Mary Caraccioli: The last decade has been this period of bubbles and busts. Have these cycles changed your investment philosophy at all?
Steve Forbes: I think it underscores that you cannot do, what they call, rearview mirror investing. And that is assume that was is in the present is going to be in the future, or what is past is going to be in the future. I remember in the 1990’s the average return on a stock was 11.x% but between the mid-1960s and the early-1980s stocks actually in the real term went down 60 or 70%. Then you have this enormous surge upwards. Where in a period of 20 year, something like the Dow went up almost 15 fold.
So a lot of volatility. And in terms of investment strategy, you have to learn to be disciplined. Everyone says they are a disciplined investor until the market goes down. Then it’s “It’s too late to get out” or the market surges and it’s “oh is it too late to get in.” You see that attitude this year. “oh I’ll wait for the next turn then I’ll be sure to get in.” You get whipsawed. For younger people, the key thing is Mary, they put in a certain amount each month into several low expense mutual funds and keep doing it and don’t get caught up on the day-today.
And in terms of strategy…yes you have to be diversified around the world with companies that have a good overseas presence. The dollar is in one of these weak periods. So you have to be diversified, but don’t over manage it. But if you don’t have time to do it, go with the mutual fund…let others babysit your money for you.
MC: How do you structure your own personal investing? Are you more aggressive than the average person or are you more conservative?
Forbes: It’s probably aggressive in the sense that most of my assets are in company. So if that does well, I’ll do well. If not, what I do on the side isn’t going to much help me. So yes. But I do also have life insurance which is probably the most conservative investment you can have. But with a good company, it doesn’t look so bad in the last two or three years. So there’s balance, but I do like mutual funds again because if you are going to do individual securities you have to have time to really examine the thing. And if you don’t, don’t do yourself a disservice. Get someone with brains to do it for you
MC: Makes sense. So you like managed mutual funds as opposed to index funds, that are not actively managed.
Forbes: Yes and sometimes if you think there is a certain sector, you can try to get and exchange traded fund or an index fund to cover it. That’s fine. But in terms of the market as a whole, realize that you are not going to beat it. And also have a realistic expectation of what it is you want. Everyone wants capital gains, but what is your time horizon. What is your true tolerance? And then you can go beyond equities and take bonds.
Who ever would have thought two years ago that treasuries would be given at fantastic returns. That you could buy a thirty year treasury at a time when the dollar is going be weakened and you get a positive return. That’s the kind of crazy environment we’re in. But you’ve got to be ready for it.
MC: Being ready for it means that you don’t have the knee jerk reaction. It’s about essentially getting a plan and sticking to it. When do you get off of that plan and say, I’m going to divert from this. It’s obviously not to the news of the day, right?
Forbes: Right and it depends on where the money is. If it’s a 401k or an IRA and you’ve followed the rules of fiduciary responsibility to yourself, that is you’ve diversified, and not put too many eggs in one basket as they say, then you can ride a storm through. If you’re not going to need the money for a few years, ride the storm through.
And you saw that very graphically after the huge hit from late 2007 to early 2009, where a typical stock went down 60%. A lot of people got out. They said I can’t afford this. I can’t stomach this. I gotta put some stock on the side. Then March comes around and you have a huge snap back on the market. Now the same thing happened in the 30’s. Even though it was a dreadful decade, a horrible decade economically, you saw these real whipsaws. Same thing in the 70’s. 75, 76 fantastic for the market, even though it was a dreadful decade.
So yeah, especially for retirement, don’t try to hit homeruns. There was a money manager in Connecticut years ago that said “For certain kinds of money play it like you should tennis.” You like to play tennis Mary. And he advised, “realize you are not going to be playing Wimbledon. ” And a sensible tennis player focuses on just get the ball over the net. Leave the fancy stuff to others. Just get the ball over the net. Same thing with investing…just get the ball over the net and you will do just fine.
MC: So when the market goes down a lot of people get in that mode that they want to play catch up. But that’s where you can get yourself into a trap, because that’s taking you off your plan for the wrong reason.
Forbes: Yes and simple things. The miracle of compound interest does work if you let it. Dollar cost averaging, and that is so simple. That is, especially if you are a little younger. When a market goes down, that is your opportunity, because if you are putting in a certain amount of money, a hundred or two-hundred a month you’re in effect buying more shares. So when the thing comes back you will get a much bigger hit.
Reinvesting dividends and basic things like that. Again…stay away from the cocktail chatter. Don’t think of yourself as a Goldman-Sachs executive, you’re going to make $100 million. No, if you get that mentality, you are just going to frustrate yourself, and hurt yourself.
MC: That’s right, because it really is about your personal situation in the long run. And it’s hard sometimes to tune everybody else out and to tune out all of the noise. There is a ton of noise out there. But it really is an understanding of what your needs are.
Forbes: And if you at parties, and if we get in an environment again, which we might someday if you live long enough, where people start to boast about what investment genius’s they are. You are going to participate by citing the example of some others. “Oh yeah. Ed at the office, what a jerk, but he really hit a homerun on that.” Fine so you can participate in the conversation. You have to try to go out there and it the homerun. Let others try to swing. Most of the time they’ll strike out. They won’t tell you.
MC: And you know we have seen this cycle over and over again, where it’s the paper boy, the dentist and everyone giving you stock tips. That’s pretty much the call to get out right? When everybody else is telling you to buy. That’s when you bolt or at least have some sort of conservative position.
Forbes: Or the recent housing bubble when everyone becomes a real estate tycoon. You know something is probably wrong. And of you have that urge to be mad, to do crazy things, have a certain portfolio and money where you can play with it. But don’t do it in your IRA. Don’t do it in your 401k. those are things that you just want to be able to sleep on. If you lose your mad money fine, but your not jeopardizing something fundamental in the future. And as you get older, again, be disciplined on your retirement. Jack Bogle, created Vanguard, his rule of thumb is your age. If you’re 50, half of your investment, 50% of your investments should be in bonds, short term instruments. 60, 60%. So if something goes wrong with equity markets or the bond markets you have cover.
MC: And that I think is the best rule of thumb is to know that you have the conservative investment for a reason. If you have to take distribution on it, cash it in…you cash in the conservative investment. You don’t worry about if the stocks are up or down. If you they are down you can hopefully hold until they come back up again. You’re not forced to sell in a time you don’t want to. And I think that’s where people think well it’s just because bonds have a certain return. It’s gives you an out if you need money.
Forbes: And as you get older you have to look at things like annuities. Again, you don’t put everything in an annuity. You have to look at expenses. And a lot of them hit you pretty hard on expenses, so you have to do some basic homework. But having an annuity is not sexy, but it does give you some balance and a bit of an anchor if the storms rise up. And so be true to yourself and be realistic about what are you cash needs? The worst thing that can happen, and people went through it, and they are going to go through it again is…the market goes down and you need to raise cash.
It is a hideous feeling and you feel bad doing it. Then when the market comes back you say “oh my God I missed it” and you’re tempted to do something you shouldn’t do.

