Investment club for San Mateo

January 8, 2007
6:30 pm, (sharp)
393 Vintage Park Dr.
Suite 220
Foster City, CA. 94404
Map: http://tinyurl.com/yesb95
We are starting a PennyJar Investment Club in San Mateo and we would be thrilled to have you join us to find out more about what PennyJar is all about! Our first meeting is January 8, 2007. The location has lots of free parking and is easy to get to; just off highway 92.

Why US $ is going down: Central Banks buying Euros

The US dollar is having a hard time lately as its value continues to decline. One of the reasons is that foreign central banks are starting to diversify their holdings away from the US $ and toward the Euro. Remember the US government finances the deficit buy selling debt (US BONDS) and that the majority of the US Bonds are bought by foreign governments. This is because the US is viewed as a safe investment. However oil producing countries that are not exactly happy with the US are pushing hard to make the Euro the standard and not the US $.

Below is excerpt from news today
Reports that the United Arab Emirates would diversify its foreign currency reserves by purchasing more euros provided the currency-moving catalyst. Traders viewed the move as symptomatic of a wider trend and quickly bid up the euro.

"By itself, the UAE's shift is small change in the foreign-exchange market," Tony Crescenzi, chief bond market strategist at Miller Tabak and a RealMoney.com contributor, wrote in a published article. But "the UAE's shift is another in a string of actions taken by the world's central banks" to diversify away from the dollar.

source: the street.com http://www.thestreet.com/_iwon/markets/metals/10329783.html?cf=WSIWON1111051500

Wall Street Meets Walt Disney

The man behind Minyanville

Someone tried to Scam me on Craigslist

I put an electric dryer for sale on Craigslist. Some guy offered me $140, which I accepted. He wanted to pay by certified check, which I also accepted (not too smart of me). I was thinking that a certified check is like cash.

Then I got this email, which smelled very bad to me:

Hi Paul,
How are you doing.Hope everything is going fine on your side, As a matter fact the deal is on and according to my secretary,he has already sent the check out to you.So the payment should arrive in a short while from now.And once you get it,i guess you know how to handle everything.And please dont bother about any other buyers.But there was a little problem which i guess we can handle with understanding.When i contacted my secretary to know maybe the payment as already been sent,i got to know that there was a misinterpretation while sending the payment.According to the instruction i gave him,he was suppose to have send you a check of $140.But instead,he sent a check of $1400. It was a terrible mistake and the check is already out for delivery to your location.But that should not disturb our own transaction.the deal is on and we will get through it.what will happen is that ,once you get the check you will take it to the bank and cash it immediately,then you deduct your $140, and a $25 dollars for your run around in cashing the check and also a $100 for sending the rest funds to my mover via western union money transfer that same day,my mover will be using the remaining funds for the pick up,i guess i can be assured in you that you can handle it with trust and have it sent to my mover.E-mail me back immediately to let me know that i can trust you to handle everything well.I will be expecting your e-mail asap.PLS AM PUTTING MY TRUST IN YOU.
Best Regards
and Stay Blessed.
Ken.

I went to internet crime complaint center and found a description on COUNTERFEIT CASHIER'S CHECK. Basically, they get victims to wire money overseas via Western Union, after they think the check has cleared, but it really hasn't.

Then I called Wells Fargo to get advice on how to proceed, or not. They told me that the scammers work outside the country and they are getting away with it. They referred me to the Internet Crime Complaint Center. Unfortunately, the ICCC only keeps track of victims and are not proactive. They don't actually investigate, only keep statistics. Great.

I cancelled the deal. From now on I deal in cash only.

I can't help but think that a lot of people are falling for this crap.

How the Dollar System works

Lately I have been trying to learn more about why the US dollar is declining and see if I can figure out a safe haven for my investments if the dollar continues to decline. While searching the web I came across this well written and SCARY article about how the dollar system works and how it might be at the end of its life. This is a very thought provoking article and it made me think beyond my current understanding of the US economy. I encourage you to read and provide comments.

Dizzy Dollar Data

One thing economists and financial reporters love to do is quote numbers.

In recent days, the "collapse" of the US dollar has been getting some headlines. A benchmark of the dollar is called the Dollar Index. It is an index created by the New York Board of Trade. It takes a basket of currencies and compares them to the US dollar. These currencies are "weighted", i.e. some have more effect than others on the index.

