Friday, December 31, 2010

Have a Happy and Healthy New Year!!!

This is has been a great year for  We've gotten over a thousand hits this year since we started in July, and we've gotten a lot of positive feedback on our content.  In 2011 we hope to bring you more interesting and informative articles.  If you like what you see, feel free to drop us a line and let us know.  If there is something you want to learn more about, also let us know.  If you hate us and think we are the worse thing to hit the Internet since the blink tag, definitely let us know, too.  We love hate mail!!!  If you don't know how to get in touch with us, click on "View My Profile".  You will find our contact information there.

Finally, I want to thank each and every one of our readers for their time and attention.  We know that you have plenty of choices on where to spend your time online, so we are gratified that you choose to spend just a sliver of that time with us.  I sincerely hope that you and your loved ones have a happy, healthy, and of course a prosperous 2011!

Thursday, December 30, 2010

Was This Really The Lost Decade For Stock Investing?

One of the fun things about this time of year is reading all of the "year in review" articles.  It is always interesting to step back and take stock (no pun intended) of the events of the past year.  USA Today went one step further with a look back at the stock market over the past decade.

[Interestingly, the author defines the decade as starting in 2001 and ending tomorrow which should please the calendar geeks out there].

According to the article, the period from the beginning of 2001 until today was a terrible one for the stock market.  The S&P 500 stock index, which is the composite price of 500 large U.S. companies, was down almost 5% over this time.  The article notes that this is only slightly better than the stock market returns from 1930 to 1939 when the economy was battered by the Great Depression.  It isn't much consolation to know the most current decade is only slightly better than the worst economic period in U.S. history.  The article goes on to paint a bleak picture of common people whose retirements were put in jeopardy from their stock market investment folly.  One interviewee states that his "faith in capital markets was definitely changed this past decade".  Another says that she "wouldn't go out of my way to invest in the stock market."  Pretty dismal stuff, huh?

But was it as bad as people think it was?  Is the perception that this was a "lost decade" for the stock market really true? 

This figure that the S&P 500 lost 5% over the past 10 years seems pretty damning.  However, it doesn't tell the whole story.  If you woke up on January 2, 2001 (the first business day of the decade), invested $10,000 in the stock market, went back to sleep, and woke up again on December 30, 2010 to check your account balance, you indeed would find that you had lost 5%.  However, this is not how most people invest their money.  Most people invest by making constant periodic investments over time.  We have a set amount invested in our 401(k) accounts every paycheck.  We put money into our IRA's once a year.  The financial experts call this dollar cost averaging.  By making steady periodic investments, most people end up not only buying when the market is high like at the beginning of 2001, but also when the market is low like at the beginning of 2009.

What type of investment result did somebody have who invested a steady $10,000 in the S&P 500 at the beginning of every year since 2001?  Let's check out the numbers:

YearAmount InvestedValue on 12/30/2010% Gain
2010$10,000.00 $11,265.67 12.66%
2009$10,000.00 $13,930.17 39.30%
2008$10,000.00 $8,568.84 -14.31%
2007$10,000.00 $8,870.62 -11.29%
2006$10,000.00 $10,076.83 0.77%
2005$10,000.00 $10,379.23 3.79%
2004$10,000.00 $11,312.68 13.13%
2003$10,000.00 $14,297.02 42.97%
2002$10,000.00 $10,956.38 9.56%
2001$10,000.00 $9,527.37 -4.73%
Total:$100,000.00 $109,184.80 9.18%

The $10,000 that you invested at the beginning of 2001 lost almost 5%.  However, the money that you invested at the beginning of 2003 would have netted you a return of almost 43%!  Yes, there are a number of down years like 2007 and 2008.  However, there are number of good years like 2009 and 2010.  If you stayed the course and continued with making your $10,000 investment every year, you would have ended up with a gain of 9%!  Yes, it probably wasn't the best decade, but at least you would have come out ahead.  This wasn't the lost decade for stock investing that some people are making it out to be.  The secret is to have made consistent periodic investments throughout the entire decade.

Of course, that is easier said than done.  Like the people quoted in the article, there were probably millions like them who pulled out of the stock market during the depths of the financial crisis only to have missed out on the gains that followed.  Nobody can predict what the stock market will do.  However, if history is any guide, the stock market has ups and downs, peaks and valleys.  If you continue to make periodic investments through dollar cost averaging, you can take advantage of these valleys by buying when the stock market is on sale.

And who doesn't love a sale?

Monday, December 27, 2010

Bonding With Bonds: Value and Risk

In my previous article about bonds, I introduced to the concept of a bond:  what it is, how it works, and some of the different flavors of bonds.  In this article, I will delve into my original question of whether or not bonds are truly the risk-free investment that some people think they are.  Before I get to that, I want to discuss how bonds are valued as this is central to understanding why bonds may not be completely risk free.

If you remember, a bond is just a loan.  I loan you some money in return for a piece of paper which says that you will pay me back at some future date.  How is the deal actually structured?  Let's take a simple example of a one year zero coupon bond.  This bond agrees to pay the person who holds the bond $100 one year from now.  If I am selling the bond to you, how much would you agree to pay me in return for a promise to receive $100 one year from now?  Maybe you will pay me $100 today for the promise of $100 a year from now.  In that case, you are earning 0% interest on your money.  You are giving me $100 now, and I am giving you back $100 a year from now.  Considering that you can probably earn at least some interest just by depositing your money in the bank, nobody would take this deal.

Most likely you would want to pay me something less than $100 for this bond.  Let's say that we strike a deal where you will pay me $97 for this bond.  At this price, you will be earning about 3.1% interest on the transaction ($3 gain divided by $97 investment equals 0.0309 or 3.1%).  Now we're talking!  In this example, 3.1% is the bond's yield, which is the annual interest rate that the buyer of the bond earns.  Note that because the bond is a one year bond, the calculation is simplified somewhat.  If this had been a two year bond, we would have to take the 3.1% (the interest earned over two years) and annualize it by taking the square root.  Generally speaking the yield on a bond that doesn't have coupon payments is:

i = nth root (F / P) - 1

i = annual yield
F = bond face amount
P = bond price
n = length of the bond in years

If the bond were a two year bond, solving for i would produce an annual yield of 0.0153 or 1.53%.

There are a couple of points to take away from this example.  First, there is a rule of thumb when it comes to bonds:

The lower the price, the higher the yield.

The example makes this pretty obvious.  The less money that you pay for the bond, the more interest you will earn on your money.  Just to hammer home the point, let's say that you bought the bond for $95 instead of $97, now you've earned 5.2% on your money.  You've invested $95 and earned $5.

