The Stock Part of Your Portfolio

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 This is the last of a three-part posting on portfolio construction.  The first explained general decisions, what financial professionals refer to as asset allocation.  The second in the series focused on bond holdings.  Here I focus on stocks.

Good diversification is the first consideration.  Your portfolio ought to hold stocks from many types of businesses.  In that way, unexpected disruptions in one sector of the economy will not hurt your overall wealth too much, while at the same time, you will gain by having holdings in an industry that experiences unexpected good fortune.  A fully diversified portfolio would hold stocks in industries in proportion to the economy’s overall industrial mix or, more conveniently, the mix of a prominent stock index.  Should you anticipate good or bad news in a particular industry, you might put more or less in that industry, but no matter how convinced you are about such information, you should still retain holdings elsewhere to cope with the inevitable, unexpected developments.

Portfolio managers use all sorts of industry breakdowns.  Here, with a word or two on each, is the 12-sector breakdown used by the Global Industry Classification Standard (GICS):

  1. Consumer staples: Including food, soap, cosmetics, and similar companies, this sector tends to offer stable businesses whose sales remain relatively steady in good times and bad.
  2. Consumer durables: This sector is dominated by the stocks of companies that make things people tend to use over long periods of time, such as autos, appliances, and furniture.  Such stocks tend to suffer more than others in hard times because it is easier for people to postpone purchases.  They usually recover faster as the economy improves.
  3. Industrials: Companies in this area produce machinery, chemicals, metals, and basically anything used in the production of other things.  For the same reasons as consumer durables, these businesses tend to suffer more than most in hard times and catch up more in recoveries.
  4. Materials: This sector includes stocks of companies that mine, produce lumber, and the like.  Their stocks are even more sensitive to economic swings than industrials, in part because the prices of their products swing in sympathy with gains and losses in sales.
  5. Technology: These stocks are less sensitive to overall economic swings, but they are highly vulnerable to innovation, which can make the stock of a successful innovator soar and that of a competitor crash. Hype and unpredictability are watchwords here.
  6. Utilities: This is possibly the most stable sector. These companies see little variation in their sales except in extreme circumstances and are regulated to give them an acceptable profit.  They have limited growth potentials but usually offer relatively high dividend flows. Because the dividend is so much a part of their appeal, they are said to behave more like bonds than stocks.
  7. Transportation: Including airlines, railroads, trucking, and the like, these stocks — especially airlines — are sensitive to the business cycle and fuel prices.  Their volatility offers considerable potential for gain matched by considerable risk.
  8. Energy: It should come as no surprise that this area rises and falls with the price of oil.  When prices are high, companies that support drilling and exploration thrive along with the oil companies themselves.  High oil prices also place a premium on alternative energy sources like wind and solar. Of course, things work in the opposite direction when oil prices fall.
  9. Finance: Banks, insurers, brokers, investment banks, money managers all have sensitivity to financial conditions and tend to rise when interest rates fall and fall when they rise.  These stocks also move in sympathy to financial markets generally.  These days, stocks in this area have become especially sensitive to legislation and government regulation.
  10. Healthcare: Because it’s a universal need, these stocks combine the stability of utilities (hospitals and medical groups) with the innovation sensitivity of technology (drug companies and medical suppliers).  This industry, too, has become highly sensitive to legislation and government regulation.
  11. Real Estate: Despite the name, these stocks are more related to construction, not location and property.  They are, as a consequence, sensitive to the economic cycle and the impact of financial conditions on mortgage borrowing.
  12. Telecommunications: These stocks are very similar to utilities with the added special sensitivity to innovation so evident in the technology area.

In addition to diversifying your portfolio among industries, it is also important to consider these two additional stock tradeoffs:

  1. Growth vs. Value: Growth stocks, as their name implies, typically grow their earnings faster than others.  When you buy them, you are effectively betting that the relatively rapid growth will continue and the stock’s price will appreciate in tandem.  Because growth companies use their earnings to increase their productive capacities, they typically pay a low or no dividend.  Value stocks, in contrast, are those that may be growing slowly (though not necessarily) and seem to have been overlooked by the market, allowing you to buy them cheaper than a fair assessment — say from the dividend discount equation — would otherwise warrant.  Buying them is effectively a bet that the market will wake up to what it has missed and re-price the stocks up to where they should be.  Because they are priced cheaply, they may well pay a higher dividend as a percent of their price.
  2. Large vs. small:Because larger companies are better established in their segment of the economy, they tend to grow at a slower pace than smaller companies which, for obvious reasons, have more to gain as they establish themselves.  In hard times, larger firms are less volatile, but over time, the stocks of smaller companies tend to outperform those of larger ones.  Because these smaller companies go out of business more often than larger ones, it is especially important that your holdings are thoroughly diversified.