The currencies, and their respective weightings are:
Euro 57.6%
Yen 13.6%
Pound 11.9%
CAN dollar 9.1%
Swiss Franc 3.6%
Swedish Krona 4.2%

In theory, the NYBOT dollar index is trade weighted. That is to say the percentage of importance on the dollar index is a reflection of trade with America.

Well, I decided to look up the actual trade figures for last year, 2005.

Here's what I found.

1. America's biggest trading partner was Canada. Almost $471 billion.
2. America's second biggest trading partner was China. About $281 billion.
3. All of Euro based Europe was somewhere over $300 billion.

Since the Euro makes up 57.6% of the index, one would think that we are doing a lot of trade with Europe. In fact, only about 11 or 12% of US trading activity is with (Euro) Europe. Canada, despite being weighted at 9.1% actually partners in 17% of US trade.

China isn't on the index. Neither is Mexico, which did over $270 billion in trade with the US. Korea and Taiwan combined did over $124 billion in trade. Also, you guessed it, NOT on the index.

Sweden and Switzerland, who make up 7.8% of the index did less than $39 billion last year, combined. That is a meagre 1.4% of US trade.

Perhaps the headline dollar index should be weighted to actual trade, not tied to some ratios that the NYBOT decides is reflective of the strength of the currency.

Bottom line is that headline numbers are often misleading. The dollar has fallen against the Euro and the Pound, but is that so bad, considering most of our foreign trade is done elsewhere? Maybe it hurts Europe more than America, particularly for tourism, airplanes and BMW's. Just a contrarian's view.

Simpler Times

At one time, the average American worker would get a job and earn money. He or she would save money in the bank to put a down payment on a house. The money in the bank would collect interest. They would buy a house and plan to have it all paid for in 20 to 30 years. The house would appreciate slightly better than inflation. Many of the companies they worked for provided pension plans. Workers did not have to be concerned with how these plans were invested; they only knew what to expect to be paid after their retirement.

Really sophisticated “investors” might have used some savings to buy securities, such as bonds or stocks. This was done with the help of a broker/advisor. There were a small number of mutual funds available to invest in. Some people bought investment properties with the intention of collecting rent (as opposed to flipping).

These days, there are so many, many choices for the individual, that it has become almost impossible for the average person to make any sense of it all. Many simply give up and surrender their money to multi-billion dollar management firms, which proceed to make outrageous amounts of profit from the management of your money, while your returns wallow in mediocrity.

Starting in January 2007, Pennyjar will be gathering small groups of individuals together to learn and gain confidence in personal finance and investing. These groups are in the form of an "investment club" but they will be much, much more than that. Our first groups will be in the San Francisco Bay area (since that's where we live).

It is important, to us, for people to be fully engaged in the process. For that reason, we will all have some "skin in the game". As a group we will be investing a small amount of money in real investments, be they stocks, bonds or some other product. Let's say, for the sake of argument, that each individual's minimum dollar comitment will be the equivavlent of about one Starbucks latte per week. Not too much, but it will be enough to make it interesting. The collective group of 10 or so members will decide on where the money gets specifically invested.

Pennyjar doesn't stop at being an investment club. We intend to make this process a lot of fun. By design, our meetings will be entertaining. There will also be a significant degree of social interaction. We are not interested in being a group of experts. Frankly, most of the supposed money "experts" are basically full of shit; they just know a lot of jargon and they know how to confuse people just enough so that they will be intimidated to hand over all thier money.

We are just regular people that want to get ahead and we agree that education and knowledge is the best path there. Better than lottery tickets, Amway, Vegas, dot.com stocks, pre-construction flips, and so on.

We are going to help people to help each other gain the knowledge and, we believe more importantly, the confidence to make good decisions. Pennyjar doesn't have all the answers, but we certainly will generate a lot of questions. And we will have a good time in the process.
We promise.

