Moving on from blogger

I've grown exhausted with Blogger's aesthetic and SOE shortcomings, and have decided to move to wordpress, at:

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Beware top-heavy ETF's

Investing in stocks is inherently risky, and the best way to reduce risk and maximize returns is to invest in a diverse portfolio over the long term. Index funds fit the bill, with low total expense ratios and a built wide basket of stocks. If you’re interested in even greater diversity, you invest in foreign ETF’s. Jason Zweig points out that …

Some emerging-market ETFs invest in indexes that are so concentrated that they mightn't fully reflect the real economy. The Brazilian market "has been top-heavy for years," says Dina Ting, who manages the iShares MSCI Brazil ETF. "There's two big companies, and then the stocks just fall off a cliff in terms of size.

Check out how big Carlos Slim's America Movil is.

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A qualified defense of Sharebuilder

Jim over at Bargaineering wonders why anybody would want to use Sharebuilder. OptionsHouse and Tradeking, respectively, offer $2.95 and $4.95 buy and sell fees—compared to $4 to buy at $9.95 to sell at Sharebuilder. Sharebuilder once uniquely offered free dividend re-investment plans; now all services offer the convenience. He concludes:

Short of taking advantage of the free money offers using a Sharebuilder promotion code , I'm not sure Sharebuilder makes much sense anymore. What used to separate them from the competition is now common among discount stock brokers and they never innovated to keep up.

Am I missing something?

Here's a couple other potential quibbles about Sharebuilder.

• Their basic pricing structure can be a little confusing at first. When you say you want to purchase $500 worth of stock, Sharebuilder actually buys $496 worth and keeps $4 commission.
• They fail to provide a convenient chart showing return on investment over time.
• You can buy only on Tuesdays.

That said, I still use Sharebuilder, and I think Jim is indeed missing something. Here is why.

For one thing, Sharebuilder is still the cheapest broker out there. Its fee plans are cheaper than $4 each if opt for the monthly packages of $12 a month or 6 trades, or $20 for 20 trades.

Here's the big thing. What you have to understand is that Sharebuilder markets itself as a service for the small-time, buy-and-hold, index fund-preferring, conservative investor who prefers keeping things simple. All its features (and shortcomings) derive from this.

Sharebuilder is not competing for the active trader, so a Tuesday-only investing time schedule is not a concern. Stocks and ETFs that interest the Sharebuilder investor are not so volatile that waiting a few days for a purchase will make much of a difference.

The expensive selling fee? I wish the fee was smaller, but it's not a dealbreaker either; a Sharebuilder user will likely have made several stock purchases at $2 or $4 each before incurring the expensive $9.95 sell fee.

The other major convenience Sharebuilder offers is the option to purchase a precise dollar amount of stock, as opposed to the traditional way of purchasing, which is to purchase X number of shares. For example, say you have $1,000, and not a penny more, to invest in Acme Corp, which is selling at $101 a share. With Sharebuilder, you can purchase exactly $1,000 worth of shares of the company, and have 9.9 shares of the company. With other brokers, you purchase 10 shares at the selling price. If it's selling at $101 a share, you can either purchase 9 shares $909.

The final reason I use Sharebuilder is the weakest. As I've written countless times, I love my ING account. I love the lack of fees, the interface, the customer service, the services. Since ING owns Sharebuilder, I enjoy instant transfers to my Sharebuilder account. The reason I started with Sharebuilder was the $50 bonus, and the nudge that ING offered.

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My Portfolio, July 21, 2009

Here it is. With investments in Goldman Sachs, ING, GE, and Bank of America, I'm still overly invested in the volatile financial sector. Being in the troubled sector means huge gains---I'm enjoying a 35% return on just Bank of America investment in just 4 months. But it also means the potential for big loses---I lost 20% of my Citibank investment, made official after I dumped their stock. But even with that loss, I'm up 20% for the year.