MC: The biggest knock to Wall Street…and as you know when everybody is getting rich no one is complaining about Wall Street, but when everybody is loosing money that is when they are complaining. The concern that I hear so often is that it is not just that they are doing something and are getting paid handsomely for it…it’s they are inventing the rules as they go and they have that unfair advantage. And therefore, when they fail, they should have been allowed to fail. Then there is this bailout where the small business man can’t be bailed out. And while the government did what it had to do in a tough situation, we didn’t want a global meltdown, there seems to be a lack of fairness in how the big banks are treated that they have unfair advantage. When the times are good, they make lots of money, but when times are bad — they don’t fail, they get bailed out.
Forbes: Well, they could not have done what they did, if the government hadn’t done what it did in printing the money or guaranteed the kind of paper that no banker would tolerate. And normally with a mortgage, you put 20% down. The government said 0% down. Well, don’t be surprised you are going to get some problems. Ignore somebody’s income, well that is something that you wouldn’t normally do. So…
MC: But where is the accountability?
Forbes: Well the accountability is…one, the government’s got to do its part. But having created the problem, then don’t compound it. Yes, we had to take emergency measures last fall, but that did not mean that the government had to come up with this too big to fail doctrine, which takes a handful of banks and makes them bigger…guarantees their paper in the marketplace to the disadvantage of somebody else. That’s profoundly wrong.
And there are some who see it. Paul Volker, former head of the Federal Reserve, now in his 80’s said this is ridiculous. This is distorting the system. So no…no too big to fail doctrine. And if that means you are not going to be able to make an acquisition because the government is not going to back stop you then so be it. So yes, the government has made it worse guaranteeing a lot of paper it shouldn’t have guaranteed and continuing to do so. Too big to fail…so if you are a certain size, government’s going to always be there to make sure you are alive. Whereas somebody else who is smaller…well sorry. No, stop it.
It’s like a natural disaster. A hurricane comes along, so you throw in the food, throw in the water, throw in the medicine, throw in the temporary shelter. Then you pull back as people start to get back on they feet. You don’t do it permanently. Well government’s got to pull back on that and too big to fail…is one of the biggest mistakes of this administration is going along with the too big to fail doctrine. No. You’ve got to know if something goes wrong, if the government won’t let the system collapse, but you as an entity will face the music broken up. And if that means creating a special bankruptcy law for financial institutions…You create it. But you don’t say…you’re too big to fail. No way.
MC: Any predictions for 2010?
Forbes: I think we’ll have some growth in 2010, but it is going to be a turbulent year. The dollar I think will be strengthened. Not because Washington suddenly sees the light, but the markets are going to force it. And so it is going to be a better year than 2009. But it should have been a much better year. So if the government immediately stabilized the dollar…oh that would go a long ways. Realizing healthcare with these 2000 page long bills…start over. Try to get some true entrepreneurship where people can create more healthcare.
You know in any other market…if there is a demand. If people want more software, Silicone Valley will turn out more software. Software writers will turn it out. Why can’t you have an environment where you do the same thing in healthcare and make it more affordable? As you did with cell phones. 20 years ago, these things were as big as shoe boxes, clunky. Hard to work. Today they are sleek, small, and everyone has them, even in the furthest reaches of Congo and Haiti…India. People do have their cell phones. So that’s the kind of environment we should encourage.
So 2010, better than 2009, or better than the fall of 2008, but it could be better. Like in sports…it’s like a ball player. Instead of hitting .150 he gets it up to .225. Better, but hey how about .300, .350.