How to pick a stock: The BUD example

In a previous posting I covered how small-fish can buy stocks even if they do not have the $$ to open a brokerage account. The costs are not trivial; Etrade($1,000) and Charles Schwab($2,000). The answer was company direct stock purchase programs. For as little as $25 a month you can buy shares of ANHEUSER BUSCH (NYSE:BUD). How do you know if buying shares of BUD is a wise investment? The short answer is... you don't. No stock picker is right 100% of the time. However you can greatly increase your success rate by applying some basic stock analysis principles and understanding your risk tolerance. Risk tolerance is a way of measuring how you FEEL about risking your money for some reward. Usually a financial planner will asked you questions to help determine you risk tolerance. (or they should). Risk tolerance determines your investment style, conservative, moderate or aggressive. The higher your tolerance the more you are willing to accept some volatility in your investments. At the PennyJar we believe you should never invest any money you cannot afford to lose. Remember our talk about discretionary income?

Let's now turn our attention to analysing aka(understanding) ANHEUSER BUSCH (NYSE:BUD). Let's pretend we know nothing about buying stocks. What would be some of the things we would need to know? Well first what is a stock? When you buy a stock you are buying a piece of a company. Stock gives you partial ownership in a company. You become partners with the company. Your fortunes are tied to the company's success. It only seems logical then that you need to understand the company. Fundamental stock analysis is about understanding the company before you become a part owner in the company. O.K. what would I like to know about the company?

What does it do?
How does it make its money?
Can I go to sleep and know the company will still be there when I wake up?
Is the company profitable? (does it make more than it spends)
Does the company reward the stock holders by paying a dividend?
Who runs the company?
How effectively do the owners spend the stock holders money? Remember companies sell stock to raise money. What they do with this raised money is important to their business and your pockets.
Do we think the stock price will go up or down?

Getting the answers to these questions will help you decide if you should buy BUD.
The best place to look for the answer to our questions is Yahoo Finance. Here is the link to BUD at Yahoo Finance

What does it do? This can be found by clicking on profile link from Yahoo Finance. And here is where we find out that BUD "engages in the production and distribution of beer worldwide". This was not surprise (hopefully). We also find out "The Entertainment segment owns and operates theme parks. The company also is involved in the real estate development business; and owns and operates The Kingsmill Resort and Conference Center in Williamsburg, Virginia".
More I want more.. Let's visit www.hoovers.com to find out more about BUD. From Hoovers we find out that BUD owns a 50% stake in Mexico's top brewer, Grupo Modelo, which makes Corona and Negra Modelo among many other brands.

Let's stop here for now. Please look around the profile link. Can you tell me the name of the CEO and the income of th CEO? How many employees?
To be continued.........

Pardon me I just had a taxable event

Call me crazy, but I recently made an offer on a home in the San Francisco Bay Area. And yes I read the headlines and know there is a decline in the housing market. If you have read my earlier post you know that I am fond of the housing bubble logic presented at patrick.net. The house I made an offer on has been on the market for 6 months. The asking price has dropped $70K over those six months. While I think markets like Las Vegas and Reno will continue to drop in value, I am obviously less confident about bay area prices falling any further. So I made the leap of faith and sold some of my stocks to come up with the down payment. The selling of my stocks is a taxable event. I had to decided which stocks to sell. I basically broke my choices into two categories.
- Losers that I have held for less than a year
- Winners that I have held for more than a year.
Why?
If you've held a stock for at least one year, you're eligible for long-term capital-gains rates. Long-term capital gains are taxed at the 20% rate for most folks, while short-term gains--or gains made on stocks held for less than one year--are taxed at ordinary income tax rates, which range from 15% to 39.6%. In my case I am in the 33% tax bracket. So by selling the winners I have held for a year or more I am saving about 13% in taxes compared to selling winners I have held for less than a year. "begin sidebar" see the potential tax draw backs of day-trading? "end sidebar" I decided to sell the losers I have held for less than a year so that I can claim the losses on this years taxes to help offset some of the gains. If my offer is accepted on the home, I will not enjoy the mortgage interest deduction until I do my 2006 taxes.

Who owns stock

Here at Pennyjar, when we talk about "little fish", we are referring to the middle class in this country. The fact of the matter is that right now in America the rich are getting richer and the middle class is treading water. This is statistical fact.

That said, does it really make sense to point at rich folks and blame them for your own current condition? Rather than blame, my strategy is to ask, "What are they doing?" and then do some of it. Blaming, or being a victim is disempowering. I find it more energizing to take some personal responsibility and change the habits that do not serve me well.

As you can see in the chart below, the top 10% weathiest people in America own roughly 80% of the stocks.

