Don’t Panic!

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Understanding how your investment transactions affect the market.

I really didn’t think a post like this was necessary, but after speaking with two different people about portfolio management in these troubled economic times, I realized that the average investor doesn’t have a clue about what a mutual fund is and how it works.

A Transfer is not Just a Transfer

Conversation One went like this:

Him: I’m thinking about transferring my Fidelity balances to bonds or t-bills.

Me: Don’t sell when the market is low.

Him: I’m not selling. Fidelity has bond and t-bill funds. I’m just transferring. When the market starts coming back, I’ll transfer back.

Conversation Two was remarkably similar:

Her: This week, I transfered all my mutual funds to a money market account.

Me: You sold your mutual funds? Now? When the market is in the toilet?

Her: No, I didn’t sell them. I just transferred them from one Putnam account to another. When the stock market starts going back up, I’ll just transfer the money back.

What followed was my attempt to explain that the “transfer” was, in reality, the sale of one mutual fund for the purchase of another. In both instances, my loved ones — yes, they are both related to me — were selling shares in a mostly stock-based mutual fund that had taken a beating with the Dow’s plunge and using the meager proceeds to invest in a different mutual fund based on less volatile (or more conservative) investment types with the same investment firm.

They didn’t see it this way because they mistakenly think that they are invested in the investment company: Fidelity, Putnam, Janus, Dreyfus, etc. They don’t understand that each mutual fund really consists of huge investments in regular publicly traded companies like GM, Washington Mutual, AIG, and countless other firms that have yet to hit the news. When they sell shares of a mutual fund that includes investments in, for example, GM, they are effectively selling GM stock. If everyone is selling, the price goes down.

Panic Feeding the Decline

Clearly, investors are the ones causing the stock market decline. Their panic sales are what’s driving down the prices, thus feeding the panic. The worse the prices get, the more people panic. Every one who cashes out — even by transferring stock based mutual funds to money market funds — is making the situation worse.

Take, for example, GM. On october 12, 2007, its shares were selling for $42.64 each. Although share prices declined slowly throughout the year, the panic of this past week really hit home. On Friday, GM shares closed at $4.89. You can see the decline in this chart:

GM.jpg

Let’s look at the reality of this. According to market valuation of GM stock, GM lost nearly 89% of its value in a year. What happened? Did a UFO hover over a few GM plants and suck them into the sky, leaving a gaping hole? Did GM inventory get spirited away by pixies in the middle of the night? Were all of GM’s cash reserves shredded for some kid’s hamster cage? Were GMs huge asset investments in equipment scrapped for their recycling value?

Of course not. GM’s company value is not just 11% of what it was this time last year. While the original stock price may have been inflated — I can’t say because I’m not an analyst and have not studied GM’s financial statements — there’s no way in hell that the company can be worth a tenth of what it was twelve months ago.

But do investors believe that GM’s total value has declined by 89% in a year? I don’t think so. I believe they’re just panicking, trying desperately to save their finances by cutting their losses. They’re running — screaming that the sky is falling — away from stocks and the declining mutual funds that are based upon their values. As a result, they’re causing much of the mayhem.

More About Mutual Funds

My personal portfolio has declined in value by at least 40% in the past year. I can’t tell you the exact amount. I haven’t looked since Monday. I’m afraid to.

My portfolio includes my retirement funds. And yes, most of them are mutual funds. Most of them were doing very well — one was posting consistent gains of 25% a year and had doubled in value in five years. Like most Americans, I’m a lazy investor. Why do all my homework to handpick investments and then watch them from day to day when an investment firm has experts who can do that for me?

But at least I have an idea of what’s in my mutual funds. Fund names often have a clue. For example an S&P 500 fund is directly tied to the securities that make up the S&P 500. If the S&P 500 goes down 5 points, so does my fund. Pretty simple, right? Another fund name might include the words “Small Market Cap.” That fund is invested in stocks of small market capitalization companies.

