efficient, but the price we pay may be the continued erosion of our precious personal freedoms. Caveat Emptor.

Why so Negative?...

When you lend money to the government by buying a Treasury bond, it’s an investment and not a favor. You expect to get back more than you put in, in the form of interest, in order to compensate you for a multitude of risks and the loss of use of your money. This makes recent news about the proliferation of negative yielding debt (shown in red below) seem perplexing.

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Yield and price work like a seesaw; the more you shell-out for a bond’s fixed payments, the lower the return on your investment. A negative yield implies that demand has driven the price of bonds so high that you’re actually paying to lend money. Surely, no one would take this offer – or would they?

The world’s negative-yielding debt totals a record $15 trillion today. There are a number of reasons for this seemingly irrational accumulation, but most of them have to do with at least one of two things: pessimism about the future and the desire for safety.

Many large institutions – such as pension funds – are mandated to keep a certain percentage of investments in their government’s debt, so they must continue buying regardless of price. This makes sense from a safety and liquidity standpoint. If you need money to pay future liabilities, a bond from someone who can raise taxes and print money to avoid default is a solid choice, even if there’s a chance that you’ll get a small negative return.

Another factor is the expectation of future deflation. Deflation occurs when prices fall due to a lack of demand for goods and services, usually when economic conditions significantly deteriorate. The implication of negative-yielding debt is that even though you are getting fewer dollars back than you invested, those future dollars will still have increased purchasing power as long as your return drops less than the general level of prices.

Also firmly in the category of a less-than-rosy outlook, is the chance that negative yields could continue to slide even farther below zero, making today’s small loss more attractive than a potentially larger loss in the future.

So, what can we take away from all this?

Negative rates can be a boon for some and a hardship for others. Borrowers are generally rewarded; one Danish bank is actually paying people to take out mortgages. Savers are punished by having to pay banks to hold their money or by falling short of expected returns. In general, negative rates can be seen not only as a signal but as a potential accelerator of a deflating economy, which can be hard to escape once entrenched. Negative rates can stifle investment as people without attractive options keep money in cash, but can also have the perverse effect of increased risk-taking as people reach for yield in unwise ways – both actions that can cause larger ripple effects on the system.

The impact of the current negative rate environment is unclear. It could be the spark that jumpstarts a sluggish world economy temporarily spooked by trade issues and geopolitical risk. Or it could be the sign of a new normal: slow-to-no growth in advanced economies due to underlying demographic and technological trends. Only time will tell if it’s sustainable, but for now the U.S. continues to look good if only by comparison, with economic growth and yields that remain low, but at least positive.

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“In Investing, What is Comfortable is Rarely Profitable.” Robert Arnott

The outlook for global economic growth is plagued by uncertainty today. Just how far will the U.S. and China go in their efforts to win the current trade war? Will the U.K. arrive at a solution to the ongoing Brexit impasse? Will central banks around the globe continue their easy money policies?

At the industry level, it seems hard to pinpoint another time in history too when so many were witnessing deep, fundamental change. In payment systems, upstarts like Apple Pay are threatening to unseat well entrenched competitors like Visa and Mastercard (also see page 2). In healthcare, public policy initiatives aimed at controlling costs may undermine the basic business models of hospitals, drug distributors and pharmaceutical companies. In the media sector, the war to capture consumer “eyeballs” is forcing unprecedented consolidation and change.

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In periods of perceived heightened risk, it is helpful to take a step back and consider the long view of history. Take a look at the chart below of the VIX. This investment index, a popular measure of expected stock market volatility, tends to rise when stocks are falling and shows when heightened jitters are creeping into the market. Over the past 20 years there have been at least 10 periods when the VIX spiked above 30. While most of us remember the 2008-2009 recession, many have forgotten the anxiety produced during the summer of 2011 (European Sovereign defaults and the downgrading of U.S. debt) or fall of 2015 (fears of slowing economic growth and falling oil prices). In behavioral finance, the tendency to place more emphasis on recent rather than old information is referred to as Recency Bias. As investors, this trait gets us into trouble when we assume that current conditions (bad or otherwise) will continue into the future. This, of course, may be true but it is not necessarily true.

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Investors should also keep in mind the idea that they receive a return precisely because they are taking on risk and, all else being equal, the more risk you assume, the greater the potential return. Over short periods of time, the stock market’s gyrations are driven by the very human emotions of fear and greed. The result? If you are investing correctly, you are likely living in a constant state of dissatisfaction. If the market is up, you wish you had invested more in the market and if it is down, you will always think you have too much invested.

So, what is an investor to do in the face of such uncertainty? Investing is as much about understanding yourself as it is understanding the markets. Conduct an honest assessment of your own ability to tolerate risk by which I mean either temporary or permanent loss of capital. If principal preservation is more important to you than capital appreciation, your portfolio should hold a good slice of more stable things like bonds and cash. And don’t forget diversification within each asset class. At its heart, the concept of diversification is really an admission that we don’t know what the future holds. An adequately diversified portfolio will never keep pace with the market’s highest-flying sector like tech today, but it will never behave like the worst either.