Maybe, if I want to be rich, I should know a little more about investing and stocks.

Maybe I should stop wasting my money on the latest gizmos, fashion trends or bling and put some of that money to work for me.

You think?

NASD tools: Check your Broker & Mutual Fund fees

Here is the quick tip of the day. You can check the license or disciplinary history of your broker or securities firm online by going to the "NASDS BrokerCheck" section of the NASD's website. Here is the link to online broker check. This site is also packed with information such as latest investment scams and a GREAT tool for comparing mutual funds for their cost. This is a MUST see if you own or are thinking of buying some mutual funds. The fees associated with mutual funds eat away at your real returns.

Mortgage con artists

This piece from CNN/Money on mortgage fraud is a MUST READ!

A lot of ordinary, well meaning folks are being taken to the cleaners by sweet talking con men. The government is trying to crack down, but their results are not very good so far.

Your best defense is knowledge.
Understand the con and render the artist impotent.

"Since the housing market started to soar in 2001, mortgage fraud has become the fastest-growing white-collar crime, according to the FBI. Last year crooks skimmed at least $1 billion from the $3 trillion U.S. mortgage market.

Now that the market is slowing, fraud is only rising. As business dries up, there's increasing pressure on lenders, brokers, title companies and appraisers to be profitable. That means loan and title documents aren't scrutinized as carefully as they might be, and courts - many of them so low-tech they resemble Mayberry - can't keep up with the volume of paper.

Then there's the mad rush to sell, particularly by people who paid high prices for homes and suddenly can't afford the mortgages.

It's like a tasting menu for con artists and grifters, so tempting that in some cities drug dealers have turned to mortgage fraud, plaguing lower-income neighborhoods with crooked mortgages rather than crystal meth."

This slideshow gives a summary of some of the common cons, including the "Rent to Steal", "Straw man swindle" and the "Million dollar dump".

Put Your Money Where Your Mouth Is

How many fund managers invest in thier own funds?
According to WSJ article today:

"It has become easier to know this thanks to a rule by the Securities and Exchange Commission that required fund companies, starting last year, to disclose whether fund managers hold stakes in funds they run. This information can generally be found in a fund's "statement of additional information," posted on a fund company's Web site. The data are given in broad dollar ranges -- specifying only if a manager has invested, say, "$1 to $10,000" in a fund, or "over $1,000,000.""

I went fishing to see how easy it is to get this information. I spent almost an hour on two mutual fund websites and scanned through some prospectus looking for disclosure of managers' "skin in the game".

Alas, I failed, miserably. I will return later to the quest.

Simplifying Paperwork

Big brokerage firms are starting to clue in that people are overwhelmed by the amount of paperwork and disclosures they have to deal with. Firms trying to make correspondence in "better English" are Bank of America, Morgan Stanley, Wachovia and Smith Barney (Citigroup). Excerpt from the WSJ below:

Wall Street Aims to Simplify
Disclosures for Clients
By JAIME LEVY PESSIN
October 31, 2006; Page D2

NEW YORK -- New Morgan Stanley customers will no longer have to read through 14 documents -- amounting to 136 pages -- to get their accounts running. Soon, their financial advisers will hand them a single, 48-page document.

Streamlining efforts like Morgan Stanley's are under way at several Wall Street firms, an acknowledgment that firms -- while satisfying a legal obligation to disclose information -- aren't necessarily informing or educating their customers.

The brokerage industry has an obligation to make multiple disclosures to their clients. Product prospectuses, possible conflicts of interest and the distinctions between fee-based brokerage and advisory accounts, among other things, must be disclosed at various stages of brokerage and advisory relationships.

Bill Lutz, a professor emeritus at Rutgers University who consults regulators and financial firms on incorporating plain language into disclosures, said he has seen companies lose clients because investors were exasperated by the lack of clarity.

Not only do more-understandable disclosures make for better customer service, he said, they reduce firms' liability in cases where customers claim they don't understand what they have signed.

"People have successfully argued, 'We just didn't understand what you were telling us,' " Mr. Lutz said.

Hacking of online brokerage accounts starts to grow

According to a report in Moneywatch.com there has been a recent increase in the hacking of online brokerage accounts. The article points out the risk of using public computers to access your accounts. We are talking about any computer that you do not have control over. This includes a computer at a hotel, library or Internet Cafe. Hackers can load keystoke logging software onto these computers and capture your username and password.