Picking Stocks

 Individual stock selections aim to feed the best possible holdings into the industry diversification and the mix of growth/value, large/small.  Here are four basic ways that stock pickers use to evaluate which stocks are the best possible holdings:

  1. Look for earnings after tax to lie along an uptrend, not simply overall earnings but the earnings for each share of stock, earnings per share in financial jargon. This information is readily available online from various investor services or in each company’s quarterly and annual reports.
  2. Look for increasing dividends. If a company is willing to pay out an increased dividend for each rise in earnings per share, it could indicate that management sees these earnings as secure. A rapidly growing firm, however, might break this rule, having need of the additional earnings to increase its productive capacities.  Company annual reports or broker reports should make this distinction clear.
  3. See that there are enough outstanding shares to ensure that there are always buyers and sellers in the market to accommodate your buying and selling needs, what financial professionals refer to as liquidity. Ten million shares outstanding can serve as a reasonable benchmark.  Less than this number could make a stock difficult to sell quickly.  Some illiquid holdings in your portfolio may have enough other attractions to recommend them, but too many illiquid holdings will create a dangerous inflexibility. Even with attractive names, you should always look for more liquidity.
  4. Seek lower price-earnings (P/E) ratios.  This is a simple division of the stock’s price by the most recent earnings per share. It tells you how much you are paying for those earnings and so is a quick way to determine how expensive one stock is compared to another.  All else equal, the lower the P/E ratio the better.

A Last Word

 There are a number of ways to achieve the diversifications required of a good stock portfolio of which more in later posts.  Even with the most thorough diversification across industries, growth orientation, and size, and so the most stable of stock portfolios, there is no getting away from the inherent volatility of stocks.  They are no place for an investor who will need to draw on the money in less than five years.

The Bond Part of Your Portfolio

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The last post explained general decisions in creating a portfolio, what financial professionals call asset allocation.  This post focuses on the bonds in the portfolio.

Bond decisions focus on two main considerations, maturity risk and credit risk.

Maturity Risk

 This is the tradeoff between yield and the term to maturity of the bonds. Long-maturity bonds tend to pay higher yields than short-maturity bonds, but their prices are also more sensitive to movements in interest rates, falling as they go up and rising as rates fall. (See the box in this post for a more complete discussion.)  Unless you have strong convictions on the future direction of interest rates (always a problematic prospect) you should aim to balance the higher current yield of longer-maturity bonds against the risk of a price decline should rates rise.

Hint:  Be aware that some bonds have a call provision that permits the bond issuer to call the bond back before it runs its full term to maturity.  If interest rates fall below levels that prevailed when the bond was initially sold, the issuer may decide to borrow anew at a lower interest cost and use the money to call back your holding.  You would get your money back and the interest due you to the date of the call, but you would lose the benefit of having a long-maturity bond appreciating in a falling rate environment.

Credit Risk

 As we mentioned in an earlier post, there is always a chance that the bond issuer will go bankrupt and fail to meet its obligations.  The greater this risk, the higher yield the bond pays, but you must decide, based on your life cycle/life style needs, how much of this risk you are willing to assume. Even if there is no bankruptcy, the prices of bonds with a greater risk might suffer on bad economic news.  With this trade-off in mind, we can identify three basic types of bonds:

  1. Treasuries: These are the obligations of the federal government.  They are issued in different maturities and carry the same maturity risk as all bonds, but they never have call provisions.  Because they are considered entirely secure credits, they generally offer lower yields than other bonds.
  2. Investment grade corporate bonds: These are issued by companies with strong finances. All else being equal, they generally pay a higher yield than U.S. treasuries.  There is only a small chance that they might have problems meeting their obligations. Credit rating agencies (of which more in a later post) show this risk on a relative scale.  (See the box at the end of this post.)  Investment-grade bonds have little risk that they will fail to pay the holder all they owe.  But they do have maturity risk, and many have call provisions.
  3. Junk bonds: Despite their colorful name, such bonds can play an important role in a portfolio.  Because they either have low credit ratings or none at all, they are considered more vulnerable to failure than other bonds and accordingly pay higher yields than other bonds of comparable maturity.  As with all bonds, these also carry maturity risk and often have call provisions.

Municipal Bonds

 This is a fourth type of bond that doesn’t fit neatly into any of these categories.  “Municipals” or “munis” are issued by states, cities, and other municipalities.  Their appeal is largely because their interest earnings are exempt from federal income tax as well as from state tax for the state in which they were issued.  Because of that break, they generally pay lower yields than bonds on which interest earnings are subject to tax.

Hint: Except in rare circumstances, the only reason to buy municipal bonds is for the tax break.  If you have a combined tax rate of less than 25-30 percent, you shouldn’t consider them.  The tax break you would enjoy would not compensate you for accepting the lower yield munis pay.

If your tax situation warrants buying them, be aware that municipal bonds are otherwise much like other bonds.  They carry more maturity risk at longer maturities and accordingly pay higher yields at longer maturities.  Their credit ratings can vary from good down to junk status, depending on past behavior and the finances of the issuing municipality.  As with other bonds, the less credit-worthy bonds tend to pay higher yields.  Many munis carry call provisions.  Municipal bonds come in three types:

  1. General Obligation Bonds (GOs): These are the safest because the full taxing authority of the issuer backs them.  They finance roads, schools, and other government projects.  They remain exempt from tax as long as no more than 10 percent of the money raised by them goes to finance a private enterprise, not pay for its services.
  2. Revenue Bonds: These pay from the income earned by a specific project or government agency, for instance the tolls from a road or a publically financed operation such as a hospital, a stadium, or convention center.
  3. Industrial Development Bonds: These bonds finance the construction of facilities that are then leased to a private corporation.  Their tax-exempt status follows the same rules as GOs.

