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Issue Date: Vol. 49, No.6, June 2009, Posted On: 6/28/2009


Finding The Silver Lining


by Allan Gilbert
Allan Gilbert, vending, vending business, vending route, vending machine, automatic retailing, office coffee service, OCS, foodservice, coin-op, coin machine, vending news, small business, business trends, service economy, retirement investment

Three years ago, I wrote an article dealing with retirement planning in the aftermath of the dot-com collapse (see VT, June 2006). Unfortunately, the two most common responses to huge financial losses are total withdrawal from the markets, based upon abject depression, or making abnormally high-risk investments in an effort to recover losses. Obviously, as we should have learned by now, neither of these approaches will be successful for long. Given the recent carnage on Wall Street, it’s probably time to revisit our plans for retirement.

When the tech bubble burst in March of 2000, millions of investors were badly hurt. They got burned because they had succumbed to the siren song of fantastic returns offered by dot-com stocks. During the last three years of the boom, some investors doubled or even tripled their money every year, and the market created a bunch of new millionaires. Whenever that happens, even rational investors find it difficult not to jump in. When the bubble burst, it was the rational investors who lost the most, because they were late getting to the party.

Early investors in a bubble lose lots of money too, but the early investors are giving back profits. Later investors lose most of their capital. In addition to suffering huge financial losses, those investors had to deal with a severe blow to their self-esteem. Many were so depressed they couldn’t bring themselves to even look at their investment reports. And retirement planning was put on hold. In fact, depending upon their age, many found they couldn’t afford to retire.

Many investors who lost heavily in the dot-com bust searched for “Hail-Mary” investment opportunities in an attempt to recoup their losses. In the June 2006 article, I described two neighbors who had bought into Florida real estate because values were going up so fast. After the collapse of real estate values in 2007, one now owns three high-end waterfront condos that are currently worth half of what he paid for them, and he owes more on the mortgages than the units are worth. The other is in marginally better shape, because he only owns two units. Both were ready to retire when the bottom fell out of the real estate market, and now they realize they will have to continue working for many more years.

If taking on abnormally high risk doesn’t work, and hiding from the problem doesn’t work either, what should we be doing to insure that we have more to retire on than social security? I respectfully suggest that a little bit of common sense will go a long way in finding the answers. Let’s consider some common-sense solutions.

TAKE CONTROL

Nothing good is going to happen if you insist upon hiding your head in the sand. No matter how depressed you feel about the state of your present investment portfolio, you need to take control over it in order to maximize your potential. As bad as it might be, it will only get worse if you don’t take action now.

If you rely upon the advice of outside professionals to help you choose investments, you may want to review that decision. Financial advisors usually work for a percentage of the assets they manage. If they are not charging you this percentage, you should understand that they are selling you something that earns them a profit, (annuities, insurance, brokerage services, etc.) and you should probably question their suggestions or motives. It is not unusual for advisors to charge fees equal to 1% or even 2% or more per year based upon the average value of your portfolio. Over the years, I have come to the conclusion that few financial advisors consistently outperform the market averages such as the S&P 500, the Russell 2000, the Nasdaq or the Dow Jones Industrial Average. Under those circumstances, you have to question the value of the services you are paying for, because you can invest directly in those averages with little or no cost.

Although a fee of 2% doesn’t sound like a lot of money, think of it in terms of profits lost. If you earn a 6% profit on an average investment of $100,000, the profit equals $6,000 before the fee. When you pay the $2,000 fee, ($100,000 X 2%) your profit is being reduced by 33%. The advisor is taking a third of your profits. And that happens during good times. In tough times, if you lose 6% of the value of your portfolio, the advisor is still going to take 2% of the value of your portfolio, thereby increasing your loss by a third. Instead of losing $6,000, you will lose $8,000.

Rather than paying a financial advisor to suggest stocks to buy, many investors have chosen to invest in professionally managed mutual funds. While this approach will help you diversify your investment over a “basket” of stocks, most mutual funds charge a sales load and/or fee that can come very close to what a financial advisor would charge to pick stocks for you.