Foul Fish Report

I subscribe to a couple of financial news mailing list. Everyday my inbox gets filled with the day’s happenings in the world of finance. Unfortunately I am too busy to read these stories everyday and I end up dragging the emails to a “save for later” folder. Today I thought it would be interesting to go through my “save for later” folder of financial news and dig out all the negative stories. I call this inaugural list of wrong doings, “The Foul Fish Report”, in keeping with the Pennyjar little fish vs. BIG fish theme.

Sept. 13 HP CEO Patricia Dunn resigns.
Her efforts to catch boardroom leakers last year led the Palo Alto, Calif., company to hire a contractor that scrutinized the private phone records of H-P's own directors and nine journalists.

Sept. 22 Dead guy gets stock
Cablevision Systems Corp. awarded options to a vice chairman after his 1999 death but backdated them, making it appear the grant was awarded when he still was alive

Sept. 27 Health insurance premiums rise 7.7%
The WSJ reports The average family premium rose 7.7% in 2006. That compared with a 3.8% rise in wages and inflation of around 3.5%.

Oct. 4 Intel investigation.
WSJ reports European Union investigators believe they have enough evidence to pursue formal antitrust charges against Intel Corp., a critical step in their five-year probe of the computer-chip maker, according to two people with knowledge of the case.

Oct. 4 Down on Dunn
HP Chairperson Patricia Dunn was named in felony complaints in California Wednesday along with four others related to a mole hunt undertaken at Hewlett-Packard while she was chairwoman of the computer maker

Oct. 4 401(k) fees too high
St. Louis attorney sued seven big employers-- Bechtel Group, Caterpillar, Exelon, General Dynamics, International Paper, Northrop Grumman and United Technologies--for allegedly allowing their employees' 401(k) plans to be hit with too-high fees, in violation of the Employee Retirement Income Security Act (ERISA).

Oct. 10 Tip of the Iceberg
The Department of Justice has begun an inquiry into potentially anticompetitive behavior among some of the world's leading private-equity funds (WSJ)

Oct. 15 Hey you caught me!
United Health CEO William McGuire plans to retire in the wake of a probe of the company's past stock-options grants. At the end of last year, Dr. McGuire's cache of unexercised options was valued at $1.78 billion. “Hey let me steal $1.78 billion and I would take the punishment of having to retire.” The beat goes on and on with this story. Here is latest list of 120 companies under scrutiny for past stock-option grants

Oct. 20 No bonuses for Costco execs
President and Chief Executive Jim Sinegal and Chief Financial Officer Richard Galanti won't receive bonuses this year.

Oct. 24 Guilty
David Kreinberg pleaded guilty to securities-fraud charges in federal court in New York. The former finance chief of Comverse Technology is the first person to plead guilty in the stock-options backdating scandal.

Oct. 24 Yikes! What happened to FORD?
Ford Motor Co.'s $5.8 billion third-quarter preliminary net loss

Oct. 26 Mutual-fund kickbacks
The SEC has launched a probe of 27 mutual-fund companies that the agency says have accepted kickbacks totaling hundreds of millions of dollars.

Oct. 26 Slick OIL.
Exxon's profit rose to $10.49 billion in the third quarter, the second-highest quarterly profit ever for a publicly traded U.S. company.

WSJ Piece on Latest Mutual Fund Investigation

SEC Probes Mutual-Fund Firms
After Settlement in Kickback Case
By TOM LAURICELLA
October 26, 2006; Page A1

The Securities and Exchange Commission has launched an investigation of 27 mutual-fund companies that the agency says have accepted kickbacks totaling hundreds of millions of dollars in recent years.

The investigation centers on alleged arrangements in which independent contractors agreed to pay rebates to mutual-fund companies in order to win lucrative contracts for jobs like producing shareholder reports and prospectuses. The probe stems from a $21.4 million settlement the SEC reached last month with Bisys Fund Services Inc., an administrative-services provider owned by Bisys Group Inc.

Regulators say Bisys, which is based in Roseland, N.J., paid a total of $230 million in kickbacks between July 1999 and June 2004 as part of an effort to win work from mutual funds. Bisys settled the civil charges without admitting or denying wrongdoing.