Enough with the search for green shoots. The Financial media is missing the point in its constant banter about green shoots. Yes there are green shoots, brown shoots, verdent pastures and drought-choked fields, but that isn’t the point. It is the landscape that has changed. You won’t see that shift if you are obsessed with a single shoot. Reporting on how the changed landscape affects the flow of commerce in different industries is the real story and the more beneficial one to anyone following the financial news. There are so many new twists and turns to navigate and to project – regulatory, geographical, sovereign, and economic, just to name a few.  Rules change here and elsewhere, economies are better some places than others, some businesses are loving the opportunities presented to them, others won’t exist next year.  Until the coverage dives just a little deeper — we won’t see the landscape for the shoots. – MC

http://business.theatlantic.com/mt-42/mt-tb.cgi/11862

Almost 3 years after my visit to an ethanol plant in Central NY, the plant owners have filed for bankruptcy. The condition of the credit markets for the last six months have been incredibly difficult for many businesses. But the timing may also be a reflection of the political winds shifting in renewables. Promises for better efficiency have yet to materialize to the degree many had hoped in the ethanol business. Despite these setbacks, I would not count ethanol out. Just look for fewer mom and pop shops. Bigger businesses that are better equipped to weather financial and political storms will become the dominant players. 

In 2006 I visited the plant that was gearing up to be the future of fuel. It was an old Miller Brewing plant that had been converted to produce ethanol. It’s investors believed in the near-future they would be producing, not just corn-based ethanol, but something much more important, cellulosic ethanol. Cellulosic ethanol is so much more efficient, because it doesn’t use corn or sugar, it uses the agricultural waste to make fuel. Three years later, it is still not commercially viable. The question is, can it get to market before the ship sails completely on ethanol?