ETFs can be bought or sold “intra-day,” exactly like a stock share. A mutual fund can only be bought or sold for its net asset value at the end of each business day. If, for example, you felt that the market was moving up quickly and wanted to invest at 10 a.m., you could buy an ETF that mirrored the S&P 500 index at 10 a.m. If you put in an order to buy a mutual fund that mirrored the same index, your purchase wouldn’t clear until 4 p.m., and today’s market gain would already be built into the inflated price you paid for the fund. With the ability to trade stocks online with a discount broker, your cost to acquire an ETF position of almost any size would be approximately $8.

LEARN HOW MARKETS WORK

Most of us have learned that it is important to get smart about running a vending business, because this is where we earn our week’s pay. We go to trade shows; talk to competitors and suppliers; read all the trade papers and everything else about the industry that we can get our hands on; go to seminars; and, in fact, do whatever we can to improve our skills and become better managers. We do this because we know it is impractical to hire an outside professional to make the hard decisions we face every day. We have learned that, if we want to be successful, we need to acquire the skills to do this for ourselves.

Well, I have a hot flash for you! Assuming reasonably good health, most of us will spend as many years attempting to earn our week’s pay out of our investment portfolio as we did out of the direct management of our company. And the size, safety and continuity of that week’s pay will be directly proportional to the time, effort and skill we put into the accumulation of investment capital while we are still working.

This suggests strongly that you need to learn how to accumulate and invest your money today, long before you retire. Simply put, no matter how busy you are running your business, you need to take the time today to tend to your future.

The sooner you start, the better. In the 2006 article, I explained that the value of a portfolio earning 10% would double in seven years. At 10%, $100,000 turns into $1,600,000 in 28 years. Such is the power of compound interest. You can’t afford to put this off.

Fortunately, it’s much easier to learn how to become a proficient investor than it is to learn how to run a vending or OCS business. Hundreds of books have been written, by smart people, about how to invest intelligently. Some of them have been written by people with an axe to grind or a product to sell, but most of them offer real knowledge. Good information also is available from trade papers, such as The Wall Street Journal or Barrons, and TV coverage of the markets is available almost 24 hours a day from sources such as CNBC or Bloomberg. And every major brokerage house, if asked, will inundate you with material designed to influence you to invest with them, and at the same time educate you. In addition, there is enough information available on the Internet to keep you busy learning about investing for the rest of your life.

Another knowledge source to consider is talking to other investors. Most of them are willing to share their successes and failures with you. I promise you it is a fascinating experience.

You will learn how capital is allocated in a free-market economy, and why projects get funded or don’t get funded at a point in time, and how you can profit from the process. You will learn why the value of fixed income investments (bonds) goes up or down based upon prevailing current interest rates, and you will learn how to value a share of stock based upon cashflow or a multiple of earnings per share. You will be exposed to a whole new level of jargon, such as “fundamental” analysis as opposed to “technical” analysis, and you will discover why you should be concerned about an “inverted yield-curve.” You also will learn the principles of asset allocation as you build your portfolio.

I understand that the process sounds daunting if you don’t have any prior experience with investments. However, I promise that most people will quickly understand the basics.

Anyone who is willing to invest a few hours a week learning the basics can become an informed investor rather quickly. The knowledge may not qualify you to become a professional trader, but it will provide the skills necessary to make informed decisions when opportunities present themselves.

When I was in my 30s, I was exposed to just such an opportunity. There were three major regional banks, based in Boston, that did most of the commercial banking business for larger companies in New England. Due to a poor economy, lax lending standards and poor profitability, the stock prices for all three banks had fallen to under $1 a share. The newspapers played up the possibility that all three banks could fail. However, the FDIC (Federal Deposit Insurance Corp.) quickly reminded depositors that they would not lose money because the government was standing behind the banks. The government would guarantee to keep the depositors solvent, in order to prevent a run on the bank. However, the FDIC doesn’t insure investors/stockholders.

The government recently provided emergency financing to bail out Chrysler, arguing that the company was “too big to fail.” In other words, the failure of Chrysler would present a systemic risk to our economy. I suspected that the government would apply the same reasoning to the New England banking crisis.