A Last Word

 Remembering the necessity of  diversification explained in the last post, the object here is not to settle on one bond or type of bond but to construct the bond portion of your portfolio with a variety of bonds that, when combined, both diversify your bond risk and meet your specific needs.










Bond Ratings


Moody’s   S&P
Aaa Best Possible AAA
Aa1 High Grade AA+
A1 Higher Medium Grade A+
Baa1 Lower Medium Grade BBB+
Ba1 Non-Investment Grade BB+
Ba2 Speculative BB
B1 Highly Speculative B+
Caa1 Significant Risk CCC+
buildingC Near Default CCC-
D In Default D





Tailoring a Portfolio

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This post and the next two are devoted to constructing an investment portfolio.  This first post takes up broad divisions – the mix of cash, stocks, and bonds — what professional investors refer to as asset allocation. The next post will focus on the portfolio’s bond assets and the third will discuss its stock assets.

Typically, a broker’s portfolio report begins with the overall amounts you have in cash, in stocks, and in bonds.  The report then gets into intricate detail, listing all the bonds, who issued each, the original “coupon” rate as a percent of the bond’s face amount, and its maturity date.  (See this earlier post for an explanation of these terms.) The broker’s report will probably also show how much you paid for each bond, its current value, and perhaps the interest payments you earned from it since the last report.  A comparable listing of the stocks in your portfolio will show the name of the issuing corporation, the number of shares you own, what you paid for them, their current value, and possibly dividend payments since the last report.

While these reports are useful to brokers, bankers, and accountants, portfolio managers look at holdings more broadly to consider how they can achieve two key objectives for you:

  1. Good diversification: An effort to avoid having too many eggs, meaning dollars, in one basket, that is too many of one security or type of security. If you could always pick the best, you would not need to diversify.  But perfect foresight is impossible, so spreading your wealth among different types of stocks and bonds will protect the portfolio from setbacks by ensuring that its different parts respond to events in different ways.  Such diversification of exposure allows your portfolio to secure the most gain with the least amount of risk.
  2. Serving the specific goals of the investor: Are your portfolio’s assets meant to provide retirement income?  To buy a vacation home? Or to pay for a newborn child’s college education? These and other long-term objectives will determine what sorts of stocks and bonds your portfolio should hold and how it should mix the types of securities to get the greatest prospective return for the least risk.

So think of the stocks and bonds in the portfolio not necessarily as individual holdings but rather as the best possible representatives of the sort of security that serves these basic aims.

There is no perfect mix.  Your right combination will depend heavily on your particular circumstances and preferences — what many in the investment business term your life-cycle/life-style situation.  Some people cope better than others with risk and occasional loses.  Those more suited to a riskier life style feel comfortable reaching for gains in a more volatile portfolio.  The mix you choose should also reflect where you are in your life cycle.  Young people investing for retirement, for example, will not need the money for years, so they can take more risk to earn greater returns than can older investors who are approaching the end of their working lives and have less opportunity to make up for an investment loss or time to wait for a market rebound after a setback.

Portfolios need to reflect such differences.  Young people, who will not need the money for years, particularly risk-takers, may want few or no bonds in their portfolios. They may want to concentrate on stocks, particularly smaller, less established stocks, because these, though more volatile than other investments, tend over time to gain more than bonds and more conservative stocks.  To be sure, stocks generally and particularly those of less established companies may suffer severe occasional reverses.  But as a group they eventually always come back.  An investor with a long time horizon can count on that recovery.  Someone older, with less opportunity to wait out a temporary setback, may want more bonds and stable, dividend-paying stocks. Retirees, who are already living off investment income, may also prefer bonds and dividend-paying stocks because they also tend to generate more immediate income than less established stocks.

There are many ways to combine stocks and bonds to meet portfolio goals. The aim is to learn their characteristics and create a good investment fit for your critical needs.  The next post will explain the role of bonds and the one following will do the same with stocks.


When You Read the Financial Pages

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Many readers have asked me about sources of information — newspapers, TV, radio, and web newsletters, to name some.  These can offer the investor invaluable guidance. They all enable you to keep up with events as well as the buzz in the investment community.  When reading, watching, or listening you should keep four questions in mind:

  • Does this information affect my holdings?
  • How does it affect them?
  • Does the information require action on my part?
  • If so, what action?

You should aim to stay current with the media every day and from as many sources as you can without driving yourself crazy or detracting from your other important obligations.