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Dividends Riposte

So my post on the tax-related downsides of stock dividends failed to impress Nelson of nocommunism.blogspot.com. The guy, I gather, fancies himself as clown the personal finance blogosphere, and he rips me as a doucher, a shithole, an idiot, fruity, and nutty. The dude even mocks my blog name. Ha! There's nothing I enjoy more than a fight, so bring it on, my fatuous friend.

I'll reiterate my argument for the unacquainted: Absent taxes, dividends neither hurt nor help an investor's return, and should matter not one iota when investing. Dividends are, as I wrote earlier, a neutral mutation. They provide just as shareholder benefit---that is, none---as a mandatory share repurchase. But because of capital gains taxes, dividends actually hurt your bottom line. If you disagree with me, you'll also disagree with many very smart financial people. As Jeremy J. Siegel writes in of Stocks For the Long Run on page 99: "From a tax standpoint, share repurchases are superior to dividends ... share repurchases generate capital gains whose tax can be deferred until the shares are sold."

Many modern firms like Google and Dell, and enlightened older ones like Berkshire Hathaway don't bother paying out dividends. Instead, they re-invest retained into the firm to purchase equipment, human capital, pay down debt, etc---in short, investing in the company to increase shareholder value and future earnings. Yes, one can make pretty solid arguments about why dividends serve as a positive signal for a firm's health: A dividend policy can focus management on delivering profits; and dividends can reduce the chances that earnings will be frittered away.

But Nocommunist Nelson doesn't argue with valid arguments. Instead, demonstrates his failure to grasp basic investing and basic math. His post makes me think of this:



Just how fatuous is Nelson? Let's count the ways!

I. I will acknowledge he is discovered an editing error. My editor (that is, me) should have corrected "stock swap" with "reverse split." That said, he misses the point. I'm pointing out that a reverse split is just as unmeaningful as a dividend. I never said companies nowadays.

II. I wrote that the value of a stock decreases when a stock goes x-dividend. Nelson replies: "A stock doesn't just go down because they've paid a dividend. The way the market performs that day has more of an impact than the dividend going x-dividend ... It means that if we look at 5 companies at random, on the day they went x-dividend, their share price should have decreased by at least the value of their quarterly dividend. (perhaps more if the market was down that day) Do they? Let's check." He then proceeds to list stocks that paid a dividend and their value. "Their share price should have decreased by at least the value of their quarterly dividend," he writes.

Nelson's rabid snark impresses more than his meek investing brainpower. Two reasons:

Income can either be used to pay dividends or be retained. When retained, the earnings become part of the shareholder's equity section of the balance sheet. Retained earnings are but one part of a stock's value. When a firm issues a dividend, shareholder's equity decreases by total value of the issued dividends. The value of each share, therefore, should decline by the amount the firm paid out divided by the number of shares. Not, as Nelson naively says, by the dividend amount.

And two, the price of a stock is set by the market, which is the aggregate of millions of humans. Stock prices fluctuate as investors speculate about future earnings and value. But the fact remains, the when stocks go x-dividend, the fundamental value of the stock decreases---because, again, the entire company value decreased by the total amount of the dividend paid out to all shareholders.

III. I write, "Paying dividends to shareholders, in other words, is the functionally the exact thing as a mandatory buyback of shares." Nelson says: No it isn't. For several reasons: 1) Shares don't always go up. A mandatory share buyback could mean being forced to sell at a loss. 2) It's MUCH more simple to pay out dividends as it is to do a mandatory share buyback. 3) Wouldn't a mandatory share buyback eventually make all of someone's shares go away? 4) You're named after granola. Nice call on that one. We've all had some shitty calls in our day, but that one takes the cake.

My response:

1) Wrong again, buddy. When all firm shareholders are forced to sell back their shares, their ownership stake in the company remains the same.

Say there's 100 stocks evenly distributed to 5 owners (5 shareholders holding 20 shares each, for a total of 100 shares). Say the company announced earnings of $700. $300 will go to the shareholders.