The pressure on the smaller ethanol producers goes beyond the credit markets. The price of corn has squeezed margins. About half the cost of goods sold for distillers comes from the price of corn. At last check corn feedstock was making up about 80% of a distiller’s COG. So it is not surprising that companies like Northeast Biofuels can’t stay in the game. Larger players in the sector are snapping up the bankrupt companies. Sunoco is reportedly purchasing NEB and there have been other deals like Valero’s move to get VeraSun’s assets. They see what the operators of NEB saw, there will be a future at least in the mid-run for ethanol. It may not be today, and corn based-ethanol may not be the long-term solution, but it will have a role to play during the transition period away from oil. The small guys may have been right, but their timing was off. Now the bigger players are buying their expensive assets cheap and can handle the unattractive margins for a longer period of time than the small shops. As you will see in my video report, the cost of getting a plant built is huge in both time and materials. Valero and Sunoco are in a better position to wait for higher ethanol standards to kick in (like raising gasoline blends from E10 to E15).

http://maryandmoney.com/videos/the-future-of-fuel-cellulosic-ethanol/

Out of the ashes of career number one, came the birth of the Vanguard Group and soon after the first Index fund. Index funds mirror market indexes and, therefore, do not need active management, resulting in lower fees. They are commonplace today, but in 1975 they were downright subversive. Bogle told me he was called un-American. Worse, he was laughed at. His critics couldn’t imagine why anyone would settle for average returns. Bogle’s theory is simple; instead of trying to beat the market – be the market. Beating the market over a long time horizon he says is incredibly difficult and something the average fund manger will never be able to do. Turns out he had exactly the right product at the right time. The little $11 million dollar fund blossomed into a $100 billion fund in under 25 years.

All of that is impressive, but it is Bogle’s passion for exposing the laziness and greed of the financial services industry that makes him a legend. High fees are just the beginning of his grievances. Ask him about corporate governance or about shareholders rights and you will really get him going. His books are a great introduction to this smart guy who is not afraid to drain the pool to show the rest of us who is swimming naked in the financial services industry. That willingness to expose the sins of Wall Street hasn’t always made him popular, but it has made him rich. He has done well for himself, by taking a stand that has, ultimately, helped all investors. At the age of 80, he is a beloved figure on Vanguard’s suburban Philadelphia campus. He is often at the office and makes himself accessible to the biggest names in business and journalism and he makes himself available to the not-so-big names. Google his name and read some of the comments of “Bogleheads” if you want to see how his message still resonates with investors 58 years after his first expose.

Happy Birthday Mr. Bogle. I wish you many, many more years doing what you love to do. Continue to give ‘em hell. – Mary Caraccioli

Barry Ritholtz is the CEO of Fusion IQ and prolific writer and blogger (The Big Picture Blog). Barry was one of the few pundits who didn’t buy into the “Golidlocks scenario” (the economy is just right) in 2007 and 2008. At the time that was the mantra on the street. He believes the current strategy of bailing out the banks is wrong. He believes the policies in play now demonstrate a division in the Obama administration. In part-one of my interview he tells me more about that and about what the Fed will have to do concerning interest rates in the months ahead.
Take a look and feel free to comment. Thanks. – Mary Caraccioli

In the last several days there has been increasing news coverage of how the media is blowing the H1N1 Virus (aka Swine Flu) out of proportion. Some have blamed the media for creating hysteria. While I am not ready to make-like-Joe-Biden (no confined spaces) just yet, I do think most businesses and other organizations would be smart to take the H1N1 seriously and make prudent decisions to help keep their employees/members healthy.
Thursday, I attended the GIC’s Monetary and Trade Conference and host David Kotok drew laughter from the crowd when he took the podium wearing a medical face mask. David wasn’t going for the cheap laugh. He actually takes pandemics seriously and with the right dose of charm and information tried to persuade his audience to do the same. He brought in masks for all attendees to take home, explaining how the N95 mask was different from a dust mask (dust masks can’t stop germs and will do nothing to stop the spread of the H1N1). Then he moved on to the business of the conference.
Serendipitously, that same evening I happened to be flipping through the channels on television and stumbled upon the movie Philadelphia (Tom Hanks character fights discrimination against AIDS patients and wins). The movie did such a great job capturing the fear and bigotry surrounding AIDS and those suffering from it. It struck me that David Kotok’s approach to H1N1 was prudent. The lawyers who fired Tom Hank’s Andrew Beckett, on the other hand, were caught up in the hysterics.
There is a third option, when it comes to reacting to the threats to your well being; that is to be smug or cynical and do nothing. We see it all the time during hurricane season. The folks who think only lemmings and losers evacuate to escape the storm.
Just how serious H1N1 will become in the days and weeks ahead is unknowable at this time. But if history has taught us anything, acting prudently, while it has its costs, is often the best course if you want to avoid becoming a victim. This holds true in investing, as well as pandemics.
If you want to know more about David’s message– take a look at his note below.-Mary

Swine Flu Strategy Update
May 3, 2009

Type A, H1N1 “swine flu” responses range from complete complacency to proactive prevention. We see both in the United States and elsewhere in the world. Some of the leading epidemiologists at the Milken Institute Global Conference give this version of flu a 50-50 chance to be a large-scale killer, according to Barron’s journalist, and my good friend, Jim McTague (see Barron’s, page 34, May 4, 2009).