Some sources are better than others.  Here are ten especially popular sources with my comments on each:

  1. The Wall Street Journal ( appears daily except Sunday, in print and on-line. It offers excellent U.S. coverage, but its international news is less complete than a global investor would want.  The Journal’s writers do a good job of separating news from editorial, and the editorial pages frequently do a fine job of analyzing the news and government as well as corporate policy, but always remember to allow for the paper’s pro-business bias.
  2. The Financial Times ( appears daily except Sunday, in print and on-line. It offers excellent news coverage, though it sacrifices depth on its U.S. reporting for superb global scope.  The FT has a more liberal editorial bias (in the American sense) than the Journal and offers some fine analysis.  It does a good job of separating news from editorial.
  3. The New York Times ( appears daily, seven days a week, in print and on-line. It once rivaled the Journal for U.S. business, economic, and financial coverage but in recent years has slipped in this regard.  The Times makes less effort than either the Journal or the FT to separate news from its editorial bias, which is most definitely liberal.
  4. Reuters ( and Yahoo Finance ( update their content continually on the web and are picked up by many other media outlets. These sources offer thorough, unbiased, and succinct reporting on all developments, domestic and foreign, but provide no analysis.
  5. Barron’s ( appears weekly, in print and on-line. It offers a cursory review of the prior week’s developments, mostly in the U.S., and also highly useful, in-depth analyses of specific subjects of financial interest.
  6. The Economist ( appears weekly, in print and on-line. It offers a comprehensive look at global economic, business, and financial developments, including the U.S.  It also does a good job of analyzing economic policies and their underlying causes.  It editorial bias is strongly free-market.
  7. Bloomberg ( updates continually on the web. It offers good news coverage and a lot of analytical and explanatory material. Its many contributing writers have varied editorial prejudices.
  8. Investopedia ( updates continually on the web. It offers thorough explanations of investment questions as well as analyses of economic and business developments.  It has a North American bias but also offers considerable global coverage.  Like Bloomberg, its many contributing writers have various editorial biases.
  9. Forbes ( appears weekly in print and updates continually on-line. It, like Barron’s, offers a concise review of the previous week’s news and in-depth financial as well as business articles, especially but not exclusively focused on the U.S.  Its strongly free-market editorial bias is evident throughout.
  10. Broadcasts, whether on television, the web, or radio, can help keep you keep up with the news, but because this is a fast-moving medium, they frequently fail to offer the depth necessary to make even simple investment decisions.

A Warning and Some Further Guidance

 Even with the highest quality news sources, the media tends to exaggerate the importance of whatever is happening at the moment, frequently at the expense of useful perspective.  Why? Because all writers want you to read their articles, so they make their subject appear urgent and pivotal.  Also, media are in the business of selling advertising, and by making their subject seem urgent, they keep you reading, ensuring that your eyes are exposed to as many ads as possible.

Here is an illustrative example.  Once a month the Department of Commerce reports on the construction of new housing units. For a number of reasons, these monthly numbers are extremely volatile.  An investor with related holdings might try to discern trends by averaging out the pattern of growth or decline over several months and take each particular month’s leaps and dives as just one piece of the picture.  But journalists have little interest in presenting the latest information in this way. They generally, want to create drama, even if it contributes little to overall understanding.

The investor must then peel away a good deal before safely extracting usable investment insight from an article or broadcast.  This might involve five steps:

  1. Distinguish between the journalist’s tendency to sensationalize and any real-world significance of a particular news item.
  2. Be aware of editorial bias that might slant how the news is reported.
  3. After you have allowed for bias, use what remains to think about how much of the news was expected and therefore already built into asset prices.
  4. If the news contains nothing surprising, then no action is required.  If it contains a significant surprise, you must judge its likely impact on prices.
  5. From that you must determine whether it warrants a buy, sell, or hold decision.

You can now see that hours of following financial news does not often require an immediate phone call to your broker, although you may learn enough to keep your eye on a developing trend.



Other Ways to Buy and Sell Stocks and Bonds

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The last post explained buying and selling stocks and bonds through brokers.  Now I will look at other popular ways to put your investment dollars to work through online services, direct purchases, mutual funds, and registered investment advisors (RIAs).

Online Services

More firms now offer ways for you to trade stocks and bonds with a click of the mouse.  Some are connected with long-established brokers; others are only online.  Many offer you tools to help. Mostly these tools process information.  With them you can organize your thinking, but none can offer the key ingredient of any investment decision: judgment in the face of uncertainty.  These firms typically make their money from trading fees that are sometimes lower than full-service brokers and sometimes even lower than discount brokers.  Some fees are set as a flat amount per trade instead of a percentage of the total value of stocks or bonds traded.  The drawback of online brokers: like discount brokers, they offer no advice beyond their online information management systems.  Many limit the choice of securities you can buy and often do not trade bonds or have severe limitations on what sorts of bonds you can trade.

Direct Purchases

You can also buy securities directly from some issuers.  The U.S. Treasury offers a way to buy bonds in addition to the savings bonds mentioned in an earlier post. There are no fees, and you can buy online through Treasury Directat This system does not enable you to sell your treasury bonds back to the government.  Should you need to sell, you would have to transfer the bonds into a brokerage account and use that broker’s services.  Nor does Treasury Direct give you a full accounting of your holdings.

Some larger companies allow you for a small fee to buy their stock issues directly. These arrangements may also offer direct reinvestment plans (DRIPs) wherein you can buy additional stock by reinvesting the dividends paid on your existing holdings.  Some of these purchase programs may even offer a discount from the market purchase price, sometimes as much as 3 to 5 percent.  You can find out about these from the company’s website.  Each company has its own rules about how many shares you must buy initially.  If you already own some of that company’s shares, they usually offer a way for you to transfer them into the plan.  All these direct plans have ways for you to sell back your shares, usually only at set intervals determined by the company.  For a complete list of companies that offer DRIPs and their terms see

Mutual Funds

 These are a popular, efficient, and usually cost-effective way to invest in stocks and bonds (and sometimes more exotic financial instruments of which more in a later post).  Mutual funds enable you to employ professional management services at relatively little expense and with relatively little in assets.  They do not substitute for a broker.  Rather, they hire a broker to put through the trades the funds make on your behalf.