Say the company purchases, for a price of $30, 10% of all shares. After the buyback, there is then 90 outstanding shares, distributed evenly among the 5 owners (5 shareholders each own 19 shares, for a total of 90 shares).

In both before and after the mandatory repurchase, each owner owns 20% of the firm.

Let's say the firm opted for a dividend instead, and each shareholder receives $3 dividend. Each shareholder still has 20 shares, for a 20% ownership stake in the company, but with $30 dividend in their pocket.

In both scenarios, the firm used its equity to purchase the shares, so value of the company just decreased by about $300. (10 purchased stocks times $30; or $3 dividends to 100 shares). In both scenarios, each shareholder owns 20% of the company. And in both scenarios, each shareholder has an extra $30 in their pocket.

Like I said, from a shareholder's point of view, absent taxes there is no difference between a mandatory buyback and a dividend! But because of capital gains taxes, each shareholder must pay 15% of their earnings in capital gains taxes, for a total of $4.50.

Say each shareholder purchases more stock with the dividend cash. It can be the same company or a new one; but when he or she sells the "new" stocks at a future date, they pay capital gains again.

If the company retained its earnings and re-invested all the earnings, the value of each stock would have retained its post-earnings increase ($3 for each share, in this case)---and the capital gains would only be paid once.

Lest I made this point unclear, I will quote Yale finance professor Robert Schiller: "It's changing the number of shares outstanding, so the value of the company declines by the same amount; it has to, as if they had just paid a dividend. If they're sending out money, the value of the company has to go down by whatever they sent out. With share repurchase, the number of shares goes down, and if they don't do share repurchase the number of shares doesn't go down. So in a sense, it's all the same to me as a shareholder whether they pay dividends or they repurchase shares." Read that last sentence again, buddy.

2) Yes, it's easier to pay dividends than do a mandatory share buyback, but so what? I said "functionally," with apologies for my typo. Oh, and, Nelson, why didn't you mock my editing? It would've been so easy!

3) If a firm opted to purchase literally every single share, then, yes, all shares would go away. But no company could afford to do so. The same ridiculous scenario could be concocted with with dividends. A company could, hypothetically, issue all its capital as a dividend, and make itself go away.

4) Check out that YouTube video again.

IV. At the end of my post, I rhetorically ask why corporations issue them and spend so much time on them. Nelson replies: "Plain and simply because investors put a value on cash. Isn't that the whole fucking point of investing?" His truism so reductive as to be meaningless. Only a simpleton places a premium on simple cash; only a fool thinks "cash is king" (which, I suppose, would render stocks as as the subordinate subjects). Cash loses due to inflation. Investors value maximizing profit overall return. Hence, they invest in stocks. Behavioral economics and investor psychology explain why investors and management spend so much energy over dividends.

There you have it. Human straw men can exist. As Nelson demonstrates, sometimes that straw man can be rabid with a fetid mouth. Thankfully for me, he is devoid financial and investing brainpower. I will admit that I smirked when reading his post mocking Trent of The Simple Dollar for pondering the efficiency of of toilet paper squares. So Nelson, buddy, keep hacking away at posts about toilet paper. It's your niche in the personal finance blogosphere! But leave the deeper, more thoughtful stuff to those with the brainpower. You chump. Continue Reading

MoneyGranola mentioned in another blog

My post on dividends was mentioned on Darwin's Finance and The Carnival of Personal Finance. Continue Reading

Dividends as a mutation

When I opened my Sharebuilder account the other night, I saw that my portfolio accumulated over $25 in quarterly dividends. Ah, the thrill of free money! Further inflating my sense triumph how I set my Sharebuilder account to free automatic dividend reinvestment—so I got free stocks! But my enthusiasm waned, then completely deflated, after I spent a few hours learning about dividends. Dividends, I learned, do not matter to the small time investor like me. I repeat—they don’t matter, they’re irrelevant, and should not affect your purchasing decisions. In fact, dividends chomp on overall your earnings. Here’s why.