Second, when a government or corporate issues a bond, it is up to the buyer to set the price of the bond.  Obviously, the seller would love to maximize the selling price, because this means that they get to borrow more money, and they have to pay back less interest.  On the other hand, the buyer would love to minimize the selling price.  They arrive at the price through simple economics:  supply and demand.

Let's say that I offer the bond not just to you, but to anybody willing to buy the bond.  You might offer me $97, but if somebody else comes along and offers me $98, I am going to sell the bond to that person and not you.  Generally, there are two factors that determine the price of a bond:

1. The interest rate that you can earn on the next best alternative.

2. The creditworthiness of the person selling the bond.

If you remember the example, we saw that nobody would be willing to pay $100 for a $100 bond that matures in one year because then you aren't earning anything on your money.  You would be more likely to put your money into a savings account, since you'll get a better return.  Let's say that a savings account would earn you 0.5%.  If that's the case, then you would want to buy the bond for a price that would earn you at least a 0.5% return.

The second factor is just as important to the price of a bond.  If there is a chance that the person issuing the bond is going to renege on the deal, you are not going to pay as much for their bonds.  This is because there is a chance that you will get nothing when the bond matures.  U.S. Government bonds generally seen as being safe because the United States has never failed to pay when a bond matures.  On the other hand, there are plenty of other governments and corporations which have failed to pay because of bad finances.  One notable example is Argentina, which defaulted on its bonds in 2002.  If a lender feels that you are a bad credit risk, they will demand a higher yield on the bond to compensate for the additional risk.

During the height of the financial crisis, people clamored to buy bonds, especially U.S. Government bonds.  Prior to the crisis, real estate investments were all the rage.  It seemed as if you could put money in property and earn a guaranteed 10%, 15%, or even 20%.  However, when that bubble burst, Government bonds were seen as a safe haven from the volatility of real estate and the stock market.  This flight to safety drove up the price of U.S issued bonds.  As a result, yields on these bonds fell.  People were willing to accept small returns because the return was guaranteed and safe. 

This brings us to the central question of whether or not bonds truly are risk free.  The answer, of course, is no.  So what are the risks of holding a bond?

The first risk obviously is the risk that the issuer is going to default.  If that happens, you might get something from the bankruptcy court, but then again you might get nothing.  That is the ultimate doomsday scenario.  To buy an investment and get nothing in return is the worse thing that could happen.  The good news is that some bonds are safer than others.  As I mentioned before, U.S. bonds are considered to be among the safest.  The perception is that only a disaster of biblical proportions would cause the United States to default on its bonds.  In addition, corporations on strong financial footing also are considered to be pretty safe.  However, that perception has changed with the recent economic crisis.  Some companies are such a bad credit risk that their bonds are considered to be very risky.  These bonds are called high-yield bonds because investors demand such a low price for buying them.  Some people refer to them as junk bonds for obvious reasons.

There is a second risk which is not quite as apparent:  interest rate risk.  This is the risk that interest rates rise after you purchase the bond.  To illustrate this risk, let's revisit our example.  Let's say that you decided to buy the one year zero coupon bond for $97 for a yield of 3.1%.  Now let's say that the next day some event occurs which causes people to demand a higher yield on this type of bond.  Instead of accepting 3.1% for this type of bond, people demand to earn 5%.  You are now stuck with an investment that only earns 3.1%.  You have two choices:

1. You can continue to hold onto the bond for the next year and earn 3.1% on your original investment.

2. You can resell the bond you bought yesterday to another willing buyer and use the proceeds to buy another bond at 5%.

Let's say that you decide to pursue option #2.  In order to entice a willing buyer, you will have to sell them the bond at a price which will yield the buyer at least 5%.  Otherwise, the buyer will just buy a similar bond from somebody else.  In order to yield 5%, you would have to sell the bond for $95.24.  This means that you would be losing $1.76 on the bond.  This a percentage loss of -1.81%!  Because interest rates rose, your bond has become less valuable.

Let's say that you decide just to hold onto your bond until maturity.  Now you are earning a return of 3.1% for the next year which still isn't that bad, right?  Maybe, maybe not.  It is possible that interest rates on this type of bond rose because inflation jumped higher, in which case your after inflation return might be negative.  It is possible that the risk of default has gone up because of some external event, in which case you aren't being compensated for the additional risk.  It is possible that six months from now you will need to sell your bond in order to pay some bill, in which case you will sell for a loss.  In any case, earning less than market returns for an investment is never a good thing.

As you can see, interest rates affect the price of a bond in an inverse fashion.  There are a couple other facts to consider that affect the magnitude of the interest rate risk:

- The longer the maturity of the bond, the more the price of the bond moves in response to a change in interest rates.

- Bonds which have a coupon payment feature are less affected by a change in interest rates than a zero coupon bond.

When you buy a bond, you essentially are locking in an investment at a particular interest rate.  If you have a one year bond, you can always wait one year until maturity, take your payment, and reinvest at a higher rate.  However, with a 30 year bond, you have to wait 30 years before you can reinvest at a higher rate.  Therefore, when rates rise, a 30 year bond's price will fall more than a one year bond's price.

Likewise, a bond that has coupon payments will allow you to reinvest the periodic payments at a higher rate of interest.  If a bond doesn't have any coupons, you cannot reinvest your money until the final maturity date.  Thus, a zero coupon bond's price is affected more than a coupon bond by a change in interest rates.

The bottom line is that bond prices fluctuate just like stock prices.  If interest rates rise, the value of the bond falls, and you lose money.  To say that any bond is risk-free is wrong, plain and simple.

Thursday, December 23, 2010

The Economic Case For Immigration Reform

This week's Economist had an interesting article about the illegal immigration of Mexicans to the United States.  The central focus of the article is not on the "big picture" questions regarding immigration reform.  Instead, it framed the discussion around the lives and experience of several migrant farm workers who came to the U.S. seeking a better life.  I came away from the article with a new appreciation for what many of these people go through just to be able to pick strawberries for $3 a day.  It really got me thinking about the whole immigration reform debate in a new light.  Are these people really costing legal American citizens their jobs?  Are these people really leaching off of the "system" without paying their fair share?  After some thought, I think many opponents of immigration reform have it backwards.  Immigration reform isn't the problem.  It's the solution.

Now before anyone starts leaving nasty comments about how I have no idea what I am talking about, please read my thoughts to their conclusion.  If you still disagree with me, then feel free to leave your thoughts, and I will listen to your point of view.