Mutual funds effectively offer you a share of a professionally managed portfolio of stocks or bonds, sometimes both.  They spare you the need to do any trading on your own.  For this service, and of course their investment expertise, they charge fees, including a small or fractional percentage of the value of your holdings.  Funds come in four varieties:

  1. No Load Funds: You buy these directly from the fund company, which charges nothing to buy into the fund, but does charge a management fee, a small percentage of the amount they hold for you.  (There may be other fees as well: see the box at the end of this post.)  Most brokers will not buy these funds for you, though many full-service brokers will provide custody and accounting for those you have bought for yourself.
  2. Load Funds: In addition to management fees, as in no-load funds, these also charge a fee when you buy into or out of the fund. The fees are levied in various ways. (See the box at the end of this post.) Load funds claim superior performance to justify these expenses, though many studies show little performance difference between load and no-load mutual funds.  You can only buy load funds through brokers.
  3. Closed-End Funds: The two kinds of mutual funds I just discussed are called open ended.  They buy and sell stocks and/or bonds, and their size, called net asset value (NAV), expands and contracts according to the market value of all their holdings.  In contrast to the previous two, closed-end funds manage a portfolio of securities that then trades on the market just like the stocks of corporations.  Think of it as buying a share in a highly specialized investment company, but one in which you have no voting rights.  The value of these shares can rise and fall, sometimes exceeding and sometimes falling below the market value of their holdings.  These, too, can only be bought or sold through a broker.
  4. Exchange-Traded Funds (ETFs): These are a subcategory of closed-end funds. They are established on the stock exchanges and based on a particular investment style or sector — energy stocks, for instance, or small companies or a segment of a market index or an entire market index.  They, too, are bought and sold only through brokers.  Some online brokers specialize in ETFs.  These specialists can offer a discount in trading because they recieve fees from the issuers of the ETFs.

Registered Investment Advisors (RIAs)

RIAs are independent teams of investment professionals whom you can hire to invest your funds.  They communicate frequently with their clients to explain what they are doing and why.  They usually impose relatively high minimum investment amounts and relatively high fees for what amounts to a personalized service.  They have to work through brokers to buy and sell for you, and you pay the brokerage costs.  RIAs are best suited to people with large pools of assets with either complicated investment needs or complex administrative and ownership structures.


Mutual funds have many different styles, some aggressive, some more conservative, and many different investment objectives.  Some funds specialize in bonds, some in stocks, some in combinations of the two.  Some seek income, while others stress price appreciation.  Some focus on small stocks, some on large stocks, some on growth, some on value.  Some have an aggressive approach, some a cautious one, and some a passive structure. (More on these distinctions in coming posts.)  Some specialize in sectors or industries.  Others specialize in different sorts of bonds, such as junk, municipals, high-grade credits.  A complete list would go on for pages.  Deciding what is right for you takes study and hard thinking about your risk tolerances and your needs.  One could build an entire portfolio out of specialized funds.  By contrast, RIAs generally take a broader approach.  Deciding which to use depends in large part on whether they are flexible enough and responsive enough to fit your needs.

Your choice of a mutual fund or RIA should depend on three criteria:

  1. How well its objectives fit yours.
  2. How well it accomplishes its goals, the performance of the fund relative to other funds and the index of stocks or bonds that best matches its objectives, or as financial people would say, it benchmarks itself.
  3. What fees it charges (to see whether the performance can justify the cost.)

With mutual funds, all this information — including their style, limitations, objectives, emphases, and performance — is available in the prospectus they are required by law to make available to you.  With RIAs, judgments on flexibility and levels of service rest with you, but otherwise they should provide you with an audited record of their investment track record so you can decide if they are worth their fees.  It is not just how well they do in absolute terms. Because all investment portfolios are built around different objectives and levels of aggressiveness, all performance must be benchmarked against portfolios with similar mixes of objectives and risk levels.  (More on these important considerations in a later post.)


Load Mutual Fund Expenses:

  • Front-End Load: You pay a sales commission when you buy the fund.  These fees can range widely, and you would be well advised to find out what they are before you buy.  Your broker can inform you, as can the fund’s prospectus or the mutual fund company’s website.  Such mutual funds usually charge less if you buy larger quantities.  The industry calls these points of difference break points.
  • Back-End Load: In lieu of a sales commission, these charge a fee if you sell before a specific period, usually some number of years. The fund company frequently waives this fee if you change to another one of their funds.  Back-end fees are less popular today than they once were.
  • Redemption Fee: This is a fee to discourage frequent trading and is charged, in addition to other fees, when you sell, typically if you do so in less than a year after purchase.
  • 12b-1 Fees: Named after the section of the federal law that allows these fees, these are charged to you to pay for some of the fund company’s sales and advertising expenses.  These, too, can range widely.
  • Fund companies charge fees for different classes of holdings. Check to see which fees apply to you.




