Tuesday, August 31, 2010

Gold by the Numbers

"Captain and kings
In the ships hold
They came to collect
Silver and gold
Silver and gold"
- Silver and Gold, U2

Lots of people have lots of opinions about the value of gold as an investment.  Most of the arguments either for or against are based upon a lot of platitudes like "gold is a hedge against inflation" or "gold just isn't all that useful except for making pretty jewelry".  Rather than rehashing the same well-worn arguments, I want to look at gold purely from a numbers standpoint.

Friday, August 27, 2010

Who Wants To Be a Billionaire?

I've written before about the power of time in building wealth.  This article takes it to the next level by examining how long it would take for the average person to become a billionaire.  I won't give away the punch line, but suffice to say that it would take several lifetimes for the average person to amass that sort of wealth.  Better get started now!

Tuesday, August 24, 2010

1% Makes a $9,000 Difference

In a previous article, I talked about how expensive mutual funds often have worse returns than cheap ones.  You might think that a fund that costs you an additional 1% per year really isn't that bad.  We're only talking about 1% after all, right?  However, if you compare two hypothetical funds that have identical returns, but where one is cheap (0.5% in expenses per year) and one is expensive (1.5% in expenses per year), that 1% per year difference adds up.

Below shows a comparison of what would happen if you invested $10,000 in a cheap fund versus an expensive fund where both funds earn 5% per year:


Start1 Year5 Years10 Years20 Years30 Years
Cheap Fund$10,000.00$10,450.00$12,461.82$15,529.69$24,117.14$37,453.18
Expensive Fund$10,000.00$10,350.00$11,876.86$14,105.99$19,897.89$28,067.94
Difference$0.00$100.00$584.96$1,423.71$4,219.25$9,385.24
% Difference0.00%0.97%4.93%10.09%21.20%33.44%

As you can see, that additional 1% per year expense erodes your investment returns significantly over time.  After 30 years, you've just given away over $9,000. 

The only way it makes sense to invest in the expensive fund is if that fund returns you an extra 1% in investment returns in order to compensate.  However, as Moringstar has shown, expensive funds rarely outperform cheap ones.

Sunday, August 22, 2010

Your Call is (Not That) Important to Us

This week I was travelling, and I happened to read an interesting article in the US Airways in flight magazine.  The article was an excerpt called Your Call is (Not That) Important to Us by Emily Yellin.  It dovetails well with what I posted last week regarding customer service.  You can read the article here.

I won't give anything away except to say that I am glad that I don't have Comcast!

Using Health Savings Accounts for Retirement Savings

One of the more interesting innovations in health insurance is the Health Savings Account (HSA).  Many employers are now offering them as part of their health insurance plans.  An HSA allows you to put away money tax-free that you can use to pay for your health care, and unused money gets rolled over from year to year.

[Note that this should not be confused with a Flexible Spending Account or FSA.  This type of account allows you to put away money tax free for medical bills.  However, this account is "use-it-or-lose-it".  If you don't use the money in your account by the end of the year, it is gone.]

The great thing about the HSA is that you don't have to pay tax when the money is going into the account, and if you use the money for health care, you don't have to pay taxes when you take the money out.  This gives you the opportunity to use this account as a vehicle to save for retirement completely tax free.

Sunday, August 15, 2010

The Value of Good Customer Service

Technical support and customer service in general seems to be one of those areas where companies are always trying to save money.  They frequently direct you to FAQ's on web sites, phone recordings, and other self-support mechanisms.  When you do need to reach somebody, you often have to go through layers of "press one for this" and "press two for that" until you can get into the queue and after 30 minutes you eventually your patience is rewarded with an operator from the lowest-cost provider of call center outsourcing services.  Does this model of support make sense?