First, let's look at the "problem" of illegal immigration purely from an economic point of view.  There are two economic arguments to which opponents of immigration reform point:

1. Illegal immigrants take jobs away from Americans and with unemployment where it is, we can't afford to let them take our jobs. 

The Economist article talks about a "test" that the United Farm Workers (UFW) union performed.  They launched a website which invited American citizens to take the jobs of migrant farm workers and work in the fields.  At the end of the test, only seven Americans accepted this offer.  The conclusion was that illegal immigrants were doing a job that no American would want to do anyway, so no Americans are losing their job.

Now opponents might say that farm work only represents a small fraction of the jobs that illegal immigrants do.  There might be other jobs that Americans are willing to do, but because illegal immigrants are cheaper, they can't get these jobs.  If you hire an illegal, you can pay them below the minimum wage, and you don't have to pay for Social Security, workers compensation, unemployment insurance.  Illegal immigrants won't complain about working conditions, and they won't file any lawsuits if they are treated unfairly.  That is why illegals are bad for American workers.

Many opponents have used this line of reasoning to argument against immigration reform.  However, if you stop and think about it logically, this sounds to me like an argument in favor of immigration reform.  After all, if these immigrants were allowed to work in the U.S. legally, they would have to be paid a fair wage, and they would be protected by the same labor laws as American citizens.  Employers couldn't threaten them with deportation if the workers complained.  In a nutshell, immigrant workers would be on a level playing field with Americans because they would be employed openly and not in the shadows.  From a labor market standpoint, giving these workers legal status would only help American workers to compete.

The second economic argument against immigration reform goes something like this:

2. Illegal immigrants use public services such as schools and health care without paying any taxes.

The Economist article paints a picture that is in contrast to this perception.  Illegal immigrants go out of their way not to consume public services.  Their fear is that if they go to a health clinic that the people there will discover that they are illegal and turn them over to the authorities.  Whether this is true or not is immaterial; it only matters what immigrants believe.  For them, any contact with public officials exposes them to the possibility of deportation, which is something that they want to avoid at all costs.

That being said, it isn't totally true that illegals don't pay taxes.  Yes, they do not pay income taxes, but they do pay other taxes.  They pay a sales tax when they buy groceries at the market.  They pay gas taxes when they fill up at the gas station.  They pay tolls when they drive on the roads.

Now, even if we assume that illegal immigrants are consuming services without contributing to the system, again this sounds like an argument in favor of immigration reform.  The reason why they don't pay any taxes is precisely because they are illegal.  If they were allowed to work here legally, their employers would be obligated to withhold income taxes, Social Security taxes, Medicare.  It is possible that immigration reform would help cut our deficit because now the U.S. Government would have a new stream of revenue!

On top of these two economic arguments against immigration reform which are really arguments in favor of it, there is one additional argument in favor of immigration reform:

Immigration re-energizes America.

Consider the environment from where these illegal immigrants are coming.  They come from areas where opportunities for a better life are limited.  Most people from these areas are content with this, but some have ambitions beyond what life has dealt them.  Many of the people in this second group dream about making a change, but only a small select few actually act upon this urge.  These driven individuals are willing to brave treks through the desert, limited food and water, bandits, and barbed wire to reach their goal.  They are willing to perform backbreaking work for literally pennies an hour just for a chance at a better life. 

I don't know about you, but these are the exactly the kind of people that America needs. These are the people who make the United States strong.  These are the people who cherish opportunity as something tangible, rather than something to be taken for granted.  I would rather have an ambitious person like this than some of the freeloaders who are allowed to live here by virtue of the fact that they were lucky enough to be born within our borders.  Immigrants can and will contribute to society if we only give them a chance to do so.

The bottom line is that some sort of immigration reform makes cents (and dollars too!).

Wednesday, December 22, 2010

Investing Lessons from John Wooden

For those who don't know who John Wooden was, he was the legendary coach of the UCLA men's basketball program during their unprecedented string of 10 titles in 12 years during the 60's and 70's.  He is considered to be among the greatest coaches in any sport.  He is revered not just for his approach to coaching basketball, but his approach to life.  Recently, he has been in the news as the University of Connecticut women's basketball time has just eclipsed his team's record for consecutive wins.  Today, I happened to be listening to some sorts talk show where they were discussing Wooden's basketball legacy.  The host made an interesting point; he said that if Coach Wooden were coaching today, he might have been fired before he had a chance to bring home all of those titles to UCLA.

John Wooden fired?  Are you crazy?!  Well, maybe not.

When Wooden first took over the Bruins basketball program, he had some early success.  In his first four seasons, UCLA won their conference and advanced to the NCAA tournament twice (back then fewer teams were invited which is why didn't make the tourney all four years).  However, after a string of successes, UCLA had a five year drought of not winning their conference and not advancing to the tournament.  In this day and age of instant gratification, there is a good chance that a coach of a previously successful program had a drought like that would no longer be coaching.

Consider Steve Lavin, who coached the same UCLA basketball team from 1996 until 2003.  In his first six seasons, his teams all had winning seasons and he made the NCAA tournament every year.  However, in his seventh year he had the temerity to only win 10 games.  He was fired after his first losing season.

Now you might say that you can't compare the two situations because times were different then.  That's exactly my point.  Today we live in an always-on, instant gratification society where we are always looking for success right now.  The phrase "good things come to those who wait" doesn't seem to resonate these days.

What does this all have to do with investing?  Plenty!

Today's financial world is dominated by short term thinking.  Many investors is inflicted with "short-term-itis".  Many people cast aside investing for the long term in search of that get rich quick scheme.  First it was the Internet stocks.  Next it was flipping real estate.  Today it is precious metals.  Nobody wants to have to wait 20 or 30 years to reap the rewards.  Many want the rewards today.

However, just as the tortoise beat the hare in that famous fable, slow and steady investing wins the race:

1. Over the long term, buying and holding stocks is a solid investment

I have shown that over any 30 year period from 1950 to the present, buying and holding the S&P 500 will make you a consistent 7% per year.  Yes, you might have years like 2008 where you lose 40%, but if you gave up and sold your stocks after that loss, you would have missed out on the 30% gain in 2009 and the nearly 20% gain so far in 2010.  It is possible that if UCLA had "sold" John Wooden during his lean years that they never would have reaped the benefit of those 10 championships.

2. Over time, the power of compound interest will grow you money exponentially

If you invested $1,000 in an S&P 500 index fund, you will "only" have $1,070 after one year.  However, after 30 years you will have $7,612.25.  7.6 times return on investment is a lot better than what you will probably earn on the latest investment fad.  It took 15 years for John Wooden to win his first title at UCLA, but once he won the titles just kept on coming!

