I was reading my favorite weekly football column called TMQ and he did a blurb about mutual funds that hit the nail right on the head:

Suppose the General Manager of the Miami Dolphins Awarded Himself the Same Bonus as the General Manager of the New England Patriots: Last week, this story appeared buried inside the business pages of The Washington Post. Why wasn’t the story on Page 1? The Post reports that the blue-blooded five, Wall Street’s five top investment banking houses, awarded their management $39 billion in bonuses for 2007 — a period when those firms combined to earn investors about $11 billion in profits. Merrill Lynch lost $8 billion in 2007, Morgan Stanley $3 billion and Bear Stearns $230 million, yet the executives of these companies were showered with billions of dollars in bonuses. Otherwise, they would refuse to do any work! Which, apparently, would be in shareholders’ interest. Merrill Lynch and Morgan Stanley could have done better by their shareholders in 2007 by simply purchasing Treasury bills; a software program designed to make simple conservative investment decisions about market-following mutual funds would have performed better in 2007 than the top management of most investment banking houses. And the software program would not have paid itself billions of dollars in bonuses for screwing up! (TMQ owns no stock in any of the mentioned firms.)

It’s one thing when profitable firms shower money on their CEOs and other top brass; often the amounts are indecent, but as long as shareholders come out ahead, the executives have at least some justification for their windfalls. But in the modern milieu of corporate kleptocracy, even when the company does terribly and the CEO makes decisions that blow up in the firm’s face, the CEO awards himself hundreds of millions of dollars, anyway. Why is this not seen as white-collar crime?

Last week’s buried Post story included this priceless quote: “‘To many people, [the bonuses] will be shocking and questionable,’ said Jeanne Branthover, managing director of Boyden Global Executive Search. ‘People in New York in the world of investment banking will understand it. It’s critical that pay is still there or you’re going to lose really good people.’” Beyond that executive headhunter firms such as Boyden have a self-interest in running up CEO pay — this can increase the search firms’ headhunting commissions — consider the reasoning: OMG, we can’t lose the really good people who cost our shareholders billions of dollars with dim-witted decisions! The notion that top corporate managers must be paid fantastic amounts because they possess incredible, astonishing expertise often is used to justify CEO pay, even when the managers who claim the incredible, astonishing expertise make foolish decisions. “We’ll put billions of dollars of money entrusted to our care into subprime gimmick mortgages backed by no documentation of income; my incredible, astonishing expertise tells me this is totally safe!”

Today the market fell sharply, while Wall Street executive bonuses rose in futures trading.
If corporate managers who screwed up received $5.85 an hour, the federal minimum wage, for the year in which they screwed up — that is, if their wallets were at risk when they perform poorly — then they might fairly argue for huge bonuses when they perform well. But there is no evidence that the people who made the big investment calls on Wall Street last year (except at Goldman Sachs, which avoided the subprime mess) are any better at what they do than people chosen at random off a Brooklyn street. You bet “people in New York in the world of investment banking” will understand huge executive bonuses paid in the same year as huge losses. What’s happening is basically a hustle, intended to enrich the executives while separating the investors from their cash. “People in New York in the world of investment banking” understand that, all right!

Pretty unbelievable… but then again I have been railing against actively managed mutual funds for quite a while.  They are making much more money on you than most people realize.

Recently at work a coworker was in the break room talking about how they have a “fully diversified portfolio.” Because I am a smart ass, I asked them how I could convert my partially diversified portfolio into a full diversified portfolio. She of course had no idea how I could do so because, well, she had no idea what she was talking about. So I thought maybe it would be a good time to give a good overview about what exactly this means.

The basic idea is very simple: invest your money into a bunch of different places so that you don’t have all your eggs in one basket. To take it a step further it generally means spreading your investments around into different investment areas such as stocks, bonds, mutual funds, money markets, gold, real estate, and the hippies down the street selling beads. If I were you, Id stick to the first few.

There are a few different types of diversification:

Horizontal Diversification:
This is when you diversify between same type investments. So this is like buying stock in Microsoft and Enovia.

Vertical Diversification
Vertical Diversification is the investment between different types of investment. It can be a really broad diversification, like diversifying between bonds and stocks, or a more narrowed diversification, like diversifying between stocks of different branches. This gives much more protection against changing economic conditions or say the collapse of the stock market.