Cumberland is in the “take this seriously and hope we’re wrong” camp. In our market actions we raised a cash reserve last week. This was easier to do after an eight-week, 30% stock market rally. So I guess it’s fair to say that the swine flu timing was opportunistic. Selling and raising cash at 850 on the S&P 500 index at the end of April is a lot easier than selling and raising cash when the S&P 500 is 666 and the date is March 9.

So far, AH1N1 “swine flu” is looking like the SARS outbreak when it comes to economics and market impact. Swine flu (so far), SARS, and avian flu (H5N1) were and are limited to a few thousand worldwide cases that have been documented and confirmed by lab tests. So far, they have triggered deaths counted in the hundreds.

SARS in 2002-3 had a death rate of about 9.5%. Swine flu (so far) has a death rate of about 6.5%. Avian flu has not jumped to an easily transmissible form. It is still a bird disease. It is also a killer. The cumulative 421 cases in the 2003-9 period have a death rate of 61%, according to the confirmed lab tests. Remember, when it comes to flu, the statistics only count those cases in which a certified lab was able to confirm the virus as the cause of death. Epidemiologists believe that there are many unreported cases in third-world countries and emerging economies.

There are three references for big flu shocks.

The first and the most infamous is the 1918-20 period involving the “Spanish flu.” That was also a variety of the H1N1 strain. Global deaths in 1918-20 attributable to that flu are estimated at between 40 and 100 million, or somewhere between 2% and 5% of the total world population. In the US about 25% of the population was infected with “Spanish flu” and about 500-700 thousand died. In 1918 the first outbreak came in the spring and was as small as the current flare-up of H1N1. The real killer phase occurred in the subsequent flu seasons of late 1918-1920.

In the Asian flu episode of 1957-58, the virus form was H2N2. Estimated global deaths were 1 to 1.5 million.

The third reference is the Hong Kong flu of 1968-9. It was the H3N2 strain and had a low death rate but a high infection rate. Globally it killed about 1 million people.

We have no idea how the current H1N1 “swine flu” risk will play out. We do know that media coverage and information flow is heightened, and that is good thing. Sensitizing large segments of the global population induces many to act preventively rather than remain complacent. We hope that it only takes a few deaths for folks to take this seriously. Preventive actions like closing schools, frequent hand washing, and wearing masks all combine to reduce spread of the virus. A race for a “swine flu” vaccine is underway; scientists now compete with the clock which ticks toward autumn flu season.

At Cumberland, we have distributed masks and hand sanitizers to all our staff; we have a flu pandemic contingency plan and have activated it. I wear an N-95 mask in public places like airports and on flights. We practice risk management in the portfolios we manage and in the business life we conduct. And we hope that the outcome will be inconvenience and not something more severe. It will be another year or two before we know the full outcome of this “swine flu.”

Many thanks to our medical friends who must remain anonymous but who confirm the seriousness of the risk. And also thanks to Barclays Capital, Credit Suisse, Wachovia, and Barron’s for data and concept assistance.

David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com

Dr. William Poole, former President of the St. Louis Federal Reserve Bank and target of the famous Jim Cramer diatribe, told me he and others at the Fed absolutely didn’t see the banking crisis coming. He said, “I missed it.” In an unemotional and straightforward discussion he also didn’t rule out the Fed losing its regulatory responsibility for the banking industry. While he stopped short of actually calling for that, he did call for visibility from all regulators. In this interview he offered me his plan for fixing the banking crisis and it is not a call for sweeping regulation. Take a look. Do you agree with the plan? Feel free to comment. Thanks -Mary

Famed investor Jim Rogers explains why he sold his NYC (before real estate prices tumbled there) and moved his family to Singapore. He believes raising his children in Asia will give them the upper hand.