3. If you stay the course, you are less likely to make emotional decisions

The general rule of thumb for investors is to buy low and sell high.  However, how many investors truly follow this advice?  When the markets were at their lowest in March, 2008, how many people were buying and how many were selling?  I think you can guess the answer.  Many people forgot that the stock market can be volatile in short term, but you can't let that volatility spook you.  In order to take advantage of the fact that stocks are going to grow in the long term, you have to stick with them through these dark periods.  Those who remembered this wisdom of not making rash decisions were rewarded by a strong bull market.  Those who sold at the market's low point are probably still kicking themselves.

The lesson here is that long term thinking trumps short term thinking every time.  Just like the way that UCLA stuck with a winner like John Wooden, sometimes you have to stick with an investment plan for the long term.  If it is sound plan that you believe in, it is almost always better to stay the course.

Monday, December 20, 2010

Bonding With Bonds: An Introduction

With the stock market ups and downs of recent years, more people are looking to bonds as a safe haven for their money.  Bonds are generally perceived as being a safer investment than stocks.  Here is what the Yahoo! Finance Banking Center says about bonds (specifically U.S. Treasuries):

"U.S. Treasury bills, notes and bonds and U.S. savings bonds are an excellent, risk-free way to preserve capital, get a pretty good return and keep your investment liquid."

Is the prevailing wisdom about bonds really true?  Are bonds really the safe investment that people think they are?  As with most important questions, the answer is not so clear cut.  However, before I delve into that question, it is best to start off with a general overview of what a bond actually is.

A bond is an IOU.  Nothing more.  Nothing less.

The lender loans some amount of money to some entity that needs to borrow money, and in return the borrower gives the lender a bond.  The bond is a piece of paper which says that the borrower will pay the person who owns that piece of paper some amount of money Y at some point in the future.  The amount Y is known as the face amount of the bond.  A bond is said to mature when this final payment becomes due.

Most bonds have an additional feature called the coupon.  This coupon feature pays the holder of the bond some percentage of the face amount periodically from the time the bond is issued until it matures.  The percentage that is paid in interest is known as the coupon rate.  Most U.S. bonds make a coupon payment semi-annually, so they pay half of the coupon rate every six months.  There are some bonds which don't have coupons; these are called zero-coupon bonds.  With these bonds, the only payment the lender receives is when the bond matures.

As a historical note, the reason why this feature is called a coupon is because in the past, the bond was a piece of paper that actually had coupons which the lender had to cut out to receive the periodic payment.  With the advent of computers and electronic banking, lenders no longer have to cut coupons.

Here is an example of a simple bond:

XYZ Corporation needs to raise money to build a new factory so it decides to sell some bonds.  The bond it issues promises to pay $1000 after 10 years with a coupon payment of $10 every six months for a coupon rate of 2% (10 x 2 / 1000).

Many entities can issue bonds.  The biggest issuer of bonds is the United States Government.  Because the Federal Government spends more money than it receives, it must fund this shortfall by borrowing this money from the general public.  It does this through bonds. The Government issues bonds of varying maturities:

Treasury Bills (T-Bills):  These are short term loans that mature in one year or less.  Because they are so short in length, they do not have coupons.

Treasury Notes:  These are bonds which mature in one to ten years.

Treasury Bonds:  These are bonds which mature in ten to thirty years.

The Government also issues Treasury Inflation-Protected Securities (TIPS) where the coupon amount of the face amount grow based upon the inflation rate.  They also issue something called Savings Bonds, which aren't really bonds in the traditional sense.

States and local governments also borrow money through bonds.  These bonds collectively known as municipal bonds.  To entice people to buy these bonds, the interest is exempt from Federal taxes as well as local taxes in the jurisdiction which issues the bond.

Governments aren't the only ones who get in on the bond act.  Private corporations also sell bonds to raise money.  These are appropriately known as corporate bonds.  Some companies may be perceived as being bad credit risks, meaning that there is a strong feeling that they will not make good on the promise to pay the bond back at maturity.  Bonds issues by companies with bad credit are known as high yield bonds or by their more descriptive moniker:  junk bonds.

In addition to all of the above, there are other, more exotic bonds out there:  asset-backed securities (where the principal and interest is "backed" by some specific thing of value), floating rate bonds (where the coupon rate varies based upon some interest rate index), convertible bonds (where the bond can be traded for stock in the company which issued the bond), and others.  As you can see, the bonds come in all sorts of varieties!

In the next post in this series, I will discuss some of the mechanics of determining a bond's value and why bonds may not be as safe as people think.  Stay tuned!

Friday, December 17, 2010

Nobody's Perfect... Not Even Warren Buffett

This past week I wrote an article comparing active investing and passive investing where I pointed out that even the most famous active investor, Warren Buffett, is a rare exception and not the rule.  Well, it turns out that even Mr. Buffett makes mistakes when it comes to stock picking.  An article in reports that in his most recent letter to shareholders, Mr. Buffett admits to several recent investment mistakes.  Regarding his investment in ConocoPhillips, Mr. Buffett says the following:

"The terrible timing of my purchase has cost Berkshire several billion dollars."

The interesting thing is that he invested in this oil company when oil prices were at their height.  So much for being able to time the market!

The article also says that he admits to making a mistake in investing in two Irish banks which appeared cheap but which caused him to lose 89% of his original investment.  Mr. Buffett says, "The tennis crowd would call my mistakes 'unforced errors'."

This just goes to show that even Warren Buffett, with all of this advantages, can't predict the stock market reliably all the time.  What hope do you or I have when we have about 1% of the time, 1% of the resources, and 1% of the skill of Mr. Buffett?

Wednesday, December 15, 2010

Sometimes It Pays To Be Passive

If you ask most people whether it is better to be passive or active, most people would answer active, which is not much of a surprise.  When you think of being active, you think of taking the initiative, of exerting influence over ones environment, of attempting to bring about change.  On the other hand when you think of being passive, you think of letting events control you, of not participating, of submitting to the will of others.  A passive person is timid while an active person takes charge.  When it comes to investing, the words active and passive come into play as well.  You can be an active investor, or you can be a passive investor. 

Which is better?  Most people would immediately say that active investing is better.  However, is that really true?

First, let's define what it means to be an active investor versus being a passive investor.  An active investor attempts to seek out winning investment opportunities.  They try to find those stocks which are going to go up in price, and they try to avoid those stocks which are going to go down.  They attempt to time the stock market by buying when its prospects look good and sell when they look bad.  Generally speaking, they actively choose what stocks to buy and when to buy them.