Say you have 10 stocks for corporation X valued at $50 each, for a total value of $500.Consider the following thought exercises:

• Are you thrilled by a stock swap? If the company declares a 2-1 swap, you have 5 stocks valued at $250 each, for a value of $500.

• Are you thrilled if a company offers you stock dividends, wherein every stockholder receives an extra, say 10% share? In this case, you’d have 11 stocks—but because the your overall company ownership percentage remains the same, as both the denominator and numerator become larger. The stock value declines as well—by about 10%. Those 11 stocks have a value of about 4.55 each—and your total value remains $500.

• Are you thrilled if the company offers a mandatory buyback 10% of your shares? The value of company declines by 10%, since the company has to spend the money to purchase the stocks. So you have 9 shares for a total value of $450, but $50 in taxable cash. You can buy back the stock, and you have 10 shares for a value of $500 once again, minus the taxes you have to pay in $50 in capital gains.

Stocks are securities that signify ownership in a corporation and represent a claim on part of the corporation's assets and/ or earnings. When we buy a stock/ share of a company, we are purchasing a cut of future value—prices fluctuate when people speculate about future value. When a corporation issues a dividend, the value of the corporation’s total assets decreases. (Incidentally, the day that a company declares a dividend, it’s said be going x-dividend. On the day the stock goes x-dividend, there’s an “x” by its price on the NYSE to indicate to investors why the price decreased.)

Paying dividends to shareholders, in other words, is the functionally the exact thing as a mandatory buyback of shares. With the dividend reinvestment, I lose no value in my investment, nor do I lose value. In fact, it’s a disadvantage: With my $25 in capital gains, I will be taxed at 15%--in addition to the normal tax I will be charged when I sell my “free” stocks at a future date. If a company reinvested its earnings, like Warren Buffett’s Berkshire Hathaway does, I would not have to pay those taxes.

If dividends are such a tax nuisance, why do corporations issue them and spend so much time on them? Why does Standard and Poor write about its dividend aristocrats? Yale professor Robert Schiller says dividends are best understood in through the lens of behavioral finance: It’s all about investor psychology. Corporations’ boards know that investors interpret dividends as something that healthy, long-lasting companies issue. Former University of Chicago professor Merton Miller called it (not accounting for taxes) a “neutral mutation,” an evolutionary biology term that describes mutations that are neither advantageous nor deleterious--hence the picture of a DNA strain in this post.
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Is police corruption necessarily economically negative?

On the personal money level, Serpico illustrated one, the luxuries of a life free of money constraints, and two, and how a corrupted culture affects the “deviant,” by-the-letter-of-the-law officer. Left unanswered by the movie, in my mind anyway, is whether widespread corruption is necessarily a bad thing. From a moral point of view, yes it’s wrong; these officers are paid to uphold the public trust. But how about from a non-moral, economic point of view? Why should we care if the officers take a few Franklins from the pimp or drug dealer, provided they are stopping crime? I’ll get to it in that in a couple paragraphs, after mentioning what the Knapp Commission officially reported.



The corruption was formally investigated by the Knapp Commission, created after the public uproar trigged by the series of New York Times articles on kickbacks and bribes. Frank Serpico was a key source on these articles. According to Wikipedia, the report identified two types of corrupt police officers, lamely dubbing them grass eaters and meat eaters. In short, the grass eaters were the passive followers. They accepted gratuities and solicited small payments from contractors, tow-truck operators, gamblers, etc, but did not actively pursue corruption payments. The meat eaters, on the other hand, were the leaders. They actively and aggressively pursued opportunities for financial gain, shaking down, for example, pimps and drug dealers for profits. The corruption, in other words, allowed the criminals continue doing business, and caused legitimate businesses competing fairly at a competitive disadvantage.

