Simple Pound

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A few days ago I added a little gimmick to the sidebar that I thought those of you who are interested in (Personal) Finance would enjoy. Since I assume that most of my readers fall into this category, I hope you will all find it helpful… The new feature I’m talking about is the Library section which gives you an overview of the books I’m reading or have most recently finished.

As I’m going through a tremendous amount of finance-related books these days (in preparation for making a career change), you will find this section updated reasonably frequently. The sidebar gives you a preview of the book I’m currently at while the Library page shows you all the relevant books I’ve read together with a short opinion on how helpful and/or entertaining I thought they were.

All books are linked directly to Amazon should you consider purchasing any one of them.

Now you’re probably wondering why this post is called “Warren Buffet and Institutional Investors” while I spent all my time talking about my new idea. Well… there is an explanation. Since I want to share a particularly good story with you that I have come across in my most recent book, I thought it would make sense to introduce you to the Library along the way. But now it’s time to focus on Warren Buffet’s opinion of Institutional Investors. He quotes the following story in one of his letters to the shareholders of Berkshire Hathaway (his company):

Originally told by Ben Graham in the 1940s, it is still applicable to the markets today and is a wonderful description of the importance of investor sentiment (no matter how unfounded it might be).

A year ago on Simple Pound: What are we tracking? Top 5 indices to invest in

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I read the following anecdote on Wise Bread a few days ago and figured it was so well written and to the point that I needed to help it spread. Let me know what you think!

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.

So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve.

“Since you are all such good customers”, he said, “I’m going to reduce the cost of your daily beer by $20″. Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his “fair share?”

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

“I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man, “but he got $10!”

“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than I!”

“That’s true!!” shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”

“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia

I couldn’t have put it any better!

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I was grocery shopping the other day when the woman in front of me in the queue handed the cashier a piece of paper and got a payout of £100. Lottery ticket – as you might have guessed. I immediately felt the urge to buy some tickets myself to try out my luck, maybe do the unthinkable – get an immediate return from just one random lottery ticket. I resisted.

Most people would surely not consider playing the lottery a sound financial decision as the odds are phenomenally against you. Yet so many people seem to do it regardless and while fully aware of the fact they’re effectively throwing their (hard-earned) money out of the window.

Technically, premium bonds belong to the same category unsound investment you would associate lottery tickets with, nevertheless roughly half the UK owns them. An estimated £36 billion (that’s £36,000,000,000 !) is held in these “investment” vehicles that are guaranteed by the government.

The idea is that you buy a number of bonds of £1 nominal value (minimum £100, maximum £32,000) each of which is entered into a prize draw once a month. Depending on whether you’re lucky or not, you’ll get a cash prize of between £50 and £1,000,000. The catch is there is no guarantee that you will receive any payout whatsoever… so in the worst case, you could be owning £32,000 worth of bonds for years and never see a single pound return on your investment. In the best case you buy 100 bonds tomorrow and win £1,000,000 in the prize draw next month… I’ll leave it to you to work out which scenario is more likely to happen.

But to be honest with you, I’m still thinking about buying a few of those bonds – just to see whether I can win anything. It might not be the wisest thing to do with my cash, but then I already have all of my savings in accounts that earn between 6.30 – 6.76% AER which is quite possibly the highest return you can get in the market at the moment. So why not be just a tiny bit irresponsible?

I guess the moral of the story is that you should always fully understand the investments you pursue and only proceed if you are completely happy to accept the risks that come with it.

If you are considering joining the crowds to put your money to work in a Premium Bond, I strongly suggest you read the following article (twice): Premium Bonds - Are they worth it? If you’re still convinced Premium Bonds are the way forward, I’ll keep my fingers crossed that you’ll experience lots of happy months with decent returns accompanied by the excitement of having “beat the system”.

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I’ve come across a really good comment in the FT the other day and have kept the page on my desk at work every since - with the intention of sharing it with you guys. Due to copyright issues I won’t be able to recite the whole article here (nor would I want to), so I’m just going to quote you the best passages.

