How I beat the market

For my first job out of college, I was hired as a fund manager.

Sort of. I landed an internship with a Protestant denomination as an assistant in their Social and Ethical Responsibility in Investments program. My official title was SER Associate, though around the office I was usually just called "the intern."

Part of the intern's duties was overseeing the denomination's portfolio of what they called alternative investments. This was money invested not just to maximize financial return, but to do good -- money invested where it would help to create jobs or to provide housing in low-income, minority and working-class communities.

Alternative investments were expected to provide a "below-market" return, although I'm not sure the people who used that phrase really understood what they were saying. The real money people mostly viewed the alternative investment portfolio as a kind of charitable write-off.

Basically, though, this portfolio was a tiny, symbolic fraction of the denomination's pension funds -- about $1.6 million -- in very safe, low-risk, low-return investments. Mostly, we're talking CDs. Certificates of deposit with minority-owned and community-based banks and S&Ls. Certificates of deposit with community development credit unions. With the exception of a $100,000 or so in various community development loan funds, it was all fully insured and required minimal oversight. That's why it didn't matter that the intern was a 22-year-old English major -- the portfolio mostly managed itself.

Most of the work I did managing this portfolio was more related to the alternative side of things than to the investment side. We had dozens of 1-year CDs at community-based banks all over the country. As those CDs neared the end of that term, I would contact the banks, requesting their latest CRA statement -- the legally required report documenting their reinvestment and loans in their communities as per the Community Reinvestment Act. I would also contact the pastors and board members of our churches in those communities to glean what their experience had been with the bank and to hear their take on its work and reputation in their communities. When we got a good report from those local church folks, we'd renew the CD. If we got a particularly glowing report, we'd put more money there.

This was the job, and the particular task, that resulted in It's a Wonderful Life being my favorite movie of all time, because I soon realized that the Bailey Bros. Building & Loan wasn't purely a myth invented by Frank Capra. These institutions really do exist and sometimes they really are the only thing preventing Bedford Falls from turning into Potterville. And there are hundreds of them -- still, even with all the tournament-bracket style consolidation going on in the banking industry.

These institutions take deposits and pay their depositors a modest rate. In turn, they loan that money out at a similarly modest rate. Their returns are lower than what you might see elsewhere, but so are their risks. They are tortoises, not hares. They seek out new loans not by blanketing the city in direct mail solicitations, but by planting and nurturing the habits and disciplines of saving and responsible borrowing within their own community.

To give you a sense of what I'm talking about, consider one piece of the alternative investment portfolio we had invested in the Pittsburgh-based Dwelling House Savings & Loan. We didn't have a CD with Dwelling House because Robert R. Lavelle -- Dwelling House's real-life version of George Bailey -- didn't fully trust that kind of flashy investment vehicle. So we had to get a passbook savings account there. It paid, if I remember correctly, 3.1 percent.

But here's the thing -- and here's why the intern was able to beat the market -- that passbook savings account at Dwelling House Savings & Loan was always going to pay around 3.1 percent. Never much more, but never much less either.

Some years that might not sound like much, but in 1991, when I was the intern, the bulk of the denomination's Wall Street investments lost money. So that 3.1 percent -- and the 4.5 percent over all from the rest of the alternative investments portfolio -- was looking pretty good. Thanks to George Bailey, the intern beat the markets.

Today's investment climate makes 1991 look like a Golden Age. In times like these, the safe, boring, modest returns paid by these simple deposits in these simple community-based banks don't look quite so boring or so modest. And "safe" sounds almost sexy.

Ironically, after the subprime mortgage crisis and the cascade of financial crises that followed it, investing in housing loans for working-class people looks more attractive than ever. These days, "alternative investments" seem like a pretty smart alternative.

Comments

[Spherical Time]

You know, that's one of the big problems I have with savings with my current banks: It doesn't seem like there are a lot of places where I can put money where I understand the mechanism of savings. Maybe I need to look for "Passbook savings accounts."

(I don't really need investment advice though guys, I'm confused enough already. Thanks though.)

The worst part is that recent events have made it obvious to me that one of the things that drives the market is the confidence. Not of investors, per se, but of the people the drive the markets. The worst part is, these people don't seem to have any sort of realistic outlook on the markets or money. For far too long they were insanely over optimistic and now they're completely pessimistic. These people, who run the banks and should have some basic economics under their belts, should understand (and should have understood) that infinite growth is impossible and every "correction" or fall in the market is not the end of the world.