Let’s say, for example, that Maria’s Big Cap Fund includes investments in 10 stocks named A – J. (In reality, it would likely include investments in far more securities, but this is a simple example.) Let’s also say that 1 share of Maria’s Big Cap Fund consists of one share each of companies A – J. When I sell a share of Maria’s Big Cap Fund, I’m selling 10 shares of stock — one each in companies A – J. If I have 500 shares of Maria’s Big Cap Fund and I “transfer” my investment to Maria’s Great Money Market Fund, I’m really selling 500 shares each of companies A – J and buying the equivalent dollar value investment in a money market.

Now say that Maria’s Big Cap Fund is really popular and there are 50,000,000 shares of it held with investors. As those investors panic and “transfer” or sell their shares in Maria’s Big Cap Fund, they’re really selling lots and lots of stock. As stock is unloaded in bulk, its value decreases. As value decreases, its price goes down.

This is part of what’s making the stock market so screwed up right now.

No Loss Until Sold

But what’s worse is that many investors are unnecessarily taking losses on their investments. They bought at one price and, as prices drop, they may be selling at a lower (or much lower) price. That’s a loss.

But if they held onto their investments and didn’t sell (or “transfer”), they wouldn’t have a loss — at least not yet. Sure, it would look horrible on their account statements or in Quicken or on whatever online service they might use to track investment value. But until the stock is sold, there is no loss.

I need to say that again, in some different words for those who might not have understood the previous words:

If you do not sell your stock, you do not lose any money.

You can argue this all day long but you will not win. A loss is only on paper until the sale is made. Paper losses aren’t worth the paper they’re printed on. (Pun intended.)

Remember “Black Monday” in 1987? At the time, it was the largest one-day percentage decline in stock market history. Remember when the dot-com bubble burst? Wikipedia even has an exact date for it: March 10, 2000. How about the market right after September 11, 2001? These are just three examples of disaster in the stock market.

But guess what? In each case, the market rebounded. Sure, a bunch of companies were shaken out of existence — primarily after about 50% of the dot-com startups were revealed to be based on ideas that couldn’t generate enough revenue to warrant their market values. But the market that emerged after these disasters was stronger. Values for most “good investments” came back.

I’ve been actively investing in the stock market, through both individual stock purchases via an online brokerage firm and mutual funds. As I mentioned earlier, my entire retirement portfolio is in a variety of diversified mutual funds. I survived as an investor through the dot-com bubble burst — my investments recovered their value within two years. And I fully expect to survive as an investor from the current market madness.

Why? Because I’m not going to sell.

I’m lucky, in a way. Although I’m not a kid, I’m still 15 years away from minimum retirement age. I have time to let my portfolio recover.

Not everyone is that lucky. Some people are just getting ready to retire. Other people — like my mm and stepdad — are already retired and tapping into that investment nest egg to meet their financial needs every day. These people are pretty much screwed — unless the stock market rebounds in a hurry.

And the stock market simply won’t rebound if everyone panics and keeps selling.

Hurricane Norbert

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Too weird for words.

You might think that Norbert is a pretty unusual name. In this country, it is. But it’s also the name of my father and brother. In the tiny NJ town where I spent many of my early years, there were four Norberts — two pairs of fathers and sons — among the 2,000 or so residents.

But that’s not what I’m blogging about. I’m blogging about Hurricane Norbert, which is currently off the west coast of Mexico, heading north. It’s a hurricane with the same name as my brother.

What’s weird is that the previous Pacific hurricane was named Marie, which is pretty darn close to my name.

Okay, you’re saying. That’s an interesting coincidence. But it’s not exactly your name so it really isn’t worth blogging about.

True. But an earlier Atlantic hurricane this season was named Laura. That’s exactly my sister’s name.

So you tell me: what are the chances of three named hurricanes, all happening one after the other, being named almost exactly for all three of the kids in a single family?

Too weird for words.

Team Earth

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I really don’t understand.

I like to think that I’m a “citizen of the world.” To me, that means that I feel that I (and my country) should be a team player on Team Earth.