Centralized corruption is more economically efficient than decentralized corruption. In a centralized corruption regime, “rent seeking” corruption is monopolized by one central agent. In the case of Serpico, it was monopolized by police precincts. The bribe collectors can disregard themselves of a “tragedy of the commons” scenario; those paying the bribes can be confident that their payment is to the entire police precinct. With no other agents collecting kickbacks from the subjects (here, contractors, pimps, etc referenced above), individual agents (here, again, referring to the policemen) keep extraction from reaching an overly predatory level that would sink the business solvency or cause blowback. Of course, an agent’s greed can become insatiable, and an agent may be interested only short term profits. But centralized corruption regime knows better than a non-centralized regime where extraction limits are.

For the drug dealers and pimps, the rent seeking trimmed profit margins. Yet as workers of the underground economy, they avoid paying legitimate taxes. The kickbacks, therefore, become the price of these businesses for the same police protection that normal, legitimate businesses pay through legitimate taxes. Under an efficient centralized corruption regime, the rent seeking (that is, the kickbacks) can be seen as a predictable “tax” for remaining in business.

Because of city-wide decentralized nature of the regime, the pimping and drugdealing businesses had to remain focused in the micromarkets where the authorities where already paid off. If they expanded their businesses to another micromarket covered by another precinct, they might have had to pay off more agents, and more agents would have been forced to compete for extraction. Or, the drug dealers and pimps would have had to pay off those with more power and authority within the NYPD. But the higher the status in the NYPD, the higher their income, and the greater the potential cost of getting caught accepting bribes. Everybody, after all, has their price; but the higher cost to bribe higher-up NYPD could be prohibitively expensive. In a de-centralized corruption regime, the welfare and economic loss is greater.

True, in this case, the businesses were a blight on society, and we want them to suffer economic losses, and we, as a society, would prefer the police to suppress and end the trades. But the police lacked the power to do so. The state is supposed to enjoy a monopoly on power and violence. When this is not the case, as it was here, where the drug dealers and pimps acquired more and more unchecked power, individual police officers loyalties can be conflicted. The agents/ policemen become unsure of who possesses the stronger force for career and even survival. Corruption is a sign of a weak police force, or an overly powerful power hub outside of government (see this story) People respond to incentives, and when an external force provides financial benefits that rival or outweigh the career and financial benefits that the state offers, even with potential costs of prosecution, people will serve the external power hubs.

So admittedly, the answer to the question raised in the beginning of this post is not very counterintuitive or surprising. Corruption, centralized or decentralized, is bad. It is a form of rent seeking and creates a social loss. But in terms of efficiency, centralized corruption is preferable.
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Is P2P management wiser than Wall Street management?

As I've stated earlier, I hope P2P works. With smart, risk-averse management, it can work, and work well. But before you invest, you should consider: Is P2P management capable of forgoing short-term profits for long-term strength?

If we learned nothing from the current financial crisis and the subsequent bailouts and recession, it's that bankers and financiers live to maximize profits in short term, long term wisdom be damned. Individual bankers have an strong incentive to find more ways to issue loans. AFter all, if one bank isn't lending to marginal lenders, then the competitor might---and rake in the short-term profits. The long term matters little to individual banker; he might not be around that long. The urge to compete lend to marginal lenders is strongest during during good economic times, and not times like these.

Competition is good for borrowers. But for the lender—that is, you, the Lending Club lender—competition might not be good. When there is competition, more firms compete for the same number of customers. Thankfully, with Lending Club, the credit score threshold remains 660 and above, which is relatively high. With Prosper flaming out because of nonexistent standards, and lenders fretting over the borrower standards, Lending Club has a strong incentive to keep their standards high and demonstrate their seriousness and permanence and stability.