The original comment was written by Jonathan Guthrie and was published in the FT on Thursday, January 10th. The heading reads “Three cheers for falling property prices”.

“The assumption that rising house prices are good is deeply embedded in our culture. A belief in witches was too, years ago.”

“We pay a heavy price for the delusional comfort that comes from owning expensive homes, both in loan charges and distorted personal priorities.”

After discussing the amazing property returns we have seen in the UK over the last 12 years (160% on average, 193% in London), he observes the following

“Such inadvertent financial coups confer bragging rights at dinner parties from Barnet to Bromley. Yet the tiramisu-scoffing asset allocators could only realise their swollen capital if they relocated permanently to Barnsley.”

“The main beneficiaries of steep prices are therefore footloose retirers […] fly-by wrinklies too mean to sling younger relatives a few grand towards their own homes.”

He continues to wonder why people could possibly interpret rising house prices as something positive…

“[…] given that disposable income would, all things being equal, rise if mortgage costs fell. More Britons could then afford the ultimate contemporary status symbol, a full tank of petrol.”

…and examines the consequences of such an attitude…

“Television makeover mavens have shown soi-distant developers how to make a packet by tarting up a basement bedsit and advertising it as a garden studio.

Buy-to-let investors have piled into residential property in […] Balkan towns whose names they cannot pronounce.”

And he finally concludes

“My hostility to national property bingo reflects ambivalence at my own commonplace success in it. Like many Britons, my annual capital gains after costs have been equivalent to almost half my salary for no more effort than a little light decorating. But I am no richer as a result, unless I sell up and sleep in a ditch.”

His opinion is so different from the often-recited press view that you instinctively want to disagree with him. However, you come to realise quite quickly that he has an awful lot of perfectly valid points and the more thought you give his argument, the more you’ll see his point.

If you’re intrigued and want to read the whole article, you should still be able to access it here, but I’m not sure whether or not you might need a subscription? In any case, enjoy!

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It has been all over the news since August this year - credit squeeze here, liquidity crisis there. So we certainly can’t claim that we haven’t had enough press and media coverage on the topic, but - if someone walked up to you and asked you to explain the credit crisis to them, would you be able to?

To come to your (and most likely my own) rescue, I luckily discovered a really good video on the FT website that explains this rather complex economic phenomenon in fairly simple, easy to follow animations. It’s definitely a must read/watch if you want to understand how the world’s largest and most stable economies were forced to their knees.

Check it out here. Don’t disregard the suggested further reading either as it will provide you with a deeper understanding of the dependencies between the different players in the market, their role in the crisis and the wider macro-economic impact the current situation is likely to have.

If any questions remain unanswered, you’re welcome to post them in the comments and I will do my best to shed some more light!

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I once again submitted an article to the Personal Finance Carnival (this time hosted at Fatpitchfinancials) and was lucky enough to be published again. I submitted my article on budgeting which also appeared as a guest post at Wellheeled.

I realise this overview is long overdue but the first couple of weeks of work plus the fact that there is so much to see and do in New York City didn’t really leave much time for blogging - at least not if I also wanted to get some sleep…

In any case, here are my personal favourites of this carnival:

• A perfect supplement to my own article, Advanced Personal Finance examines 10 ways to save money in your budget.
• Do you know the richest man on earth? Warren Buffet comes to mind, but Carlos Slim is the man we’re really after. He calls a stunning 67.8 billion dollars his own and his companies account for nearly half of the Mexican stock exchange’s value. Read more here.
• PowerWealth examines what Shakespeare knew about personal finance and asks whether you consume, save, invest or speculate.
• You are a personal finance junkie if you find yourself nodding along while reading My Wealth Builder’s article. And if you’re not a finance junkie yet, I strongly suggest you become one…

After reading the article on Carlos Slim I kept wondering who the richest woman on earth is. Does anyone know? Otherwise I will certainly find out for you!

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