So they need billions to restore their "confidence" and then blow the money on CEO bonuses and $4 million dollar Christmas parties.

The people that lead our companies seem to have fallen to the least common denominator, which perhaps is what is damaging the confidence of the little people that are investing.

[dewde]

That was fascinating. And refreshing.

peace|dewde

[Dylan]

I had a friend who recently got into stocks, and convinced me to do so too. (In theory, it's a good time to get in, assuming that it's gone as low as it's going to go.) Like Spherical Time said, the more I learn about stocks, the more surprised I am that we actually have a working economy. There's so many weird ways of buying and selling stock he's read about (options, margins, shorting, etc.) that I don't completely understand. I can't fully wrap my head around how they work, and what I do get sounds a lot like gambling to me.

The more I look at the market, the more I'm convinced I just need to take out a CD rather than leaving money in savings or investing it in stocks/funds. (I like to play it safe.) And while I thought about shopping around, this post makes me wonder if I shouldn't just get one from my current bank. It's a local bank centered in my hometown--although where I'm living now, the nearest branch is about 20 minutes away. I know at least one person who works there. I don't know that it would meet the SER criteria of community involvement that Fred talked about, but at the very least they aren't advertising loans through direct mail like he describes. (Of course, going there rather than shopping for a few more percentage points also requires less work on my part, so my motives wouldn't be entirely altruistic.)

[cjmr's husband]

I <3 my credit union.

[Alex R]

Fred and readers might appreciate this story from Newsweek about "ethical" subprime lenders -- banks that really take the time to work with less affluent borrowers and lend them money that other banks might not. Apparently, these banks have been *more* profitable than the industry as a whole lately, and might include some of the same banks where you were putting your CDs.

[Edward Liu]

I work on Wall Street, and the first rule of investment I've always lived by is that if you don't understand how the math works on an investment, then you shouldn't do it. Interest-bearing bank accounts, buying stock positions, mortgages, and CDs -- all these things I understand. I don't even understand home equity loans and why I would want one, despite the many banks telling me I need one. The one thing I really understand about options and warrants and a lot of the other fun things that can be done with money is that you can lose a whole lot very quickly if you bet wrong, and if I'm going to do that, I'd rather go to Vegas with friends and play blackjack. At least that's kind of fun instead of nerve-wracking.

If your math stinks, then don't trust your investment advisors, bankers, or anyone else to do the math for you. And get better at math.

Dylan: Confidence does drive markets as much as anything else because markets are made of people and people don't always act rationally. This is the secret that no Wall Street analyst ever wants to admit or talk about or account for because it's unpredictable, and therefore easier to ignore than to try and deal with. When Greenspan got up in front of Congress and looked surprised at the state of the economy, my interpretation of what he said was, "Wow! Who knew people could be stupid, greedy, and stupid AND greedy when lots of money is at stake?"

[hapax]

I've read a lot trying to understand the most recent Wall Street debacle, and this (via Making Light) is one of the best I've read.

It's long, but it's worth it, both because it gets at the heart of the insanity behind the recent collapse, and is a fascinating character study in its own right. Some commenter called it "a world-building exercise for a financial science fiction novel" (or words to that effect), and I heartily concur.

Right now, I'm sinking all my money into educating my children. That's the best investment I can think of. (But I still feel wistful about the log flume)

[J]

*There's so many weird ways of buying and selling stock he's read about (options, margins, shorting, etc.) that I don't completely understand. I can't fully wrap my head around how they work, and what I do get sounds a lot like gambling to me.*

With regard to the ones you mentioned, Options, margins, shorting, the good advice is Don't, Don't and Don't.

[JRoth]

Mr. Lavelle is just as wonderful as Fred's thumbnail would suggest - I was working with a group of sixth graders on a community newspaper, and he happily bought half-page ads to support us, as well as talking to the kids about saving.

A lifelong Republican (he is a banker, after all), he switched affiliations to be able to vote for Obama in the primary this year.

[J]

Anyway, this is why I'm filled with optimism right now because we're really through the political looking glass--literally *through*, as it we've passed through it and now it's behind us. Maybe I'm concluding too much but it seems like people have suddenly realized that Democrats are really the family values people insofar as they actual form functioning families, that Democrats are the prosperity people insofar as they make and are careful with money rather than spending and losing it and that Democrats are the strong-security people insofar as they're able to end wars rather than just start them.