As a general rule the upside of diversifying is that you have protection from losing all of your investment should something go wrong with one company or one sector. The downside is that the average of all the investment parts will always be below the return of the top performer. Stocks have the greatest upside, but also can have a huge downside where as some things such as bonds tend to be lower performers but stable. Just one more thing to think about.

So I saw something on the binary dollar that I absolutely love.  Its a how to get rich Venn diagram…however I thought that they left out one huge thing.  Their two points were make lots of money and save lots of money.  I decided to take it one step further (anyone hear the money truck coming?)

Ah yes, beautiful.

One of my main struggles is my penchant for eating out way way too much.  In fact, if there was one thing I could do to cut costs it would be to cut back on the amount that I eat out.  At one point I had a “thousand dollar month” of eating out.  This actually is fairly common for people who eat out a lot.  

 My favorite restaurant by far is the Melting Pot.  Now, unfortunately its also one of the most expensive places in town, and the thing I like there, is the most expensive dish.  Lobster tail is quite frankly one of the best foods on earth, ever.  In any case I did a price comparison comparing the last time I ate there, versus how much the same meal would have cost to make at home.  It goes a little something like this

Does that mean I am going to stop going there?  Quite frankly, no.  There are a lot of intangibles about going there….the atmosphere, all the different sauces they give you, and how my girlfriend eats the chicken and I get the lobster tail mmmm.  But the point is that it is a LOT cheaper to eat the same foods if you cook it yourself…and you can save a ton of money that way. Plus then I can skip the whole salad step, which in my opinion is a perfectly good waste of space that I could be filling up with delicious meat.

 I also did a bit of a survey around my friends and figured that most of them could save almost $400 a month and still eat well and drink mostly to their hearts content.  So lets say we take that $400/month and put it toward say, a yacht.  Now I figure 40 is a sweet age to own a yacht.  So if I invested that $400/month 10% in an index fund and then pull it out when Im 40, I could hop in my money truck, drive down to a dealer and get myself one of these:

 This particular yacht was on sale for $156,000.00….what a steal!  Though you have to find your own women/men to sunbathe on the front.

First of all, what is interest?
Interest is the cost of borrowing money. The person doing the lending gets a fee for allowing the borrower to use their money for a set rate of time. The original amount that is loaned to the borrower is called the principal and the percentage of that original amount which is paid over a period of time is called the “interest rate.” That percentage times the principal is the interest. For example lets take Dave and John.

Dave: John I need to borrow $10 to buy a qdoba burrito. I will pay you back tomorrow…
John: Why would you buy a qdoba burrito?
Dave: It tastes good.
John: Ok, here is $10 but I will charge you 10% interest per day on that.

…..Next Day…..

John: Ok that will be $10 + (10% X $10) so, that will be $11 please.
Dave: whoa $11?
John: Yeah, you should learn what interest means.

So what is compounding interest?
Compounding interest means that whenever interest is calculated, it is based on the original principal AND also any interest that has been earned. So the more often that that the interest is compounded, the faster the total (principal + earnings) grows.

What is this important for me?
Compounding interest is what allows something now to be worth many times the original investment many years from now (say, retirement age). Check out my retirement section for a bunch of examples of that.

How can I calculate compounding interest?
There is a rule called the rule of 72 that makes this fairly easy. It’s not exact, but it gives a pretty good approximation. 72 divided by the interest is equal to the number of periods needed to double the principal. So:

72/i = n

What is a typical example of this?
The stock market. Over the past 75+ years the stock market has averaged a rate of growth of around 11% per year. So if we say 12% just to make dividing 72 easy, thats 72/12 = 6. So at 11% per year it would take just over 6 years to double your money. Thats why people always talk about 6-7 years to double your money investing. It’s based on the average market return.

And I’m not referring to the bonsai.

Or to this. Though if someone finds one of these, please let me know.

Instead a money tree would look a little more like this:

Ok so the graphic isnt very good. But its what it represents that is so mind numbingly awesome that it deserves its own post. Two words: compounding interest. What does this have to do with a money tree? Well think of your initial investment as planting a seed to your money tree. Assuming the market returns at 10% your tree grows another branch with your money on it. Whats better is that every new branch has twice as much money fruit as the branch below it. Then when you are ready, pick away, free money from your very own money tree.