For some common queries, I think that self-support makes a lot of sense, both for the company and for the consumer.  I remember when I was working at an electronics store in the days before there was the Internet, about 90% of the calls that came in were asking for the store's hours or asking for directions to the store.  As you can imagine, this took up quite a bit of time and effort for something that can can automated easily.  Now, stores put this sort of information on their web sites or through a recorded phone message.  People can get the information that they need easily and the company can redirect their employees to higher value activities (i.e. selling product).

However, when a customer calls with a more complicated question, a more personal touch is necessary.  Often times, the customer who is calling has some sort of issue or problem which needs to be solved.  This is a critical point in time for the company, because this is where you can lose a customer for life, or gain them for life.  How many times have you had some sort of a problem with a product, called the support line, and been disappointed with the company's response?  When this happens, not only do you vow to never do business with that company again, but you also might be compelled to tell others about what happened.  Not only will the company lose your future business, but they might also lose the business of dozens of other people.  In this age of social networking, word of mouth has more of a reach than it had in the past.

On the other hand, if the company handles your problem professionally and without any hassles, not only will you be more likely to continue to do business with them, but you are likely to sing the praises of that company to others.  The company just might have gained hundreds or thousands of dollars (or more) in additional sales by treating your problem like it is the company's only problem.

The question I have for companies, then, is why is customer service an afterthought to be outsourced and downsized, rather than a competitive advantage that deserves the proper amount of investment?

Here are my suggestions on what companies should do in order to make customer service a competitive advantage:

1. Make it easy to talk to a person.

Nothing is more frustrating than having to wade through "press 1" hell just to wait 30 minutes to talk to a person.  This just gets the relationship off on a wrong foot.

2. Empower the person to do whatever it takes to make the customer happy, even if that means giving the customer a refund.

Having a liberal return policy in general can help make the sale.  People are more likely to buy a product if they perceive that the risk is low.  If they know that they have an "out", so to speak, it provides some measure of safety to make that leap and buy.  Ultimately, the goal is to get people to try your product, love it, and sell its virtues to others.  Think of it as a form of marketing.

Also, if the customer does have an issue, if you give them their money back without any strings attached, they will come away from the transaction with a good feeling about your company and will be more likely to come back in the future.

3. Make customer service a core competency.  Don't outsource it to the lowest bidder.

Many of these outsourced call centers service all different companies.  The operators don't have a vested interest in making your company look good, and they don't have any incentive to differentiate the service that your company provides from that of another company.  Also, the low cost provider is low cost because it pays its people the least.  When you don't pay people a lot, you get what you pay for in terms of talent.  Anybody who has any sort of ambition and drive won't stay there for long.  Those people will be replaced by whomever they can find off the street.  Do you think that somebody like that is going to care about making your company look good in the eye of your customers?

The other advantage of keeping it in house is that you can keep tabs on the sorts of problems that are occurring.  If all of your complaints are coming through a call center half a world away, how likely is it that you will get a true picture of what your customers are saying about your product?  Not very likely.  On the other hand, if your call center is at your corporate office, it makes it easier to keep tabs on the pulse of your customers.

4. Pay customer service people a good wage and give them a career path.

This sort of goes along with #3.  Since you should have a web site or phone recordings that handle all of the common questions with simple answers, the only calls that should be coming in to a person are those that require special handling and complex problem solving.  You want to make sure that the person answering those questions are up to the task.  There is nothing more frustrating to a customer then a person on the other end who has no clue.  If you pay people well and show that this isn't just another dead end job, you are likely to get smart and ambitious people who can provide exceptional customer service.

At the end of the day, the customer service rep is the face and voice of your company.  He or she is the one who is interacting with your customers directly.  This interaction can make or break your company.  Shouldn't this role be treated as an investment rather than just another expense to be cut?

Saturday, August 7, 2010

The Stock Market is NOT Like Vegas

From time to time, I hear people saying that putting your money in the stock market is akin to gambling it away in Vegas.  I must admit that the cocktail waitresses are prettier in Vegas than they are at the NYSE; however, investing your money in the stock market is nothing like gambling in Vegas.  In fact, the numbers show that they are polar opposites!