I thought that, under the worst set of circumstances, the government would allow one of the three banks to fail. But there was no way they could allow all of them to fail. It would decimate the New England economy. And, if my assumptions were correct and one of them “disappeared,” then the surviving two should prosper handsomely because of reduced competition. All three banks appeared to be weak, so I didn’t know which one -- if any -- would fail. I convinced my partner that we should each invest $10,000, divided equally among the three banks.

Over the next six months, the FDIC forced the sale of the weakest bank to the strongest bank, at a price of 1¢ per share. This meant that we lost about a third of our investment. However, the value of our shares in the other two banks began to climb astronomically. Over the next five years, the value of our total investment of $10,000 climbed to more than $200,000 apiece. Those funds became the basis of our retirement investment accounts.

Fast forward to today. We are in the midst of the worst recession since the Great Depression of 1929. Our economy, and the economies of most of the free world, have gone to Hell in a handbasket. As of the date of this writing, U.S. unemployment has climbed to 8.5% and shows every sign of going much higher; home values have dropped by 25% to 40%; and mortgage foreclosures are at an all-time high. Past-due credit card debt and the personal and corporate bankruptcy rate are also at all-time highs. Most private investment accounts have been decimated. Account losses in the 30% to 50% range are the norm. The news has never been worse in my experience. However, the government has decided that our “free market” simply cannot afford to fail.

The government has determined that 19 of the largest banks in the country are "too big to fail." Their failure would present a systemic risk to the economy that is simply unacceptable. The same day the Treasury announced its "Troubled Asset Relief Program" (TARP), I bought shares in each of those 19 banks. I also bought shares in American International Group, the insurance company to which the government lent $180 billion.

The government has determined that 19 of the largest banks in the country are "too big to fail." Their failure would present a systemic risk to the economy that is simply unacceptable. The same day the Treasury announced its "Troubled Asset Relief Program" (TARP), I bought shares in each of those 19 banks. I also bought shares in American International Group, the insurance company to which the government lent $180 billion.

The government has determined that 19 of the largest banks in the country are "too big to fail." Their failure would present a systemic risk to the economy that is simply unacceptable. The same day the Treasury announced its "Troubled Asset Relief Program" (TARP), I bought shares in each of those 19 banks. I also bought shares in American International Group, the insurance company to which the government lent $180 billion.

In the process, the government has become the largest stockholder of those companies and has started to wield its clout. I frankly don't have a lot of faith in the government as a management team, given its track record with the post office and healthcare. But I believe that whatever benefits they are able to negotiate with the unions and the creditors will also be extended to Ford, which has not taken any government bailout money so far. With no heavy-handed oversight by the government, I think Ford is going to be the strongest survivor in the auto group, and that's the way I bet.

While it's too early to claim victory for my investments, I'm very pleased with the trends. As of May 15, the S&P 500 had advanced more than 35% from its March lows, and my bank stocks have more than doubled. Ford, which I bought at $1.50 a share, has traded over $6, and only recently retreated to $5.40 when the company raised $1.2 billion with a new offering, diluting the value of the pre-existing shares.

Markets always overreact on both the upside and downside. This time, I sincerely believe the markets have valued stocks as though we were re-entering the Great Depression. Given the government's intervention, I honestly believe we are being offered a once-in-a-generation opportunity to buy stocks that are truly value-priced.

I am not suggesting that the market cannot go lower and re-test the lows. Obviously it can, and in fact it probably will, even before this article gets published. However, rational investing and retirement planning are not about finding the market low and waiting for it to happen before buying in. Finding market lows is like trying to catch a falling sharp knife: It's a good way to lose your fingers. However, if you are investing money for the long term -- five years or more -- there is no question in my mind that values will be much higher by then.

It's time to go back to work, and plan for the future!


ALLAN Z. GILBERT founded New England Vending Corp. (Lowell, MA) in 1959, and led its expansion into a leading regional provider of full-line vending, coffee service and foodservice management. He founded Data Intelligence Systems Corp. (DISC), a computer software publisher and system integrator for vending, and Lemon Tree Systems Inc., which franchised a vending-and-cafeteria concept. He established Merrimac Financial Associates in 1984, and it made an initial public offering through the New York Stock Exchange in 1998. He became managing partner of The Merrimac Consulting Group in 1988.


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