PHILADELPHIA REFLECTIONS
Musings of a Philadelphia Physician who has served the community for six decades

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Investing, Philadelphia Style
Land ownership once was the only practical form of savings, until banking matured in the mid-19th century. Philadelphia took an early lead in what is now called investment and still defines a certain style of it.

Philadelphia Economics (3)
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Health Savings Accounts, Regular, and Lifetime
We explain the distinction between Health Savings Accounts, Flexible Spending Accounts, and Lifetime Health Savings Accounts. Sometimes abbreviated as HSA, FSA, and L-HSA. Congress should make it easier to switch between them. All three are superior to "pay as you go", health insurance now in common use, only slightly modified by Obamacare. It's like term life insurance compared to whole-life. (www.philadelphia-reflections.com/topic/262.htm)

Investing for the Common Man

Some of my best friends are investment advisors. They are some of the most urbane, pleasant, and smart people around town, and until recently some of the most prosperous, not to say, rich. Many brokerages were founded as private offices to service the particular needs of one very rich family, and then expanded to include the public for a fee. They are not and never were, fiduciaries. They have no legal obligation to put the customer's interest ahead of their own, and they are very careful to tell you that, in the body language of behavior. For that reason, they were very careful with new customers, and the customers had the perception that they were privileged to be accepted as customers. Such old-line brokerages were a 19th Century sideline for people who owned family businesses, but had some capital to spare. Shortly after World War I, brokerages thrived as family stockholder businesses declined, gradually morphing into a world dominated by public stockholder corporations. A specialized business, investment banking, concentrated on merger and acquisitions, and at first converted most large family businesses into stockholder corporations.As that opportunity graduallh dried up, investment banks began to trade on their own accounts, sold bond flotations, and created derivatives. By the end of the 2008 crash, there were only two independent stock brokerages in Philadelphia; all the many others had been absorbed into national firms. Only about five of them dominated the field in 2014. In about a century, family businesses of all sorts had disappearpreaed; that unrecognized fact was a major factor underlying the social uproars of the 1960s. No longer did the owner of a family business expect his son to take it over; in fact, no longer did the fathers of daughters organize local social events to thrown the next generation of local leaders together at parties.If you wnat to hire someone to run your business today, the natgural thing is to hire a search firm to find somebody in San Francisco to run your business. This phenomenon spread out to almost all traded and professions, including shoemakers and stock brokers. It's all rather sad.

,P. During that century the cream was skimmed off, leaving family businesses as a relic of the past, and brokerage houses were threatened with the loss of their main product to convert, as well as their main supply of respectful clients to buy them. The electronic computer had a lot to do with this, making mass production of a Savile Row business into a low cost, mass producing mass marketing organization. No longer did you learn the trade by associating with a master of it; you went to business school to learn the techniques. Your SAT score became more important than your rolodex. Or your city club, or your prep school, or golf handicap. Or, for that matter, whose daughter you married.

Nowadays, there are even more private offices, but the owner is apt to have made his pile as a chemical engineer, and his manager went to business school, polished up his skills in a big investment firm, and got hired as the local expert on what to do with all that money, on how to educate the clueless owner, and how to manage his worthless children. If he did well in the private office, he was fixed for life. If he did well but felt restless, he was apt to start his own hedge fund. In all this professionalization of an artisan trade, nestled within a relentlessly competitive environment, the customer relations retained many of the mannerisms and attitudes of its family business origins. For one thing, most new investors have either inherited money or earned it in some totally non-financial arena, and are totally at sea in their new unfamiliar role. Realizing their helplessness, and probably foreseeing a lifetime of dependence on investment, they are scared. Anticipating failure, they are preparing the IBM defense. That is, they are like beginners put in charge of buying a computer in the early days. If you bought an IBM computer, it might cost more and do less, but no one would criticize you for selecting IBM. That's how customers approach the problem. The financial advisers feel entitled to a luxury lifestyle, and charge the generous fees which will lead to it. Neither client nor adviser allows the relationship to consider the only thing which matters: how does your track record compare with cheaper competitors? What a nasty low-class question to ask.