Team Earth is the team that works together for the benefit of our world. When we see a crisis looming — global warming comes to mind — we work together to try to prevent it. When we see drought in one part of the world causing mass starvation, we step in with funds and technology to help the victims. When we see genocide killing off huge ethic groups in a country or region, we take action against the murderers.

The players on Team Earth do what’s right for the world. They don’t do just what will benefit themselves, especially at the expense of others.

So I can’t understand it when I hear the comments of some Americans — especially those living the good life — when they talk about “bombing the hell” out of one country, stealing the oil of another country, and ignoring the serious problems of yet another country.

I can’t understand why people would rather set up oil rigs in a pristine wilderness to provide just 5% of our country’s current oil use in 2020 or beyond when they could be spending the same money developing alternative energy sources that don’t destroy the planet — or simply act responsibly to reduce their consumption of fossil fuels. (Do we really need to commute to work in vehicles like Hummers?”)

I can’t understand why people who have health plans (today) are so opposed to a universal health care system that would protect those who are less fortunate from financial ruin in the event of a catastrophic health problem.

I can’t understand why any American — other than a very wealthy one — would support a candidate who would give a taxpayer earning more than $2.9 million per year a $269,000 tax cut (on top of the tax cuts already handed out by G.W. Bush) while cutting the taxes of folks making less than $19K by less than $20 — all while the government is funding an expensive War in Iraq and bailing out financial institutions. (The numbers are summarized here, and here’s a video for those who struggle with tables of numbers.

I know I’m not the only player on Team Earth. But am I the only American player on the team?

Grounded by the Light

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How the failure of a $42.50 part can result in $3,000 in lost revenue.

It was Friday morning and, for a change, I was running early. I had to pick up a passenger in Scottsdale for a day trip to the Grand Canyon. It would be my first Phoenix-area charter for the 2008/2009 winter season. I was due at Scottsdale Airport, about 40 air minutes away, at 9 AM; it was 7:40 AM.

The helicopter was on a west end helipad at Wickenburg Municipal Airport (E25). I started the engine, engaged the clutch, and brought the engine up to 55% RPM while the clutch belts grabbed at the upper sheave, turned the drive shaft, and began spinning the rotor blades. I started unfolding my Phoenix sectional chart to jot down the frequencies for the airports I’d be flying near or to.

That’s when I noticed that the Governor light was on. I looked at the governor switch on the end of the collective. The governor was turned on. But the illuminated light said it was turned off.

I toggled the switch. No change.

I pulled the circuit breaker, waited a moment, and then pushed it back in. No change.

Damn.

I disengaged the clutch, let the rotor RPM wind down for the prerequisite 30 seconds, and pulled fuel mixture to shut down the engine.

About the R44 Governor

For those of you who don’t know what a helicopter governor is, here’s the short explanation.

When you fly a helicopter, you pull the collective lever up to increase the pitch of all rotor blades and climb. As you increase pitch, drag on the blades also increases. To keep the blades spinning at full RPM, you need to increase the throttle. The same is true, but in reverse, when you lower the collective to decrease pitch.

In the old days, the pilot had to coordinate the increase or decrease of collective with the increase or decrease in throttle as he flew. This greatly increases the pilot’s workload. Some modern helicopters still require this attention to the throttle. But most modern helicopters have what’s called a governor. This is an electronic device that automatically adjusts the throttle as needed to keep RPM in the green arc. On a Robinson helicopter, you can actually feel the governor at work sometimes as it twists the throttle while you’re holding its grip.

In the early days of Robinson helicopters, before there was a governor, a lot of pilots were getting themselves into deadly trouble by not keeping the RPM high enough for flight. Robinson introduced the governor and made it required for flight.

If you have a governor failure in flight, you can turn it off and manually adjust the throttle to maintain proper RPM. This happened to me once and it wasn’t a big deal. But, at the same time, if you have a governor failure before you take off, you can’t take off. It’s required for flight. (And yes, you can get a ferry permit to fly the helicopter to a mechanic, if necessary, to make the repair.)

So here I was, with a governor light on, telling me that the governor was not working properly. I was not able to fly until I resolved the problem.