The very word "conservative" right now is like a pair of underpants whose elastic waistband got snagged over the spindle in the washing machine and got comically stretched out during the cycle so that you can't even wear them anymore. My local bank didn't do the thing that 'conservatives' were doing the past 10 years (i.e. they DIDN'T bug-eyedly, mouth-pantingly chase after quick money, limbs akimbo, silk ties flapping behind them), but rather made loans to teachers, college professors and other economic 'losers'. Was this 'liberal' or was this 'conservative'? Both and neither.

Maybe I'm stretching (like the aforementioned underpants, maybe?) but I see a link between my conservative liberal bank and the various gay and lesbian couples I know, all of whom are solid citizens and as loyal as dachshunds, whereas any number of my straight, religious extended family are busy with implosions of their second or third marriages (I have one pair of cousins who've married and divorced *each other* three times; I shit you not), or are AWOL from the U.S. Navy, or have moved back in with mom'n'dad after the gig as a house-flipper went sour.

[Lila]

J, amen to the "family values" comment. Contrast the McCains' demeanor towards each other with the Obamas'. Of course there are successful and failed relationships on both sides of the divide, but it pisses me off (as a liberal who's been married for 28 years to the man I fell in love with as a teenager) when the other guys claim all the good stuff is exclusively theirs.

[Caravelle]

Dylan: Confidence does drive markets as much as anything else because markets are made of people and people don't always act rationally.

I don't know that much about markets, but it seemed to me the issue of confidence in markets wasn't because people don't act rationally, but because they act self-interestedly.
As I understand it, if bad news goes around about a stock or the market in general the price is likely to drop because people don't want to own bad stock that's going to lose value. And the more people sell, the more the price drops. It's a bit like a Prisoner's Dilemma with everybody else, with a twist : if you keep the stock when everybody sells you're screwed, but if you keep the stock and everybody else does the same you don't necessarily get the best outcome : the rumors might be founded, something might happen to make those stocks lose value. So selling really isn't irrational.

Am I totally wrong about this ?

[Daughter]

Off-topic, but related to your November 11 post, "Someday, Some Way": have you seen the new item offered by the American Family Association? https://store.afa.net/pc-10000310-11-christmas-cross.aspx

[Thalia]

So they need billions to restore their "confidence" and then blow the money on CEO bonuses and $4 million dollar Christmas parties.

I don't pretend to have a clue about half this stuff, but every time I hear about $x,000... parties, I think of all the waiters and cooks I know who need those jobs, so one day, I think, maybe I can figure out how stuff gets wasted....

[cjmr's husband]

I'd certainly rather see more of the bailout money spent on Christmas parties and less on CEO bonuses.

It depends on the party, I suppose. If the money is going to waiters and cooks, fine. But how much on the expensive imported wine? (Not much, we're talking about wall street, more of the money is going to more illicit imported recreational substances)

But then, what do I know, my company cancelled the Christmas parties this year.

[drakepope]

I'd certainly rather see more of the bailout money spent on Christmas parties and less on CEO bonuses.

I'd certainly rather see more of the bailout money spent on ACTUALLY BAILING OUT CORPORATIONS! YOU KNOW, WHAT THE MONEY WAS ACTUALLY APPROPRIATED FOR! GODDAMN IT, WHAT IS WRONG WITH THESE UNBELIEVABLE STUPID BASTARDS? WHAT THE FUCK ARE YOU PARTYING FOR? YOU FUCKED UP! YOU FUCKED THE ECONOMY, YOU FUCKED UP PEOPLE'S JOBS, YOU DID MORE TO DRAG THIS COUNTRY INTO A RECESSION THAN GODDAMN AL QAEDA! PUT DOWN THE FUCKING BONGS, GET OUT OF THE FUCKING HOT TUBS, AND DO YOUR GODDAMN JOBS!!!

In all seriousness, I love how they're not even trying to pretend as if they're going to change and improve their business practices in the future. Now that they have the money (with no oversight, might I add!) they're just going to make the same bad choices and the same stupid, savage, cruel decisions unless we stop them and tear them apart and let new capitalists and new entrepreneurs improve.

[Spherical Time]

Edward Liu: Confidence does drive markets as much as anything else because markets are made of people and people don't always act rationally.