While the alleged kickbacks would have taken only a tiny toll on individual investors, perhaps shaving a few hundredths of a percent a year off their fund accounts and returns, the latest investigation comes as the fund industry is struggling to rebuild its reputation after a series of trading scandals that triggered regulatory crackdowns and fines totaling more than $1 billion.

Critics have long complained about fund companies using shareholder money for their own benefit. For example, funds are allowed to use trading commissions, which are deducted from shareholder funds, to pay for research that may not benefit individual fund investors. They can also levy fees on their investors for marketing, although attracting more investors benefits the fund company and not necessarily its existing shareholders. Both these practices are highly regulated to prevent abuses. Nonetheless, regulators and other observers say the latest scandal is part of a distressing pattern of fund companies misusing shareholder money.

"This is far worse conduct" than previous fund-trading scandals, said Mercer Bullard, a law professor at the University of Mississippi who specializes in mutual-fund matters. "Receiving a kickback that comes indirectly out of the pockets of shareholders is the functional equivalent of embezzlement."

In part based on information from Bisys, the SEC has sent letters to some of the 27 fund companies asking them to provide details about their ties to Bisys, according to people familiar with the probe. They didn't identify any of the companies. However, the investigation is unlikely to include many of the very largest fund companies, which tend to have in-house units that handle administrative functions.

Most of Bisys's clients were bank-run funds, many of which tended to be smaller firms with several billion of dollars under management. A handful of banks, however, do rank among the larger fund managers.

The SEC says the alleged kickbacks involving Bisys and other service providers worked with the help of secret side agreements. The service providers charged shareholder accounts for administrative services but, unbeknownst to the funds' investors or independent board members, the providers agreed to rebate part of that money to fund advisers, who would then use it to cover their marketing expenses. In exchange for the kickbacks, the advisers would recommend to their funds' boards that the service providers' contracts be renewed.

At issue in the probe is whether fund companies misused their investors' money and misled their boards about why they were hiring certain service providers, according to people familiar with the probe. "These matters raise questions about whether there was a breach of duty to shareholders," said Philip Khinda, an attorney who represents a number of fund boards that have been investigating their funds' arrangements with Bisys.

In its complaint against Bisys, the SEC described the actions of one fund company, which it referred to as "Adviser A," that allegedly demanded millions of dollars in kickbacks in return for recommending that Bisys's contract be renewed. Another 26 fund families had similar deals -- some written, and some only oral -- with the firm, the SEC said.

The agency didn't identify any of the fund companies in the complaint but, according to people familiar with the investigation, "Adviser A" is AmSouth Funds, which was then a unit of AmSouth Bancorp of Birmingham, Ala.

AmSouth Bancorp declined to comment on whether or not it is the company referred to as "Adviser A," but it said it is cooperating with the SEC.

In 2005, after the alleged arrangement with Bisys had ended, the AmSouth Funds, which then totaled $5.5 billion in assets, were sold to Pioneer Investments. A spokesman for Pioneer declined to comment.

The SEC's Bisys complaint says a senior executive at "Adviser A" told Bisys in 1999 that if it didn't agree to a kickback arrangement, one of its competitors would. Indeed, the SEC alleged in its complaint that "other administrators" besides Bisys cut such deals.

Bisys's main competitor is SEI Investments Co. A spokesman for SEI, which is based in Oaks, Pa., said that as a matter of policy the company wouldn't comment on whether it had received inquiries from the SEC nor on whether it had similar rebate agreements with fund companies.

Bisys accepted the deal with "Adviser A," and over the next five years, funds totaling $17.3 million were deducted from shareholder accounts at the fund company, according to the SEC. The money was used by "Adviser A" mainly to cover marketing costs that would normally come out of its own pocket. The adviser also used some of the money to pay the initiation fee and monthly dues at a country club, the SEC's complaint says.

In the arrangement with "Adviser A," Bisys would be paid 0.20% of fund's assets, the SEC said. However, Bisys kept only roughly one-quarter of that amount. About one-third was paid to "Adviser A" in an above-board contract, the SEC says, while the remainder was kicked back to the adviser through a "marketing budget."

In its settlement with the SEC, Bisys agreed to terminate such agreements and change its policies. It disciplined or fired a number of employees.