Intermittency

Did you ever notice that a mechanical problem never manifests itself when a mechanic is around to observe it?

I fetched Ed, my Wickenburg mechanic, along with my parts manual. (Unfortunately, the maintenance manual was still up in Page.) Together, we went back to the helicopter to look at the situation.

I flicked on the master switch. The governor light remained off — as it should with the governor turned on.

Damn!

We got the Robinson factory tech support guy on the phone. Ed spoke to him; it made no sense for me to be in the middle of the conversation. When he hung up, we went through the motions of checking to see if the governor was still functioning.

Ed removed the panel behind the front passenger seat where the governor is installed. Everything looked good. We raised and lowered the collective. Everything seemed to be running fine. Then I started up the engine while Ed watched the governor in action. I warmed up, then brought the RPMs up to 80%. The governor, as designed, began twisting the throttle to bring the RPMs up to the top of the green arc on the tachometer. The light remained off.

So the governor seemed to be functioning fine.

I shut down and Ed looked under the instrument panel where a relay that controlled the light was located. It looked fine — no loose wires, no signs of burning or melting. Everything looked perfectly functional.

Now I was in a quandary. The governor and its light were working fine, so I was legal to fly. But what if I got up to the Grand Canyon with my passenger and the light came on again? We’d be stuck up there. That would be a bad thing.

I decided to fly down to Scottsdale as planned. If I had no trouble on the way down there, I’d do the flight to the Grand Canyon. But if I had a problem on my way down or when I got down there, I’d cancel the flight.

The Best Laid Plans…

With the plan laid and everything buttoned back up, I prepared to leave again. An hour had passed; I’d called the client and warned him I’d be late, explaining exactly why. I climbed back into the helicopter, buckled up, and began my startup procedure.

The light came on as soon as I flicked the master switch. Of course, Ed wasn’t around to see it.

Damn!

Now I knew I wasn’t going to fly to Scottsdale or the Grand Canyon that day. But I still needed an answer to one question: was the governor functioning even with the indicator light on?

I ran up the helicopter to 80% RPM. The governor took over and brought it smoothly to the top of the green arc. The governor was still working.

Troubleshooting and Doing the Math

At this point, I had a full summary of information for troubleshooting: The governor light was intermittently going on when it shouldn’t. The governor was working fine, even when the light was on. (Remember, light on is supposed to mean governor off.)

After shutting down and calling the client to cancel, I called Robinson’s tech support again and spoke to the same guy. I told him the symptoms. He said the only thing that could possibly cause the problem was a bad relay under the instrument panel.

I ordered a new one. It cost $42.50 plus shipping. Installation would be another hour or so at $75/hour, but would not happen until Monday at the earliest.

So I had to cancel my Grand Canyon charter that day and my appearance to do helicopter rides at Old Congress Days the following day. I also had to turn down a Phoenix Area tour on Sunday. In all, I figure I lost about $3,000 in revenue.

All for a failed $42.50 part.

The Rules

Now some of you might be saying, it’s not the governor that failed. It’s just the light. You should be able to fly.

Others might be suggesting that I just disconnect the damn light. (Three people in Wickenburg actually did suggest that.)

But I play by the rules. I’ve got too much time and money in my helicopter operations to risk losing my Part 135 certificate or pilot license for breaking the rules.

The rule I was worried about that day was my Part 135 requirements. Because I don’t have a minimum equipment list (MEL) I cannot legally fly my helicopter on any Part 135 flight with any part of the helicopter not functioning. A charter to the Grand Canyon would be a Part 135 flight. Clearly, a broken light would preclude me from flying that mission.

You could argue that I’d still be able to do the helicopter rides at Old Congress Days. After all, they were not Part 135 operations. They were part 91 (or 136). You could argue that the functionality of the light didn’t matter since the light is not required for flight. The governor is what’s required and it still worked fine.