How to Buy Stocks and Bonds

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Although TV and Hollywood paint Wall Street as chaotic and mysterious, buying and selling stocks and bonds is really straightforward.  In the age of the Internet, buying and selling has become especially user friendly.  Because most investors use brokers, this post will concentrate on them: later posts will deal with alternatives.

How Brokers Work 

Brokers have many advantages.  Because they have membership on the organized exchanges where stocks trade, they are well placed to act quickly and effectively.  And because of their web of associations, brokers can easily navigate the complexities of bond trading for their clients.  Bonds generally do not trade on organized exchanges.  Instead, in what are called principal transactions, a seller, for instance, offers the bond through a broker to an investment bank, which, after settling on a price, takes ownership of the bond and then finds a more permanent buyer.  As a brokerage client, however, you don’t have this bother.  You simply tell your broker what to do, the broker comes back with a price, and you either agree or reject the trade.

Selecting a Broker

Choose a broker in much the same way you choose a bank. (See this earlier post.)  Most people get recommendations of family or friends.  Your boss, accountant, or banker might offer suggestions.  The Internet can offer guidance, too.  A good place to start is with the Financial Industry Regulatory Authority (FINRA) website, Once you have a list of potential brokers, talk to them or go on line to research the following:

  1. Find out what account size the broker requires.  A high minimum may not be right for you.
  2. Ask for references.  If a broker refuses, that is a bad sign.
  3. How long has the broker been a broker?  It’s a plus if the broker practiced during a difficult market environment, such as 2008-09.
  4. Ask the broker for ideas on how to invest your portfolio.  If the broker responds by questioning you, that indicates that he or she is sensitive to your needs. You can then judge if the broker’s response is appropriate, even if it is not quite what you have considered.  Beware if you get an answer filled with references to hot stocks of the day: it suggests an effort to impress you without much regard for your needs.

Setting Up an Account

 Once you decide on a broker, establishing an account is easy and costs nothing up front.  The broker will need to determine that you are who you say you are and get your personal information, including social security number (for tax purposes).  Post 9/11 laws put to prevent money laundering have made this process more elaborate than it once was, but it remains straightforward.  The broker should ask about the following: the size of your assets, how long you have been an investor, what your objectives are, and what is your tolerance for risk.  Though this may seem intrusive, it is necessary so that the broker can serve you better, for instance, to make recommendations and to warn you when you contemplate an action that the broker feels might conflict with your general goals and preferences.

Types of Accounts

 Once your account is established, the broker will report to you regularly and almost certainly give you online access to review your holdings.  The broker will not only trade at your direction, but will also take custody of the assets you have bought and sold through these trades: the ownership remains yours.  This custody arrangement enables the broker to keep track of the securities, their associated cash flows, dividend and interest payments, and tax reporting.

Brokers are compensated mainly by charging, as a fee, a small percent of the total amount traded each time you buy or sell a stock. With bonds, brokers are paid because the price they bid to buy the bond for themselves is slightly lower than the price they ask when they then sell it to you.  This is called the bid-ask spread.  These fees or spreads are usually a fraction of a one percent of the amount involved in the trade.  So-called discount brokers charge lower fees but provide less comprehensive service.  Brokerage is a highly competitive business and fees remain relatively low with all brokers, certainly lower than they were some years ago.  Still, the expense should encourage you to keep your trading to a minimum.  (There are tax consequences, too, of which more in a coming post.)  There are basically four different sorts of accounts:

  1. Directed Account: (Some brokers call this by a different name.) Such an account effectively leaves all decisions up to you.  You direct the broker on all sells and buys.  Each action incurs a fee.  Full service brokers will offer advice based on their insight and research as well as on the strategy of their firm.  You can take the advice or not.
  2. Discretionary Account: Here, you authorize the broker to buy and sell for you at the  broker’s discretion.  (Discount brokers seldom offer this arrangement.)  Your broker will rely mostly on his or her firm’s research.   Before you begin such an arrangement, you should set out clear guidelines — you can always withdraw this permission or modify specific decisions.  Here, too, you pay a fee for each trade.
  3. “Account Fee Arrangements”: This is what I call such accounts. (They have many different names).  These accounts bill you based on the overall size of your assets but allow you to trade as much as you like without a fee.  Account fee arrangements are best suited to those who, for one reason or another, want to trade frequently.
  4. Margin Account: This arrangement, which can co-exist with any other account structure, enables you to buy securities on credit. The law stipulates how much you have to put down on each transaction and sets rules on the interest you pay on the borrowed portion of your purchase.  If the value of a security bought on margin drops, the broker may ask you for additional funds  (a “margin call”) because the security you have effectively pledged to ensure repayment is now worth less than when you originally pledged it.  Laws govern how margin calls (words investors usually say with a shudder) are handled.  Many tax-advantaged accounts, such as IRAs and 401(k) arrangements forbid margin purchases.

For many investors, especially small investors, mutual funds provide an easy, less costly way to put their money to work in stocks and bonds.  My next post will deal with these and other ways to get your investment dollars to work.