A passive investor doesn't try to figure out which stocks to buy.  Rather than picking and choosing which stocks to buy, a passive investor buys every stock through an index mutual fund.  Rather than trying to time the market to figure out when it will go up and down, a passive investor invests the same amount every month.  Generally speaking, a passive investor doesn't concern himself or herself with the movements of the market or individual stocks.

Which is a better strategy?

Obviously, if you could figure out which stocks are going to go up and which are going to go down, it is better to buy the gainers and sell the losers.  The key word is "if".  Can somebody figure out in advance which stocks are going to be winners?

If you have been a loyal reader of this site, you probably can guess what my opinion on the matter is.  I am of the opinion that there is no way to reliably and repeatedly predict the direction of individual stocks or the stock market as a whole.  You may get lucky from time to time in the same way that a blind squirrel finds a nut.  However, don't confuse luck for skill.

Professor Burt Malkiel laid out an excellent case for the random nature of financial markets in his book A Random Walk Down Wall Street.  His premise is that any information that would influence the price of any individual stock is already incorporated in the price of the stock.  In academic circles, this is known as the efficient market hypothesis or EMH.  Here is an example of how the this works:

Let's say that the Food and Drug Administration announces that they determined that a certain drug cures cancer.  Obviously, the company that developed this drug is going to make billions and billions of dollars selling this miracle cure.  As an investor you would think that it would make sense to buy the stock of this company in anticipation of the coming windfall.  However, within seconds of the announcement, the people who hold the stock will demand a much higher price to part with their shares of stock.  Before you can even pick up the phone to call your broker, that information will have caused the stock price to rise, and you will have missed out on any financial benefit from knowing that information.

This is true of any type of information about a stock.  By the time it becomes public knowledge, it is too late to benefit from that information because that information is already incorporated into the price of the stock.  It would appear, then, that the only way to figure out which stocks are going to go up is to have some information about the stock that nobody knows about.  By the time you read about it in the Wall Street Journal or see it on CNBC it is way too late.

Now if you are egotistical, you may think that you are special.  You may think that you are smarter than the average stock trader because you have noticed something that nobody else has seen.  You are wrong.  There are always events that affect the price of stocks that nobody can predict unless they are psychic.  There is no way to predict natural disasters.  Who could have predicted the wildfires in Russia which caused a shortage of wheat?  Who could have predicted that a well in Gulf of Mexico would explode and lead to one of the biggest environment disasters in U.S. history?  Who could have predicted that there would be a terrorist attack that would cause a total shutdown of airline travel and then lead to two wars?  All of these inherently unpredictable events impacted various stocks on the stock market. 

Many people use what is known as charting or technical analysis.  This involves looking at the movement of stocks to see if there are patterns.  There is a whole litany of terms for various patterns, and these patterns supposedly indicate whether it is time to buy or sell a stock.  The mere fact that these patterns are well known means that they cannot be exploited.  Let's say that there is a pattern that a stock always rises on a Wednesday.  Once that pattern becomes common knowledge, people will start buying on Tuesday in anticipation, and the stock price will go up on Tuesday instead of Wednesday.  The mere identification of the pattern eliminates the pattern in a "quantum physics"-y kind of way.

The biggest counter argument to the efficient market hypothesis and passive investing is Warren Buffett.  Warren is one of the richest men in America, and he made his money by investing in stocks of companies that he thought would increase in value.  Certainly his track record speaks for itself.  The stock of his company, Berkshire Hathaway, has gone up 76% over the past decade.  Meanwhile, the S&P 500, which is price of 500 large U.S. corporations, has gone down over the past decade.  It appears as if Mr. Buffett has trounced the overall stock market through shrewed investment decisions.  If Mr. Buffett can do it, then anybody should be able to do it, right?

Well... not really.

First of all, Mr. Buffett isn't your ordinary investor.  When most people buy a stock, they exert no influence over the management of the company they buy.  Sure, they get to vote for the board of directories and an ocassion proxy question.  However, those votes don't really count for much.  When Warren Buffett buys a stock, he doesn't buy 10 shares or 100 shares.  He buys thousands or even millions of shares.  When he wants to influence how a company is managed, he can call up the CEO, and his calls get answered and his advice gets listened to.  He is not only an investor, but he is an owner in the truest sense of the word.  If you or I think that a company is heading in the wrong direction, we have no way to change the company's course.  We can only sell our stock and move on.

Second of all, Mr. Buffett has access to deals that the average investor doesn't.  At the height of the financial crisis, Mr. Buffett was able to buy $5 billion of "preferred stock" in Goldman Sachs.  This preferred stock was a sweet deal for him.  It pays out a 10% dividend every year, meaning that he gets $500 million every year from Goldman Sachs in return for his investment.  The average investor would have loved to get in on this deal, but it was offered to Mr. Buffett and only him.  It is easy to make a killing on stocks when you are a preferred customer.

Finally, investing is Mr. Buffett's life.  He spends more time thinking about stocks then most people think about everything else combined.  In addition, he employs a team of experts to assist him in his work.  If there is any insights to be gained into how a stock if going to perform, Mr. Buffett and his team will know about it, and they will know about it before you or me.  That is an advantage that he and all of the other professional investors have over us average folks.

If you don't believe me that passive investing is the way to go for the average amateur investor, maybe you will take the word of the master himself.  Warren Buffett has stated repeatedly that most people are better off investing in index funds rather than in individual stocks.  He has even gone so far as to bet that Vanguard's passively managed S&P 500 stock index fund will outperform five hedge funds (proceeds going to charity).

The bottom line here is that it is difficult (if not impossible) for the average person to consistently predict the stock market.  Rather than trying to predict it and see your predictions go wrong, you are better off just buying a low cost index fund that contains every stock and calling it a day.  It just goes to show that sometimes the passive approach is the best approach.

Sunday, December 12, 2010

Targeting Target Date Funds: An Update

Yesterday, I posted an article about target date funds where I compared the holdings of three popular ones.  A picture is worth a thousand words, so I created a chart which shows the relative stock holdings of each:

As you can see, prior to 2030, all three hold about the same percentage of assets in stocks.  Generally, the T. Rowe price is the most aggressive, and the Fidelity is the least aggressive.  However, they start to converge up until 2030.  After 2030 they start to diverge again.  The Fidelity fund's stock holdings drop to 20% over a 10 year period, while the T. Rowe Price fund drops to 20% much more gradually.  The Vanguard fund drops at about the same rate as the T. Rowe Price fund, but it only drops to 30%.  As a result, the Vanguard fund becomes the more aggressive after 2050.

