Know Thyself and Buyer Beware

Know thyself and buyer beware. These are phrases I not only preach but also practice, particularly when I make financial decisions each year. I have been talking about the importance of financial literacy with friends and also leaders in the Latino community. Here are a few thoughts.

I believe in self-honesty and knowing what you don’t know, self-education, and self-reliance. Let me take the last first, and tell you why and how they apply in becoming a financially literate individual.

Self-reliance. When I graduated from Harvard in the mid-1980s, I had no money, I was in debt, and I was about to enter graduate school at Yale, to assume even more debt and continue my education. I watched every penny. My bed for years was cinderblocks I found on the street covered by an old sheet of plywood and topped by a thick piece of foam. I saved money, even while at school, and opened my first money market fund.

Self-reliance and my cost-cutting ways were my methods of increasing the amount of capital even when I was earning small salaries as a teaching assistant. Yet even then, I knew that unless I made my savings grow, I would never go beyond a hand-to-mouth existence. So I also began investing in mutual funds. It was the beginning of one of the greatest bull markets in history, so I was also lucky.

Because I used my own investment money, no committee had to be consulted, no outside investor would ring my phone in the middle of the night to cry about losses, and I could choose out-of-favor or even unknown companies (except to me) and invest in them for the long-term. Self-reliance also meant patient money.

Self-education. As I invested, I also began to read. Benjamin Graham. Peter Lynch. Ralph Wanger. Warren Buffett. Barron’s and The Wall Street Journal. John Bogle. Jeremy Siegel. Philip A. Fisher. I am still reading books about investing, by investors and fund managers, and professors of finance. I also taught myself financial accounting, by reading accounting books. I wanted to be able to read and understand 10-K reports and annual reports, and how companies work to make profits.

But my education was not just book-learning. As I invested and learned on the fly, I saw how the financial press was manipulated by many mutual fund companies that trumpeted ‘stellar funds’ with great short-term records, only to have these same funds explode with assets the next year and the managers produce mediocre returns or leave for more money to other fund firms. These ‘stellar funds’ also carried high costs: win or lose, the fund managers still made money for themselves.

Costs matter. Costs are permanent. Invest in index funds, which are the lowest cost funds, particularly at a place like Vanguard. Index funds also have no prima donna fund managers. Buy three or four index funds that represent the stock and bond categories you want to be in, and that should be the plan for the majority of investors who are passive. Passive simply means you are not buying and selling individual stocks, you don’t have the time and inclination, and it’s better to know what you don’t know and invest in index funds. Investing is Socratic: those who don’t know who they are as investors will soon be ripped off by manipulators who appeal to the greed and vanity of the hapless.

Self-honesty. I made many investing mistakes. In my early years, I invested with ‘stellar stock funds,’ which soon tanked. Taco Cabana, another mistake. Stay away from restaurants and airlines. I know certain industries pretty well, but others are too difficult for me to understand, or too unpredictable as businesses. I stay away from what I don’t know, and if I want to know I do hours, even years, of homework.

I have not made many mistakes selling; I don’t know why. I do have a sense of when to get out when I have followed and invested in a company for years. But I have made mistakes buying early, a bit too high, for example. Over-enthusiasm. In a market rout, I don’t panic. I have thick skin, and I don’t report to anybody on my investments. Last March, the nadir of recent stock market valuations, I was indeed worried, yet I stuck to my individual stocks and index funds. I did nothing, which was the smartest thing I did all year.

Investing is about being efficient with the extra capital you have. Invest it well, learn who you are as an investor, and make saving money your constant priority. Then investing will be your path to independence.

Bear Market Blues

Another day, another drop in the Dow. We had an interesting discussion as a family yesterday: how to cut back on expenses to save as much money as possible. Laura and I told the kids about our investments, and how along with everybody else in this country we are suffering from this vicious, relentless decline in equities. We are okay, and I have never invested in anything fancy with the small portfolio of stocks I have, mostly in healthcare. Our portfolio has done better than the S&P 500 over the past fourteen months, yet it’s little solace to be down 35 percent even if the market is down 50 percent. The kids suggested turning off more lights to save electricity and eliminating cable and just watching TV on the Internet. I suspect many families across the country are having these discussions, and I know many are making much tougher decisions than whether or not to keep cable.

I wonder how this deep recession will affect our long-term attitudes. We have never been big spenders, and I have always paid off my credit card balances at the end of the month. I don’t like the punishing interest rates or late fees from plastic. I pay our mortgage fifteen days early each month; I try to be responsible. In our living room, I still have the speakers I had in college twenty-five years ago, but we do spend heavily on books and about once a week I buy a few culinary treats from Zabar’s. This economic downturn has forced me to ask myself many questions. Have we been careful enough with our finances? Are we ready for a long-term decline in the economy, in the stock market? Should we have saved even more money, and invested it even more conservatively, so that our kids can afford college in four years?

There is a great deal of self-doubt, self-assessment occurring in my head. I know I have not been reckless with our family’s finances. In comparison to what I hear in the news, of people investing in mortgages with teaser rates, of credit-card holders paying only the minimum with exorbitant interest rates on massive balances, of spenders who did not save much for many years but instead took out home-equity lines of credit, I know I did none of these things. We spent what we needed; Laura and I have saved 10-20 percent of our income each year; and I invested it. My friends and family have assured me I have been conservative with our finances, and yet I still feel I am failing. I simply want my family to be okay; I want my children to go to whatever college they want in four years.

Besides questioning myself, I am also angry. Angry at the ridiculous 21st Century version of American democracy. I find it more akin to several mobs shouting at each other, trying to sway the middle who simply wants to live in peace and with a modest prosperity. The democratic political and economic discussion to solve our problems, I have always believed, would only be as good as the character of the participants in this discussion. But what happens when ‘character’ is defined and warped by the means of communicating your message? We are losing newspaper editors and reporters every year, but TV pundits and braggarts on the radio, both experts of pithy sound bytes, define, ambush, and drive ‘political discussion.’

What will happen when we don’t even remember that there used to be a time when careful, self-critical, and even profound political debate defined at least a significant part of what occurred in the great American conversation to solve our problems? When we don’t even have the memory of a better political discussion, I believe we will become more mob-like, and less democratic. I believe we will be prone to radical influences with simplistic solutions, which in reality solve nothing. Be careful whom you pay attention to: the more you pay attention to them, the less you will be able to decide for yourself why you began to pay attention to them in the first place.

These are sobering times. Will we get sober leaders to help us out of this mess? Will we even have the capacity to listen to them anymore? I don’t know, but I am still hopeful.