Other Alternatives for Savings

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I have used other posts to describe several alternatives for the saver.  In one, I focused on commercial banks, in another on savings banks and credit unions, and a third post on investment clubs.  Here I offer yet another option: U.S. government savings bonds. This post also includes a note on on-line banking.

U.S. Government Savings Bonds

Savings bonds are about as safe an investment as exists.  They guarantee repayment plus interest at a set future date. You can also redeem these bonds, including the accrued interest, before the stated maturity date. Called Series EE bonds, they pay a rate that the Treasury sets each May and November. Once you have bought the bond, that rate is guaranteed for its stated term — up to 30 years on some bonds.

Savings bonds are sold at a discount.”  This does not mean a special low price, but rather that the bond sells at a substantially lower price than the repayment amount to account for all the interest it will accrue over its term to maturity.  Unlike savings accounts at banks or credit unions, which pay interest out at regular intervals over time, the earnings on savings bonds come in one lump sum when the bond matures.  For example, you may buy a $50 bond for only $25.  The $50 the Treasury gives you at maturity repays you your original $25 plus all the interest earned on it during the time that the Treasury held the money. The Treasury sells bonds of various maturities in denominations of $50, $100, $200, $500, and $1,000.

At one time, you could buy paper savings bonds at banks for no fee.  You got a piece of heavy, elaborately printed paper indicating the amount due to you at maturity.  The bank also registered you as a holder with the U.S. Treasury.  But now, for the sake of economy and security, the Treasury sells EE savings bonds directly to the purchaser though its “TreasuryDirect” program: the entire transaction is electronic.  Holders of paper bonds can transfer them to their digital counterpart free through the Treasury’s “SmartExchange” program.  You can learn more about these programs, including the prevailing rate the government pays on savings bonds, on the Treasury’s website, There you can also learn about the Treasury’s inflation-indexed savings bonds, called I-bonds.  Unlike EE-bonds, these come with a guarantee they will keep up with inflation.

Here are some of the tradeoffs between savings bonds and the other savings options we have already discussed:

  • The rate of interest is similar to that of a savings account, either at a commercial bank, savings banks, or credit union. If anything, EE-savings bonds offer a marginally lower rate because they are so safe.
  • The fixed interest rate to maturity can cut two ways. On the positive side, you know exactly what you are getting.  Should market rates fall, you will continue to earn at the original stated rate.  With other accounts, the rate goes up and down — “floats” in financial jargon — depending on variations in Federal Reserve policy and financial markets.  On the negative side, the savings bond will only pay you the stated interest rate even if interest rates rise, whereas the rates paid by a savings account will eventually float up to where market interest rates are.
  • Liquidity is limited. You can get back your money on EE-bonds or I-bonds before maturity, including accrued interest, but doing so is a lot less convenient than having an account at a savings bank, credit union, or commercial bank, especially one that has a network of ATMs.
  • Government savings bonds have tax advantages that savings accounts don’t.  The interest earnings on them are free of state and local income taxes.  You must pay federal income tax on the income from the bonds, but you can elect to defer the tax bill until the bonds mature.  Government savings bonds also have tax advantages if you use them to pay for a child’s education.  If you put the bonds in the child’s name, set to mature when the money will be needed for college, the interest on the bonds is taxed at the student’s presumably lower income tax rate.  (More on these and other tax-advantaged investments in a later post.)

A Note on Online Banking

 Recent years have seen the appearance of online banks.  They offer banking services, including saving accounts, solely through the Internet — they have no physical presence.  Theoretically, their lower overhead costs should allow them to pay higher interest rates than brick-and-mortar establishments, but recent (admittedly unscientific) surveys reveal little difference in those rates. Although some people might feel uneasy about entrusting their savings to an entity with no physical presence, the record thus far shows no greater problem with online arrangements than with others.  Keep in mind that most banking, even in the oldest of institutions, is now more electronic than physical.  The list of firms offering on-line arrangements is growing, including some that are large and well established.  Make sure that any online bank you are considering has the same insurance – especially Federal Deposit Insurance — and safety checks that traditional firms do.


Bonds: What Are They and How Do They Work?

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The Basics

 This post provides essential background on bonds.  A bond is simply a loan from the buyer of the bond to its issuer. When an established company or a government needs to borrow, it doesn’t go to a commercial bank, as an individual or small business would, it hires an investment bank to issue bonds on its behalf. Each piece of this “paper,” as the financial community calls it, binds the business or government to repay the face value of the bond plus interest at a designated date.  At one time, investment banks actually issued paper certificates with dollar amounts printed on their face, which is where the expression “face amount” comes from.  Now, of course, almost everything is electronic.

Because bonds are promises, they are sometimes called “promissory notes.”  Because they are the issuer’s debt, they are also often called “debentures.”  But whatever the name, they bind the issuer to make the designated payments to the holder on time, hence the use of the word “bond,”as in “their word is their bond.”

In addition to issuing this debt, the financial community makes an active market by buying outstanding paper from existing owners and re-selling it to others. Because this “secondary market”gives those who first bought the bonds a way to get their money out before the bonds’ due date, maturity date, as it is frequently called, its existence encourages people to buy bond issues in the first place.

