Sunday, March 4, 2012

Managing a Tiny Hedge Fund

Kit and I nearly broke even financially in our bakery and vegetable business last year. Or, as the IRS would define it, our “hobby.” We DID learn a lot. We can produce and sell excellent products at a good price. However, to make a major profit we would need to increase production 100X by capitalization of machinery and land improvement. At my age of 61, I don’t think that we could spread those costs over enough years to justify the risk. Plus, I doubt that we could sell 100X product, certainly not in the Saturday market. We plan to continue and even expand our “hobby”, maybe even contribute to our livelihood. But, to pay our major bills, we need to develop other sources of income.

A creative and sustainable life requires using what you have. When I was an engineer in the 1980s and 90s, we diligently saved through IRAs and a 401K plan. Creatively making a sustainable profit on these savings, our tiny hedge fund, is now a necessity. My natural inclination would be just to buy CDs and index funds. Unfortunately, interest paid on CDs is close to 0% right now. And index funds haven’t done much better since 1999. Finally, according to Money Magazine, 79% of professional fund managers failed to do as well as the indexes last year. Therefore, necessity has thrust us into the world of investing. Surprisingly, the effort has drawn on my analytical engineering skills and been a bit of fun.

Before the 2008 stock market meltdown, I had smelled trouble coming. Studying at least 50 books on investing, financial management, and economics taught me something. For any silly thing you want to do with your money, there is an investment “expert” out there to tell you “It’s a smart move.” Usually, the “expert” is selling his services to help you do the silly better. It is interesting to read the pre 2008 books where “experts”, the same ones still giving advice, encouraged people to take advantage of adjustable rate mortgages. “Housing values always go up.” They promised. Some “experts” on TV told invertors to “Buy more stocks.” just as the meltdown began.

Since 2008, I’ve diligently continued studying finances, especially 100’s of hours last winter. The best attitude to take is the 1930’s adage, “Nobody knows nothin’.” In this spirit, good financial advisers follow “Managed portfolio theory”. By this plan, individuals own investments in categories, which should respond oppositely in a crisis, for example generally stocks and government securities. Thereby a crisis should not completely destroy an investor’s resources. Remembering that investment “experts” and professionals aren’t always reliable, the problem is in the selection of the specific investments. Adding to the difficulty, the economy has unprecedented challenges. Government debt, loss of our manufacturing competitiveness, and worldwide shortage of resources will mean that the economy and investments will not respond in the future the way they have previously. In this environment, every investment is based on an expectation of an uncertain future. Therefore, if anybody’s interested, following are Drew’s economic predictions regardless of which party wins the 2012 election.

.1. The US economy in spite of dramatic ups and downs and a few exceptional stocks will stumble along for the foreseeable future. The days of general growth on which so many investment strategies are based are over.

.2. The tax code provisions for capital gains and dividend exclusions for most earners will remain in place for the foreseeable future. (An interesting note: Traditional IRAs are fully taxable when withdrawn. Many of us who invested in IRAs in the 1980s and 90s, could have been better off by paying the tax rates then and paying the current capital gains on the profits now.)

.3. The Federal Reserve will maintain low interest rates for the foreseeable future. They have indicated until at least 2014.

.4. Inflation remains a major long term, although not immediate, threat.

.5. A major reduction in both stock and bond prices will eventually occur (Ask Greece about this.) and will hit the "growth" stocks hardest. Dividend and interest income, if established wisely, should remain more stable.

.6. Energy cost will certainly trend higher long term.

Using this projection, we have purchased dividend stocks, energy, and REITs to cover our minimal budget plus TIPS bonds and gold to balance them long term. If you have insightful ideas, we would love to hear them.

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