Last summer, AmSouth gave its own version of its dealings with Bisys. At the time, it disclosed that the SEC had informed the bank it intended to bring civil charges against it related to the service provider. It said that the probe related to "past arrangements under which Bisys used a portion of the fees paid to it by the fund family to pay for marketing and other expenses."

The mutual-fund industry has been dogged by scandals in recent years. In 2003, it came under fire after revelations that a number of big companies let favored clients conduct short-term trading, earning profits at the expense of ordinary shareholders. The following year, regulators cracked down on fund companies that used stock-trading commissions, which are deducted from shareholder accounts, to pay for marketing activities the companies would otherwise have had to cover themselves.

Brokers cost you Billions

I have been reading a study by Daniel Bergstresser and Peter Tufano, both at Harvard Business School, and the University of Oregon's John Chalmers.

The reports compares the performance of mutual funds bought through a broker compared to funds bought directly. The conclusion is that, through brokers, "consumers pay extra distribution fees to buy funds with non-distribution expenses. The funds they buy under perform those in the direct channel, even before deductions of any distribution related expenses."

Statistics don't lie. The statistics say that, by using a broker, you are
1. paying higher sales fees
2. to buy funds with higher management fees
3. that get crappy returns.

The crappy returns cost investors approximately $9 billion per year, and that is not including distribution expenses.

Why is this happening?

I go to the section 9, titled "Do Brokers Merely Sell what they are Paid to Sell?

Here, the authors refer to the obvious hypothesis that "brokers may give priority to their self-interest or to the interests of the management companies whose funds they sell."

The statistical evidence indicates that higher fees paid to brokers result in higher sales for the mutual fund paying the fee. According to the report, "These results suggest that sales incentives are more effective in the broker channel, consistent with the old saw that funds are sold, not bought - and that paying a salesforce on a higher piece-rate scale may induce additional sales"

Ultimately, all the fees and commissions come from the investors. Your money.

Do you know what you are paying in fees?
Do you know how much of your money your broker is getting?

Coming Up Short

Mutual-fund investors' real results are often surprisingly poor.
• Over the past 10 years, owners of diversified U.S. stock funds collected 7.3% a year, less than their funds' 8.8% published return.

• In 19 stock markets, investors underperformed a buy-and-hold strategy by 1.5 percentage points a year since 1973.

• Over seven years, broker-sold stock funds lagged behind directly sold funds by half a percentage point a year after expenses.


Sources: Morningstar Inc.; academic studies

130/30

So what is the 130/30 strategy?

Let's start at the beginning. The "Alpha".

I am not referring to the first letter of the alphabet or the biggest gorilla in the troupe. In finance, alpha has a different meaning.

It is a measure of how well an investment, usually a mutual fund, performs in comparison to the overall market. In an oversimplified example, if the whole market goes up 10% and your specific investment goes up 10%, then the alpha of that investement would be zero.

Things get a little more complicated because Alpha also considers the relative risk of whatever stocks are being bought. If a fund manager invests in stocks that are very stable (i.e. prices don't fluctuate too much), the alpha is calculated differently than if the fund manager invests in very volatile stocks.

Conventional wisdom states:
Stable stocks are safer - volatile stocks are riskier.

Therefore, if one invests in risky stocks, the potential profits should be higher. Alpha takes that into consideration. A mutual fund specializing in nanotechnology start ups would have to deliver much higher profits than a collection of blue chip mega-corporations to get the same "alpha" ranking.

So, getting back to 130/30. The goal is to increase the alpha while maintaining low volatility. It works like this:

Let's assume $100 investment.

1. Buy $100 of large cap stocks
2. Sell short $30 of the stocks in your portfolio
3. Take the proceeds of the short sale and buy more large cap stocks.

Confusing? Just a bit. Selling short is like betting that a share price will go down. How this is achieved can be complex and possibly another post on the blog. These days, shorting often involves trading of options and derivatives. The important thing to know is that the more a stock falls, the more profit the investor makes.

The tacit assumption is that the managers of the 130/30 fund are good at picking winner and loser stocks. Ultimately, that is going to determine performance.

The cool thing is that this strategy limits losses when markets turn downward. This is how risk is reduced, without sacrificing performance. It could limit profits in a crazy bull market. But in the long race, it is often profitable to bet on the tortoise, not the hare.