Reporters are running out of words to describe the drop in stock prices yesterday after the U.S. House of Representatives voted down the $700 billion bailout of the financial system: crash, plunge, carnage, bloodbath. Supporters of the plan said that the bailout is necessary to prevent further financial collapse. Others fear that even $700 billion would not be enough. What is usually left unstated in these discussions is what will happen if government doesn’t act. This part is usually left to our imaginations. In a more fearful moment, I tend to recall images I’ve seen of the homeless and hungry in the swirling dust of the great depression. Maybe others imagine burning buildings and widespread panic. The truth is that supporters of a bailout probably get more mileage out of leaving the consequences unsaid. We imagine much worse outcomes than most commentators would predict. I have little doubt that the U.S. government will ultimately have to do something fairly costly to li...

According to a sheet of paper stuffed in my mail slot, it’s “time to think about being paid what you’re worth.” Investors Group is taking on twelve new “consultants” in my area. This prompted me to poke around the Investors Group web site to look at their investment products. I didn’t much like what I saw. Presumably, Investors Group (IG) consultants would sell IG mutual funds among other things. The fund selector on IG’s web site showed 84 funds designated as “aggressive growth,” which seems to mean stock funds. The dollar-weighted average management expense ratio (MER) was 2.65% per year! This is staggeringly high. Most forecasters consider an estimate for the long-term compound return from stocks of 6% above inflation to be optimistic. IG stock funds take away nearly half of this return in MERs. Actually, it’s worse than the 2.65% I calculated. This percentage is for the back-end loaded version of the funds, where you pay a percentage upon leaving the fund if you leave too s...

There is no shortage of pundits who offer predictions of what will happen to particular stocks or the stock market in general. You’ll find them on television, radio, and innumerable blogs. I’m open to the possibility that some investors can guess the long-term success of a particular business, but I simply don’t believe any short-term predictions that I hear. Here is why: if these pundits actually get it right a significant fraction of the time, then they could make much more money investing based on their predictions instead of wasting their time as pundits. To prove this, I decided to run some Monte Carlo simulations. Suppose that our pundit Peter predicts whether the S&P 500 will beat inflation each month, and he gets it right 80% of the time. So, 20% of the time when he picks stocks to win, he is wrong, and 20% of the time when he picks inflation to win, he is wrong. This may seem like only a mildly impressive record, but I’ll show how Peter can make himself fabulously wea...

In his article about the new ban on short selling 800 US financial stocks , Larry MacDonald discussed some of the pitfalls of short selling. This reminded me of one of the more interesting ways that short sellers can come out on the losing end. Short selling is the practice of borrowing stock and selling it so that you effectively own a negative number of shares. Short sellers hope that the stock drops so that they can later buy the stock back at a lower price, pocket the difference, and return the borrowed shares. Until recently, this practice was perfectly legal. Now, short selling is banned on certain beleaguered financial stocks. As Larry said, the biggest reason why short selling is a difficult game is that stocks tend to go up. When you pick a stock to short, you have to have far better insight into the stock’s future than other investors just to break even. Using short sales to make more money than you could have made by simply owning an index is very difficult. Some ...

In his book, Twilight in the Desert , Matthew R. Simmons makes the case that Saudi Arabia’s oil production will soon peak as the most easily recovered oil is depleted. His extremely detailed analysis contrasts sharply with the Saudi assertion that they can satisfy world demand for another 50 years. Much of his technical information comes from Saudi technical papers that seem to contradict their public statements. Simmons provides mountains of technical information that amounts to circumstantial evidence that oil supplies are dwindling. However, as he points out, it is up to the Saudis to prove their claims about how much oil is still in the ground and how quickly it can be supplied to the world. Assessing the nature of oil fields and how much oil they contain is very difficult. As much as anything this could account for the seeming lack of reliable information about oil reserves. Even if we knew how much oil is in the ground, it’s not clear how much of it can be recovered economica...

Preet over at Where Does All My Money Go recently discussed the importance of paying attention to investment fees. In a lighter moment, he had some fun with a fund screener and listed funds with yearly MERs above 8% ! To appreciate how ridiculously high this is, you need to see the effect over a long period of time. As I have discussed before, MERs are paid every year , and investors have to be cautious about comparing them to one-time costs. After one year in a fund charging an 8% MER you would still have 92% of your money. The next year, though, the fund would take 8% of your remaining 92% leaving you with 84.64% of your money. Over 25 years, an 8% MER would chew up 87.5% of your money. Suppose that your initial investment grows to $250,000 after 25 years. If you didn’t have to pay the 8% MER, you would have finished with $2 million! Things get even sillier with the worst fund Preet listed: “Dynamic Power Hedge Fund-F” with an MER of 13.94%. I’m not sure what this name ...

Suppose you’re given a chance to bet on the toss of a coin. If it comes up heads you win $20, and if tails you lose $10. Would you take this bet? Given a chance to do it 100 times in a row would you do it? This experiment was actually performed in a coffee shop in Westwood, Los Angeles, as explained by Jason Zweig in his book, Your Money & Your Brain . The average outcome is to win $5 every time you take this bet. But, if you do it only once, you could lose $10 instead of winning $20. What about doing it 100 times? The expected outcome is to win $500. The odds that you’ll actually lose money are less than 1 in 2000. The odds of losing $200 or more are less than one in a million. The odds of winning more than $200 are over 97%. This is an incredibly good bet. Amazingly, two out of three people accepted the one-time bet, but only 43% said they would be willing to repeat the bet 100 times. What are the possible explanations for the 57% of people who turned this down? ...