Canadian Financial DIY gave us a great summary of the Canadian political party platforms . As usual, the NDP have the most entertaining promises. The Green Party are a close second with their promises to raise the GST and legalize marijuana. Whenever I hear political promises, I tend to think about the side effects that will be caused. Charlie Munger, long-time business partner of Warren Buffett, illustrated the concept of second-order effects nicely in a speech at UCSB (pdf) : "A truck trailer business had a plant in Texas whose workman’s comp costs were 30% of payroll. This means that for every ten people working at the plant, the equivalent of three more were at home getting paid because they were supposedly unable to work. Workman’s comp is important for legitimate health problems, but 30% is ridiculous. When legislators created the workman’s comp rules, did they project costs based on existing sick-day rates, or did they anticipate the secondary effects of soaring n...

Lots of red ink has been flowing two days in a row now. According to Jason Zweig in his book Your Money and Your Brain , “after two repetitions of a stimulus ... the human brain automatically, unconsciously, and uncontrollably expects a third repetition.” If Zweig is right, then we must all be anticipating the end of the world. Stocks will keep dropping every day until there is nothing left. Things really are different this time. The sky is falling. All kidding aside, I do find myself looking for someone authoritative to explain that the world’s financial problems are now under control. I’m not sure who qualifies as sufficiently authoritative. President Bush does not. Warren Buffett might be good enough, but he’s too busy buying up businesses at fire-sale prices. For now, the financial system is still in surgery, and we’re in the waiting room hoping to hear from the surgeon soon.

Even after the U.S. government settled on its $700 billion bailout plan, markets continue to drop on Monday. Investors who sold out of the market before this latest drop are congratulating themselves. Unfortunately for them, they still need to make another right guess to come out ahead. Because I don’t believe we’re headed for anarchy, I expect recent stock market losses to reverse sometime in the future. It may not be for months or years, but I expect the sun to shine again. If I’m right about this, then any bears who sold before recent price drops will have to guess when to jump back into stocks. I suspect that most of them will buy back in at a higher price than their selling price. A curious thing about human nature is that many of those investors who end up paying more than their selling price to buy back in will be happy with themselves anyway. Even though they have lost on their market-timing gamble, these investors will cheerfully tell others about how they got out of...

We’re used to getting the hard sell for extended warranties on many of the things we buy. When I bought my latest television, I had to say no three times before the salesman finally gave up. It was the usual deal: the manufacturer warranty lasts for a while and I was offered a two-year extension for “only” $149. This magically dropped to $79 in less than 30 seconds. None of this is very surprising, but I did get a surprise while buying a replacement battery after my car key finally died. At first I could unlock my car from 50 feet away. This distance began to shrink until finally the battery in the key died completely. This is actually my second car key battery replacement, and I confidently got out a tiny screwdriver to remove some tiny screws to get at the battery. The guy at the electronics store had no problem finding a replacement battery after I handed him the old one. Store guy: “How long did your battery last?” Me: “What? Oh. Uh, 2 or 3 years.” Store guy: “That’ll be $5...

Whenever times are turbulent, we are tempted to say that “things are different this time.” While there are aspects of the current financial crisis that are unique, they also have much in common with past recessions and the great depression. In a moment of fear, we can begin to imagine that the current crisis won’t end and that we should all be buying bonds and gold in preparation for the breakdown of civilization. Our economy will either recover or there will be chaos. If there is chaos, then nothing will maintain its value. Even real estate will be worthless because titles will be insecure. The only sensible course of action is to plan for a recovery. Another lesson from the great depression comes from the fact that the government of the time did not attempt a bailout of the type that US lawmakers are currently working on. It’s easy to argue against a bailout. Why should we use public money to help rich bankers? As banks fail, the other institutions they owe money to will...

You’d think that if a mutual fund reported a 3-year return of over 24% per year, most of its investors would be quite happy. After all, any money kept in the fund over those 3 years would nearly double. Looks can be deceiving. Reported returns aren’t enough information to tell how the investors have fared. Suppose that ABC Explosive Growth Fund starts out with $10 million of investors’ money. To simplify our example, we’ll only allow money to enter or leave the fund at the start of each year. After one year, another $10 million of new investor money enters the fund. After another year, investors pour an additional $60 million into the fund. After the end of the third year, suppose that ABC fund holds $80 million. Note that this exactly equals the total amount of money contributed to the fund ($10 million twice and then $60 million). So ABC generated zero net return over those 3 years. Does this mean that their reported 3-year return will be 0%? Nope. In coming up with t...

After Monday’s big drop in stock prices over the failed vote on the financial bailout, Tuesday saw prices come most of the way back. Apparently, investors as a whole think that lawmakers will find some way to contain the financial problems. The net effect for diversified investors who sat tight through it all is minimal. Those who panicked and sold at the wrong time are facing real losses. When stock prices fall quickly and then immediately reverse course, it’s called a whipsaw. The same name is used when stock prices rise quickly and suddenly reverse course. The effect is reminiscent of the action of a saw going back and forth cutting through wood. Such whipsaws generate a lot of concern and discussion, but they really make little difference if you don’t do any trading. Unfortunately, many investors got caught up in the panic and sold their stock holdings near the low point of the whipsaw and plan to “wait until things calm down.” Unfortunately, these investors have alread...