The point is that you need to examine the holdings of your target date fund before you invest so that you are comfortable with its investment philosophy.  Knowing what you are investing in the cornerstone of being a smart financial consumer.  Just because target date funds are advertised as set-it-and-forget-it investments doesn't mean that you don't have to know what you are "setting" your money to.

Saturday, December 11, 2010

Targeting Target Date Funds

You may have heard about target date funds (or life cycle funds as they are sometimes called) as they have grown in popularity over the past decade.  What are they?  They are mutual funds that are offered by an investment company that automatically adjusts their mix of assets over time.  The theory is that if you are far away from some investment goal (usually retirement) you can afford to invest in more risky assets like stocks, since over long periods of time, riskier assets have the best returns.  However, as you get closer to your investment goal, you will want to shift your investments into less risky investments since you have less time to recoup any investment losses.  These funds automatically adjust based upon this strategy.

Most companies offer various target date funds.  You pick the fund whose target date is close to your retirement date, and the fund adjusts the asset mix as you get closer to retirement.  Let's say that you plan to retire 20 years from now in 2030.  You would choose a target date fund whose target date is 2030.  In 2010, that fund will be more heavily invested in stocks since you still have 20 years to go before you need the money.  However, as you get closer to retirement and beyond, your exposure to stocks will decrease until it reaches some minimum amount.

Why would somebody invest in a target date fund?  The biggest advantage is that these funds are truly "set-it-and-forget-it".  You simply deposit the money in the fund, and you don't have to worry about constantly adjusting the asset mix over time.  All you have to do is pick the fund whose target date matches your expected retirement date. 

On the other hand, this set-it-and-forget it advantage is a double-edged sword.  The disadvantage is that not all target date funds are created equally.  Some funds might take more risks and some might take less.  As an example, I took a look at three popular target date funds:  Fidelity Freedom 2030 Fund, T. Rowe Price Retirement 2030 Fund, and Vanguard Target Retirement 2030 Fund.

As of today, all three have about the same asset allocation more or less:  60-65% domestic stocks, 16-17% international stocks, and the rest in bonds.  So far, the all look about the same.

When the funds reach their target date of 2030, again all three will have about the same asset allocation:  around 40% domestic stocks, 10-15% international stocks, and the rest in bonds and other short term investments.  Still not much difference.

However, the difference comes in after you reach retirement.  All three funds continue to decrease their exposure to stocks after retirement, but the rate at which this happens varies.

The Fidelity fund is scheduled to eventually get down to about 20% stocks after "10 to 15 years after the year 2030" according to the prospectus.  That means that you will reach 20% sometime between 2040 and 2045.

The T. Rowe Price fund invests more aggressively in retirement.  Again, the fund is scheduled to reduce its stock holdings to 20%.  However, it is scheduled to reach this level in 2060, 30 years after retirement.  Because it reaches its 20% minimum over a longer period of time than the Fidelity fund, the T. Rowe Price  fund stays invested in stocks for longer.

The Vanguard fund is the most aggressive of all in retirement.  This fund reduces its stock holdings to 30% which is higher than the other two funds.  It reaches this milestone about 10 years after retirement.

The person who is likely to invest in target date funds is not likely to look very closely at how a target date fund invests.  They are looking for an investment that they don't have to think about.  However, an investor might find that the investment philosophy of the fund doesn't match his or hers.  For instance, an investor who has a low risk tolerance might not feel comfortable having 30% invested in stocks during retirement.  This person would be better off with the Fidelity fund.  However, that person might not take to time to look at how the fund invests and will only realize that the fund is too risky after taking losses when the stock market dips.  On the flip side, an investor who is more aggressive would be better off in the Vanguard fund because it keeps more money in stocks during retirement.

The lesson here is that target date funds might be a good thing for people who don't want to think too much about investing.  However, that doesn't mean that you don't have to do your homework.  You still have to have some understanding of what you are getting into so that you pick the target date fund that matches your investment goals and personality.

Thursday, December 9, 2010

The Foreclosure From Hell

I came across a story in the Wall Street Journal about a woman in Florida by the name of Patsy Campbell who has been in foreclosure for the last 25 years.  Since 1985 she has continued to live in her house despite not making any mortgage payments.  Ms. Campbell defiantly claims that she has every right to remain in her home until the case against her is adjudicated. However, she appears to be using every trick in the book to delay that day of reckoning.  The article describes some of the various tactics that she has used to stop the bank from booting her out of her home:

Ms. Campbell has challenged her foreclosure on the grounds that her mortgage was improperly transferred between banks and federal agencies, that lawyers for the bank had waited too long to prosecute the case, that a Florida law shields her from all her creditors, and for dozens of other reasons. Once, she questioned whether there really was a debt at all, saying the lender improperly separated the note from the mortgage contract.

She has managed to stave off the banks partly because several courts have recognized that some of her legal arguments have some merit—however minor. Two foreclosure actions against her, for example, were thrown out because her lender sat on its hands too long after filing a case and lost its window to foreclose.

Her latest tactic is to declare bankruptcy.  This puts a hold on the foreclosure proceedings until the hold is lifted by the bankruptcy-court judge.  According to the article, this will delay things at least four months, at which point the case will go to trial.  When that happens, who knows what new tactic Ms. Campbell will devise.

Now article states that she stopped paying her mortgage not because of a desire to freeload, but because an illness caused her to lose her job and get behind on her bills. However, once she recovered (and one can infer from the article that she did recover), she either should have resumed payments to make good on her debt, or given up the house. By mounting dubious challenge after dubious challenge, she is just trying to avoid the debt altogether.

On the one hand, there is nothing illegal about what Ms. Campbell is doing.  She is "working" the system to the fullest extent possible.  The law states that she is entitled to due process prior to the bank seizing her home, and it seems like from the article that the lenders have made a lot of missteps to say the least.  As with all U.S. citizens, she is entitled to have her day in court, and if it takes 25 years, that is not her fault.

Other the other hand, what she is doing is immoral in my humble opinion.  When her husband bought the house, he took out a loan and signed a contract which said that he would either pay back the loan or lose his home.  When he died, Ms. Campbell decided to stay in the house and take on that obligation.  By not paying her mortgage as agreed, she is failing to live up to the terms of the contract.  This may not be theft from a legal standpoint, but it is from a moral one.  While she certainly has a right to continue to live in the house, that does not make it right.