Let's ask an even nastier question, anyway. How does the whole class of active managers compare with a random walk on Wall Street? In fact, if you subtract the fees they charge, almost everyone does worse than index funds. In fact, if you take Warren Buffet, the most famous investor alive, and compare the performance of his company, Berkshire Hathaway, with Vanguard's total market index (VTI), it is pretty hard to tell the difference. Warren Buffet is one of the richest men alive, but his performance including administrative costs does not justify the purchase of his stock, or in fact the performance of any stock-picker. If you pick out the best manager you can find, regaardless of hisfluency with words like alpha and moveable alpha, and make sure to include the fees he charges, you will almost invariably find you would have done just as well with an index fund. Do two things: make certain you pick the beginning date, and put several years performance through an internet website known as BigCharts. Remember, almost any numerical series can be manipulated by selecting a favorable beginning date, so you choose it, and preferably chose several of them. BigCharts is free, and it provides for automatically plotting the historical charts of several funds at once, different colors for each. You can if you wish, browse through Ibbotson's atlas of the prices of all classes of stock for the past century. What Ibbotson demonstrates in overwhelming detail, is that different classes of stock differ from each other, but they consistently revert to the same mean. Using a logorithmic scale and plotting total return (stock price plus dividends), small and mid-cap stocks hold steadily to a 12% annual return, while large capitalization stocks (the ones you have probably heaard of) "command a premium price", which is to say they return 10%. Bonds return less, U.S. Treasury bonds return still less, and inflation has been a little more that 3%.

The first thing this study proves is that if you made less than 3% return, you lost money, by allowing inflation to eat it up. If an investment manager cannot show better results than 3% inflation, you are better off avoiding him. Don't avoid the question. Ask it.

Secondly, it's hard to answer why you should not put your money in a small-cap index fund, with administrative fees well below a fraction of one percent. Several index funds with several billions of dollars of deposits have fifteen-year administrative fees of less than a tenth of a percent, and total returns of 12%. Why not buy them, and never sell them except in emergencies? It's hard to see why that is the wrong thing to do, but it means concentrating investment in hundreds or thousands of companies too small to recognize. Admittedly, some of these stocks will go broke, but others will skyrocket. However, it is easy to understand the fearfulness of a new investor, who wants to own big companies he has heard of. He wants to own IBM and General Electric. Very well, buy an index fund with low fees, and try never to sell it. That way, you will make 10% and both minimize taxes and transaction costs. But remember that inflation is going to reduce the results by 3%, so the difference between 12% and 10% is really the much greater difference between 9% and 7%. If you reduce it further by buying a hedge fund with a typical 2% surcharge, it is the difference between 7% and 5%. If you fail to put the funds into a tax-exempt retirement fund, you will reduce your after-tax return to either 4% or 3%. Perhaps from this simplified example it becomes clear how sales fees of $250 per transaction may seem fair to both you and your manager, but they soon reduce the investment return to such pitiful levels that it isn't worth the risk. Don't do it. Don't let it happen. Transaction fees of $7 a trade are available from several investment companies with deposits in the trillions. The marketplace says this service is worth $7 a trade and 0.07% yearly administrative cost. Your broker has to make a living, yes. But you have to afford retirement, also yes.

Actually, that isn't all. Most qualified retirement funds are retail, and the funds they choose are wholesale. Beware of funds which charge you $250 to make a monthly or quarterly, or even annual minimum required distribution, for sending you the money you could ask to be send to you directly for a fee of $7. Some of the biggest banks in America do exactly that. Your fund was inexpensive, but your agent was very dear. Unless your manager sends you regular performance reports, and includes every penny of fees; and unless the net of inflation is 5%, you have a reason to move your account. Past results are no predictor of future performance, that is true. But past behavior is a very good predictor of future behavior, as my grandfather told me, and as I tell you. No second chances allowed.

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