I could agree, but I decided not to take the chance. Doing helicopter rides is not an easy job — especially at Congress’s confined space helipad. Flight after flight, I’m taking off and landing heavy, concentrating on clearing the short chain link fence and taller mesquite trees, keeping an eye out for trains (don’t ask), and dealing with the distractions of passengers. My work load is heavy enough without having to worry about whether the governor light can warn me about a governor failure. I decided it just wasn’t worth the risk.

I just don’t believe in taking unnecessary chances.

Writing Tips: Master the Basics

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If there’s only one thing you do before starting a career as a writer, this is it.

Today, I’m doing a presentation for Wickenburg High School’s Journalism class. I suspect that they’re a bunch of seniors who are interested in journalism or some other branch of writing. Although I’m not a journalist, I feel qualified to speak to them about careers in writing. And since being asked to do this presentation, I’ve been giving the topics I want to discuss a lot of thought.

The Basics

The best piece of advice I can offer anyone considering a career in writing is to master the basics. I mean that quite literally: master the basics of writing. This includes the following:

  • Spelling. Yes, I know that there are spelling checkers in word processors — and even blog offline composition tools like the one I’m using to write this. And no, I’m not saying that you need to know how to spell every word you might ever write absolutely perfectly. But I am saying that you need basic spelling skills. This will help ensure that you don’t misspell a word that spells another word (and, thus, won’t be caught by a spelling checker) or use the wrong word (then instead of than, your instead of you’re, etc.).
  • Want more tips about grammar?
    Read “Grammar is Important“

    Grammar. Again, perfect grammar isn’t an absolute requirement, but a writer’s grammar should certainly be much better than average. Don’t use the grammar checker in a word processor — if you need to rely on that, you may as well give up on any idea of being a writer. The best way to learn grammar is to read and study good writing. I’m not talking about Dickens here. And I’m certainly not talking about blogs. I’m talking about The New York Times, NewsWeek, and other quality publications that are written and edited by professionals. Don’t get the idea that grammar rules are meant to be broken so they don’t matter. You need to learn the rules before you can break them.

  • Punctuation. This goes with grammar. Punctuation is pretty easy. If you can’t master it, you’re not going to impress many editors.
  • Style. Here’s where things start drifting away from what you can learn in basic English classes. Every writer should be able to develop his or her own style or voice. This is something that comes with practice — I don’t think it can be taught. Style includes vocabulary and word usage, as well as the rhythm of your sentences and paragraphs. I believe that the only way a writer can develop his or her own style is by writing and then rewriting. A lot. Every day. Once you’ve got your own style, you should be able to go the next step, which is to emulate (okay, copy) someone else’s style. In fact, a good writer should be able to write in whatever style he or she is called upon to write in.

Here’s the deal. If you try to start a career as a writer and you haven’t mastered the basics, there isn’t much of a chance of you getting a job as a writer. No editor is going to want to deal with submitted work that is fraught with basic writing errors. It’ll take too long to edit.

And if you expect to be a freelance writer, your chances of getting published are slim if you can’t submit an error-free manuscript.

It doesn’t matter what kind of writing you want to do — newspaper journalist, technical writer, advertising copywriter, short story author, novelist. If you can’t write, you’re not going to get work as a writer. It’s as simple as that.

A Story with a Point

And to finish this piece off, I’ll tell you — and that high school class — a true story. Back in 1978, when I started college, English 101 and 102 were freshman year requirements. These two courses took what we supposedly learned in high school to the next level.

I wasn’t very interested in taking English — I wanted to take a creative writing class instead. Fortunately, my college offered a way out. I could write an essay about a topic of interest to me and submit that for evaluation. if the essay was good enough, I wouldn’t have to take either freshman English class.

I wrote the essay. It was about how high school fails to prepare young people for life. I was 17 at the time — please don’t do the math — and already thinking about these things. The essay was a hit. I was exempted from freshman English.

This story has a point. Before I got to college, I had already developed above average writing skills. This served me well throughout high school and college — I aced almost every report and essay test question, mostly because I already knew how to organize and present my thoughts in writing far better than most other students.

These are the kinds of skills every writer needs to develop before beginning a writing career. If you want to be a writer, master the basics now.