One can view Ms. Campbell as a woman before her time.  With the implosion of the real estate market, many otherwise upstanding citizens are engaging in a practice known as a strategic default.  This is where a person walks away from a house whose mortgage is greater than the value of the house despite the fact that the person has the ability to make the payments on the mortgage.  This isn't a case where somebody can't make their mortgage payments because they lose their job or become sick.  This is where a person actively chooses not to pay.

Attorney Jim Porter advocates such a strategy.  He argues that there is nothing wrong with this:

Let me initially say that you should have no guilt or remorse about not making payments to your lender. No one likes to default, but your mortgage is a contract — a legal document — not a moral promise. The deed of trust has language in it that should you default, the lender can take back your property. That was the agreed deal. Get over the perceived negative social stigma-at least that is my advice.

As much as I would love to disagree with him, he is correct in the sense that there is no social stigma to reneging on a loan.  Rather than shaming people for not living up to one's obligations, people are applauded for making what is perceived to be a wise financial decision.  While it may seem like a smart move to walk away from a money losing obligation, it undermines the adage "a promise is a promise". 

Now you may think that I am just being an old-fashioned pollyanna, but "a promise is a promise" helps to facilitate the economy and society in general.  Much of our financial system is based upon trust:  trust that when party A loans party B money that party A has a good chance of getting it back.  Sometimes unforeseen circumstances cause the borrow to default on an obligation, and that is part of the cost of doing business for the lender.  However, when there is a good chance that the borrower might decide not to repay a loan just because they want a free lunch, who is going to lend money?  Lenders are only going to lend money whose reputation is sterling, or they will demand a higher rate of interest increasing the cost of borrowing.

This is the situation that many parts of the financial system are in now.  There are people who want to refinance mortgages at low interest rates that are being turned away because the banks don't trust them.  There are small businesses who want to borrow money to hire more staff so they can expand that are being turned away because banks don't trust them either.  This lack of trust has tangible and serious consequences.

So yes, you can legally walk away from your obligations like Ms. Campbell has done and like Mr. Porter recommends.  However, there are consequences to this line of thinking, both moral and to the economy as a whole.

Monday, December 6, 2010

Buyer Beware on eBay

The web marketplace eBay is arguably one of the most influential websites of the dot com era.  It has globalized the local flea market and has given rise to countless home-based businesses.  However, at its heart, eBay is just a flea market on steroids.  As in a traditional flea market, there are honest sellers and there are shady ones.  eBay has tried to combat this through its feedback system.  However, that hasn't stopped businesspeople from taking advantage of unsuspecting consumers.

Recently, I have intrigued by Amazon's Kindle e-reader.  The idea of carrying around all of your books on one device is convienent, especially while travelling.  Also, many books are cheaper in their electronic version, and most classics are even free!  On top of that, you can have books wirelessly sent to your Kindle immediately after purchasing, so you don't have to wait a week for them to arrive at your doorstep.  Currently, Amazon sells a Wifi-only version of the Kindle for $139 and a version with both Wifi and 3G cellular sells for $189.  In both cases, the shipping is free.

At those price points I don't feel ready to pull the trigger on a purchase.  However, in an effort to save a few bucks, I turned to eBay to see what online sellers are charging for them.  While there appeared to be many private sellers who were selling used ones at below Amazon's price, there were also quite a few who were selling the Kindle for more than what Amazon charges. 

One seller is offering a Wifi-only Kindle for $169.99 plus $14.99 shipping for a grand total of $184.98.  (Note that I included a link for educational purposes only.  Please do not buy a Kindle from this seller!)  This is $45.98 higher than buying a new one directly from Amazon and only $4.02 less expensive than the 3G version of the Kindle purchased from the source.  In fairness the seller states near the top of the listing that this is the Wifi-only version, so there is nothing illegal going on.

Here is another seller offering the Wif-only Kindle for $179.98 with shipping.  Again, the seller does say that this is the Wifi-only version in the description, there is nothing illegal here.  This seller mentions "Free 1.8m ebook info" in the title of the ad.  However, you will see that they are just offering you "assistance" on how you are access free ebooks.  They aren't actually providing you with these freebies are part of the deal.

(By the way, here is information on how you can get these free ebooks.  No purchase necessary!!!)

Here is a third Wifi-only deal for $183.99 including shipping.  This one is a slightly better deal than the first two in that the seller actually includes a DVD with 15,000 classic ebooks - the same ones that you could download for free with the advice that you would have gotten from the second seller.

So far, I don't have any problem with the first three deals, other than the price.  All three stated prominently that you are getting the Wifi-only version, so if you choose to purchase from them instead of Amazon, shame on you.  However, this fourth example is a little more troubling to me.  In this example, the seller is offering a Kindle for $177.46.  The title and the text at the top of the ad say that it has built in Wifi.  However, nowhere in the ad does it state that this is the Wifi-only version of the Kindle.  It does say that it has "built-in Wifi", but so does the more expensive 3G cellular version.  How do I know that the seller is offering a Wifi-only version?  The seller's description is an exact copy of Amazon's product description of the Wifi-only Kindle.

Now I can't guess why these four sellers are offering Kindles at a price that is higher than Amazon.  However, it seems like there is an opportunity for these sellers to profit from unsuspecting buyers.  The bottom line is that just because something is being sold on eBay doesn't make it a good deal.  In other words...

Buyer beware!

Thursday, December 2, 2010

Statistics Make Fools Of Us All

The phrase "lies, damn lies, and statistics" succinctly expresses the power that numbers have to obfuscate the truth.  It always amazes me how easy it is for statistics to be misinterpreted by even the best of us.  One of my favorite personal finance blogs is Free Money Finance.  While I do not know the author personally, he always strikes me as a person who is logical, level-headed, and generally well versed in subjects related to personal finance.  That is why I am dismayed to report that over the past week, he has not only misinterpreted statistics once, but twice!

Let me state for the record that it is not my intent to rake the author over the coals, so to speak.  I am willing to give him the benefit of the doubt and assume that his mistakes were not done purposefully or to further some hidden agenda.  The point of bringing this to light is to show how even somebody who seems to be an authority can misinterpret statistics and to illustrate that you cannot take statistics at face value, no matter how authoritative the source appears to be.

The first statistical lapse came on Sunday when he posted the article Given Grows Your Net Worth.  In his article he cites several "studies" which show that people who give to charity end up richer, not poorer:

We've talked about this before, but a series of studies by BYU professor Arthur C. Brooks found the following:

“My conclusion was, sure enough, that when people get richer, they tend to give more money away. But I also came up with the following counterintuitive finding—that when people give more money away, they tend to prosper.”