But I worry as Lending Club becomes more established and management can take their goodwill and existence for granted, profit motive might push them to make more loans. Continue Reading

Serpico: Still Tilting at Windmills

In the 1960s and 1970s, New York City hit its nadir. Summer riots where as expected as sticky August humidity. It was a time when the sanitation worker strike led to 10-foot high piles of trash stacking city streets. Affluent and middle class whites fled the city for the suburbs, depriving the city of its tax base. Years after the events of the movie, the city avoided bankruptcy only after a federal bailout. And police engaged in widespread corruption. As the New York Times wrote about the corruption of the era: “From organized shakedowns at bars and construction sites, to payoffs from gamblers and drug dealers to ignore their growing influence, no officer seemed to be immune from the scourge of a department found to be riddled with graft and unable to police itself.” Serpico tells the story of Frank Serpico, a plainclothes officer who refused to participate in this culture of graft and corruption, became an NYPD whistleblower, and as a direct result, a pariah. The movie portrays Serpico, played by Al Pacino, as an idealist who became a cop out of love for his New York and fellow New Yorkers, and for the rush of fighting crime. Throughout the movie, Al Pacino possesses empty, anxious gaze and frequently avoiding eye contact with his fellow policemen (at this time, they were all men). He is burdened in sprit by the omnipresent corruption around him, and by the anticlimax that is the end result of his lifelong goal.

Subtly, the movie suggests that Serpico is the type of person so purely independent of—or, depending on one’s semantic choice, isolated from—clique, group, as to be a bit of a loner. He is the Greenwich Village-living counterculture guy who worked as a cop; he was a cop who wore long hair, listened to opera and liked ballet, and hung out with drugged up dreamers. By the last frame of the movie, he is deaf, stoically sitting against a railing as he awaits for a boat to take him to Europe. His obsession with being a straight cop cost him relationships both romantic and professional.

Most relevant to the money blog is also how the movie illustrates the luxuries of living without the constraint of money, and its branches/ tentacles of career, family and children, status, and debt. A couple scenes I found to be illustrative of this aspect of the movie:

One scene has him following, while still on duty, his plainclothes partner, Don, into an apartment. “I keep this place for socializing,” quips the partner. “Someday we'll get a couple of broads, huh? Have a little party.” When the partner attempts to hand Serpico his cut of the money, Serpico waves him off. “Look, Don ... if I was broke, if I had a family … I don't know. But I'm not broke, and I don't have a family. So why the fuck stick my neck out? You know what I mean?”

Don, his partner, responds: “It’s already out, Frank, not taking the money.” People, generally, act rationally, and when they act irrationally, there’s a fundamental misplaced rationality to it. For Serpico to decline the kickback money was to expose himself as a troublemaker in the eyes of both his peers and supervisors; to become the “corrupt” deviant. Besides the career and financial incentives, the fact was that in these neighborhoods, the pimps and drug dealers officers accumulated more patronage power than the officers themselves--a textbook precondition to police corruption.

Obviously, self-interest wasn’t what trigged Serpico to wave off the money. Instead, it was being true to his self. In most circumstances, people are constrained by adulthood and responsibility, by children, family, debt, career, status. Not Serpico. He lacked a domestic life; had no debt; his career, status, and identity derived from working as a straight cop in the city of New York—not income levels and status within the NYPD.


Two other separate scenes gel in mind as one. Serpico attends a Greenwich Village party with the woman he was dating at the time. She wants to be an actress, she says. At the party he meets her friends: The poet who works for an advertising agency, the actress who works for a photographer, the novelist working for an insurance company. Upon learning that he is a cop, incidentally, the friends slink away. “How come all your friends are on their way to being somebody else?” he muses to her between meeting people.

Later on in the movie, they’re bathing together. She announces that unless he marries her, she will marry somebody else and leave for Texas in a few weeks (it is counterculture, you know). Serpico asks her about her intent to pursue her goals. “A girl has to get married some day,” she says. “You’re a long way from some day,” Serpico says. He never answers the question about marriage, and she is never seen or heard from in the movie.

The scenes suggest that everybody has goals, hopes, and dreams we want to pursue. But money, life, and adulthood constrains the pursuit of the goal. She had to give up her dream at some point, as did the poet and novelist, as do most of us when we realize that we are merely tilting at windmills. But again, not Serpico. He was free, and he possessed the iconoclastic personality that was attracted to being the outlier. For Serpico, that “some day” never came.
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