You know, the funny thing is that it isn't the little people that were panicking. Why are the people with economics degrees panicking, when they know that panicking (or at least acting like they are panicking) is what will cause the disaster.

This shouldn't be a binary problem. It isn't either "economic utopia, let's go make bad investments!" or "the world is ending, don't lend money to anyone ever!" There should have been a middle ground, and it pisses me off to see billions of dollars going to people that weren't even smart enough to find it.

To cjmr's husband and drakepope, I'd rather see the money go to neither bonuses or parties because, as drakepope mentions, the money wasn't supposed to be for that sort of thing. However, if it was one or the other, I'd rather see it go for the Christmas parties.

[drakepope]

To cjmr's husband and drakepope, I'd rather see the money go to neither bonuses or parties because, as drakepope mentions, the money wasn't supposed to be for that sort of thing. However, if it was one or the other, I'd rather see it go for the Christmas parties.

Okay fine, I agree with you, but only in the same sense that if I HAD TO pick between using the money for crystal meth or using the money for child porn I'd probably pick crystal meth. Both options make me angry, but I can sort of deal with the first one.

[Spalanzani]

J:"i.e. they DIDN'T bug-eyedly, mouth-pantingly chase after quick money, limbs akimbo, silk ties flapping behind them"

Wait, how do you run with limbs akimbo?

[MercuryBlue]

akimbo: adjective 1. (used of arms and legs) bent outward with the joint away from the body; "a tailor sitting with legs akimbo"; "stood with arms akimbo"

With your hands on your hips and elbows outward, I assume.

[Spalanzani]

That's a weird mental image. And what about the legs? How would you run with your legs like that?

[Jon P]

With regard to the ones you mentioned, Options, margins, shorting, the good advice is Don't, Don't and Don't.

I'm a math guy, and in college, some of my friends tried to get me into, essentially the stock market club, specifically the group that does financial derivatives like options, figuring my math skills would supplement their market knowledge and we'd make money. The club was disorganized, so nothing came of it, but I could never understand what the hell was actually being bought and sold.

My parents recently retired and are now doing some options trading (or something like that). Every now and then, they attempt to explain to me how it works. I've adopted my sister's standard response:
Dad: If Stock X goes up past 40, we exercise our options, and make money. If it goes down, we use our stop limits, and don't lose money. (or something like that)
Sister: I have a bank account. It goes up.

[Reynard]

Posted by Daughter: have you seen the new item offered by the American Family Association?

Well, it's really no worse than most of the other Christmas kitsch that you can find at your local Big-Box store -- but an $85+ "donation"??? Heck, I could probably *make* something like that out of a string of lights and a plastic, cross-shaped funerary floral frame for about 1/5th of that.

Posted by cjmr's husband: But then, what do I know, my company cancelled the Christmas parties this year.

For the employees, maybe; but what makes you think that they aren't going to have a "Suits Only" party on the sly?* As stupid as they sometimes are, MBAs can be tricky bastards.

*I remember reading about this happening a number of years (pre-Google) ago, but unfortunately I can't find any specific examples.

[jamoche]

Most of the other Christmas kitsch doesn't look like it's burning!

[Amaryllis]

Good lord-- don't these people know the implications of a burning cross?

But then, this is their notion of a "hate crime:"
A retired Christian couple were subjected to an 80-minute interrogation by police after the couple made a polite complaint to their local council about its 'gay rights' policies, which included making pro-homosexual literature avialable in public buildings.

It could happen to YOU.
(Spelling as in the original.)

[Jenny Islander]

I also heart my credit union. If you don't expect to have $10,000 in checking ever in your life, if you think people who put up their houses as collateral for a vacation in Boca are crazy, if you are sick of being treated like a second-class citizen because your money is in the bank instead of in bank stock . . . find a credit union.

[cjmr]

One of these days I'm going to actually run that spreadsheet and see if we'd have had more money now had we invested that IRA in CDs at the credit union at 6% interest than doing what the financial advisor advised us to do with it in May 2000.

I think we would have beaten the market, even with the run back up that it's now crashing from.

[Consumer Unit 5012]

I have some money in a 401k from a previous job, and they send me quarterly balance notices.

As of late, it's been going DOWN every quarter.

Explain to me why hiding the money under my mattress is a BAD idea, again?

[Nick Kiddle]

Explain to me why hiding the money under my mattress is a BAD idea, again?

It's apparently the first place a burglar looks. You're much better off investing in an underfloor safe.