“Specifically, here’s what I found: Say you have two identical families—same religion, same race, same number of kids, same town, same level of education—everything’s the same, except that one family gives $100 more to charity than the second family. Then the giving family will earn on average $375 more in income than the non-giving family—and that’s statistically attributable to the gift.”

So, if you give $100 you're not worse off by $100. You're actually better off by $375.  Think of the implications of this at growing levels of giving. For instance:
•If you give $100, you're better off by $375.
•If you give $1,000, you're better off by $3,750.
•If you give $10,000, you're better off by $37,500.
•If you give $100,000, you're better off by $375,000.
•If you give $1,000,000, you're better off by $3,750,000.

Certainly makes a compelling case for giving as much as you can, huh?

He is citing a study which shows that families who give more earn more on average.  However, he immediately jumps to the conclusion that the giving more leads to a higher income.  There is no way that you can conclude that based upon the statistics.  There are, in fact, three possible conclusions:

1. More giving leads to a higher income.
2. Higher income leads to more giving.
3. Giving and income are both the result of some third factor and are not directly related to one another.

Immediately the author jumps to the conclusion that #1 is true, and he engages in some crazy extrapolation which makes his case look even more ridiculous.  At first when I read this, I thought that he was engaging in sarcasm, but there is no indication in his article that sarcasm is intended.  He even concludes by saying that the research "seems pretty solid".

This is a common mistake that most people make.  Somebody shows that two statistics are correlated and rather than trying to understand whether they are correlated because of 1, 2, or 3, they pick the choice which best agrees with their point of view and ignore the other possibilities.

A few years ago, there were a number of "studies" showing that children who had listened to classic music when they were young did better in school than those that didn't.  Immediately, people jumped to the conclusion that classic music was the key to raising a genius, and a new cottage industry was formed to sell overpriced CD's to crazed parents.  Nobody stopped to consider that maybe parents who would expose their children to classic music were more educated themselves and thus more likely to have smarter than average kids (option 3 above).

The second misleading statistic that was quoted by the author of Free Money Finance was the following from his article Interesting Facts on Cars and Wealth.  Note that the author of Free Money Finance is quoting another blogger, Dr. Thomas Stanley.  The words in quotes are Dr. Stanley's.

And here's a thought from his follow-up post titled Frugal Millionaire with a Mercedes? II:

"Too many Americans may believe that by driving a new car they are emulating economically successful people. But only 8.6% of those driving this year's model motor vehicle are millionaires [those with $1M in investments]. Don't ever feel degraded if you are riding around in a used motor vehicle."

The implication here is that because only 8.6% of people driving new cars are millionaires, millionaires are not likely to be driving new cars.  Again, this lone statistic doesn't prove or disprove this proposition.  Dr. Stanley, who is being quoted, is jumping to a conclusion that isn't supported by this one fact.

The fact is that millionaires make up a small fraction of the total population, so it makes total sense that they would represent a small fraction of new car buyers.  Just because they only represent 8.6% of new car buyers doesn't mean that only 8.6% of millionaires drive new cars.  However, Dr. Stanley concludes exactly that.  The statistic which would prove his case would be the percentage of millionaires who drive new cars versus used cars.  It is possible that even though 8.6% of new cars are driven by millionaires, 75% of all millionaires might drive new cars.  We just don't know.

The lesson here is that numbers carry so much authority that people are just blinded by them.  If somebody makes a claim and happen to throw in a number, people automatically accept the claim as fact regardless of whether the number is actually relevant to the claim!  Even though Free Money Finance's author is just quoting the statistic, he isn't totally off the hook.  Rather than just accepting the claim as fact because an irrelevant number was presented along with the claim, he should have used his initiative and questioned the number and the claim.

Like I said at the outset, it wasn't my intent to through Free Money Finance under the bus.  It is to show how even the best of us can be made to look foolish by misleading statistics.  The bottom line is that when presented with statistics, you have to think about what is being said and whether it makes logical sense.

Wednesday, December 1, 2010

Reading This Can Save You 15% On Your Car Insurance... Really!

It seems like everywhere you look, you are bombarded with ads for companies claiming to save you money on your car insurance.  If you take these claims on face value, you should be able to continually switch insurance companies and eventually drive your annual premium down to practically nothing!  Let's say that you are currently paying $1000/year to insure your car.  If you switch and save 15%, you'd expected to pay $850.  Switch again and now your premium is $722.50.  Do it again and now you are paying $614.13.  Rinse and repeat another 70 or so times and you are paying under a penny a year!  Obviously I am engaging in a little mathematical hyperbole here, but the point is that nobody truly can promise to save you 15% on your car insurance by switching.

Let's take a close look a couple of the common claims:

"People who switched to Allstate save an average of $348 per year.", or
"Drivers who switched this week saved an average of $494"

This is a common selling point of many companies.  Most people read this might think that if they switch to Company XYZ, they are guaranteed to save some money.  However, what the words actually mean is different in a subtle way.  They are saying that of the people who choose to switch, those people save money.  If you stop and think about it, that makes perfect sense.  If the insurance offered is more expensive, you wouldn't switch, now would you?  You would only switch if Company XYZ offers a better deal.  Those who end of paying more would decide not to switch, and therefore they would not be included in the average.  The average only includes people who save money. 

It's sort of like saying that the average height of people over six feet tall is higher than the average height of all people.  Of course that's the case because the average height of people over six feet tall includes only the tallest people.  Likewise, of course the average savings of people who switch is higher than what the average savings would be for the population at large, because only people who save money are switching.

A second common claim goes something like this:

"15 minutes could save you 15% or more on your car insurance"

Unless you have been living a cave, you've probably heard this claim before (although it's so ubiquitous that even a caveman has heard it).  Again, on the face of it, this sounds like switching will save you 15% (or more).  Sounds like a great deal to me.  However, notice the word could in the tagline.  Switching might save you 15% or even more than 15%;  however, it could also save you less than 15%.  In fact, it could save you nothing. 

The bottom line is that there is way of knowing what 15 minutes could save you, according to this statement.  They could have easily replaced 15% with 50%, and this statement would mean exactly the same thing!  Of course, some marketing genius probably assumed (and rightly so) that saving 50% would sound ludicrous but that 15% could sound plausible. 

The lesson here is that you have to take all of these auto insurance advertisements with a grain of salt.  By all means you should compare prices but understand that not all of these claims are what they are cracked up to be.