Most of the games in the casions are designed so that the "house" makes money.  You might get a streak of luck and win over the short term, but the house eventually wins over the long term.  If you sat down at a blackjack table and played for an hour, there is a chance that you will come out ahead.  If you stay there for ten hours, the chances of you coming out ahead gets smaller.  Stay there for a day, a week, or a year and you will find that the chances of you coming out ahead diminishes to almost zero.  The moral of the story is that the longer you spend gambling in a casino, the less of a chance you have at leaving with more money than you came with.

The stock market is just the opposite.  Over the short term, there is a very real chance that you will lose money.  You only have to look back a couple of years to know that!  However, the numbers show that the longer you keep your money in stocks, the more likely you are to come out ahead.

In order to prove this, I looked at the price of the S&P 500 stock index going back to 1950.  (The S&P 500 represents the stock price of the 500 biggest U.S. companies.)  Specifically, I looked at the annual return of the S&P 500 stocks for every 1 year, 5 year, 10 year, 20 year, and 30 year period from 1950 until 2010.  Then I took the average, standard deviation, min, and max of all of these periods.

As an example, for the 30 year period analysis I looked at the returns if you had invested over the following time periods:

1950 through 1980
1951 through 1981
1952 through 1982
...
1980 through 2010

In total, there were 31 thirty year periods.  After I calculated the returns for these 31 thirty year periods, I found the average, standard deviation, min, and max of all of these returns.

(For those who aren't stat heads, the standard deviation is a measure of variability.  The higher the standard deviation, the bigger the swings are from period to period.)

The results were quite interesting:


1 Year5 Years10 Years20 Years30 Years
Annual Return - Average8.39%7.51%7.40%7.25%7.17%
Annual Return - Std Deviation15.86%6.83%4.88%3.06%1.42%
Annual Return - Min-40.09%-6.10%-4.28%2.83%5.39%
Annual Return - Max40.45%24.28%15.71%13.60%9.77%


(Note that I annualized the returns, so that the 7.51% average return for the 5 year periods means that over the average 5 year period, you would make 7.51% on your money per year.)

Over the course of a single year, your return will average 8.39%, but there is a lot of variation from year to year.  You could potentially lose over 40%, or you could gain over 40%.  If you are saving for a short term goal, like a vacation or a car, you probably can't afford to have all of your money in the stock market.  You could come out way ahead, or you could lose almost half of your money!

However, note how the standard deviation decreases as the amount of time you leave your money in the stock market increases.  Over the average 20 year period, the least amount that you would make is 2.83% per year.  In other words, if you had invested your money in the stock market and left it there for 20 years, you would always come out ahead.  The 30 year numbers are even more consistent.

The lesson here is that the longer you had been able to keep your money in the stock market, the more likely you were to come out ahead.  For long term investors, the stock market certainly merits consideration.

Monday, August 2, 2010

Beware Mutual Fund Ripoffs

Mutual funds should be easy to compare.  All of them basically work the same way.  You give the mutual fund a chunk of money and, in return, it gives you back some amount of money minus some fees.  Therefore, it should be pretty easy to separate the good ones from the bad ones.  However, people seem to have trouble doing just that, because there are so many junk mutual funds that have literally billions of dollars in assets.

Let's take a simple U.S. large company mutual fund.  This is a mutual fund that invests in the stock of large U.S. companies like Apple and Coca-Cola.  If you were interested in investing in this sector, you could invest in a brand name fund like the Wells Fargo Advantage Endevor Select Fund (symbol STAEX).  This fund has the Wells Fargo brand name associated with it, and it has the word "Advantage" in the name.  So far so good.  On top of that, it has $1.3 billion in total assets, so a lot of people have entrusted their money to it, so they must be doing something right.  Right?

Let's look at the numbers.