Prices in this secondary market fluctuate, depending on changes in demand and supply for bonds generally and also for specific bonds.  When investors have a growing appetite for bonds, the secondary markets fills with buyers.  Their demand pushes up prices, and, according to the nature of bonds, pushes yields down.   (Prices and yields always go in opposite directions.  At the end of this post, a box on “bond math” explains how this works.)  When a flood of new bond issues overwhelms buyers’ appetites or when many existing holders want to sell in the secondary market, the supply of bonds for sale exceeds the demand and prices tend to fall.  Yields accordingly rise.  (Again, see the box on “bond math.”)

Making Money in Bonds

 There are three ways to make money in bonds:

  1. The primary way is through the regular payment of interest over the life of the bond.  Most bonds pay semi-annually, some quarterly.  Other bonds pay their accumulated interest in one lump at maturity.  (These are called “zeros,” because they pay nothing during the period from issuance to maturity.)
  2. Money is made and lost in bonds when they appreciate or depreciate at maturity, depending on whether the buyer in the secondary market purchased at a discount or premium to their face amont. (See box on “bond math.”)
  3. Because prices fluctuate over the life of the bond, you might also gain with a timely sale if you see the prevailing market price for the bond has risen above your purchase price.

The Roots of Price Fluctuations

Supply and demand fluctuate in the secondary market for a number of reasons, but four dominate:

Federal Reserve Policy

The Federal Reserve (Fed in financial jargon) is the government’s bank and the bankers’ bank, often referred to as the “central bank.”  Almost every nation has one to control flows of new money in their economies, mostly in order to smooth economic fluctuations.  When policy-makers want to raise economic activity, they increase the amount of money in circulation, and when they want to cool the economy, they decrease it.  These decisions affect bond prices.

When a central bank increases money flows it enlarges funds available for lending, heightening the demand for bonds, and thus lowering yields.  By reducing the cost of borrowing, the Fed encourages people and businesses to borrow and spend more, which speeds up the pace at which the economy’s wheels spin.  But when the Fed, needing to slow the economy, decreases the flow of money, the demand for bonds falls, their prices fall as well, and their yields rise.  Interest rates are so critical that the Fed announces its policy decisions in terms of short-term interest rates, specifically the rate that banks charge each other for overnight loans, the “federal funds rate.”  But while the Fed talks about a very short-term interest rate, its intent is to move the economy by affecting all rates and yields and thus bond prices.


 Because bonds make all payments in fixed dollar amounts – both the repayment at maturity and the contracted rate of interest, called the coupon rate — they are especially vulnerable to the effects of inflation.  High rates of inflation quickly erode the real purchasing power of all these fixed dollar payments. In the early 1980s, when the United States suffered inflation rates higher than 10 percent, the real buying power of the fixed-dollar payments on bonds fell by half in less than seven years.  Needless to say, then, that investors shy away from bonds when they expect inflation to rise.  The resulting decline in demand depresses their prices and raises yields and continues to do so until investors believe that the yields bonds pay have risen high enough to compensate for the inflation-driven loss of purchasing power.  Of course, when investors expect less inflation, their interest in bonds intensifies, they buy, and all this happens in reverse.


Liquidity refers to how much money is readily available for the purchase and sale of securities – stocks and bonds.  In general, it affects prices in much the same way as does the Fed’s adjustments in the money supply.  Individual bonds have different liquidity considerations.

Bonds are said to be liquid when there is an abundance of potential buyers and sellers in the marketplace.  In this environment, traders can easily find buyers and sellers: in other words, they flow readily.  The most liquid issues in the world are US Treasury bonds.  Trillions of dollars of these bonds exist in the market and they are owned by millions of people and institutions.  There is a steady stream of new issues, while billions of dollars of bonds mature, that is come due for repayment every month.  Because the ease of trading makes investors feel more comfortable with US Treasuries, and similarly liquid bonds, they can pay a slightly lower yield than other, less liquid bonds.  Bonds that have unusual features or less active issuers or lower amounts circulating in markets are harder for traders to move and so tend to pay higher yields.  (This higher yield on illiquid bonds may appeal to investors who expect to hold them to maturity.)

Matters of Quality

 Supply, demand, and hence prices also vary according to what is called the “credit quality” of a bond.  Though the issuer is legally bound to fulfill its obligation, it cannot do so if it ceases to exist.  Companies sometimes go bankrupt, governments can be overthrown or go through something close to bankruptcy.  The greater the likelihood of such a mishap, the lower the bond’s price and accordingly the higher its yield, presumably to compensate investors for the potential of loss.  Some bonds, US Treasuries for instance, are all but certain to meet their obligations. They are considered to have the highest credit quality, and command relatively higher prices and offer lower yields than even the strongest corporation.

Three credit-rating agencies specialize in tracking the quality of bonds: Standard and Poor’s,; Moody’s,; and Fitch,  They work for a fee, which issuers pay, hoping to get good ratings and so better prices for their bonds (and, accordingly, lower yields.)  Bond issuers also buy the ratings because a non-rated bond, as they are called, is suspect and thus harder to sell.

The ratings go from AAA, or some variation on this notation, for the most credit worthy issues down to CCC for the least.  The ratings are determined by the current financial health of the issuer, as well as future prospects, based on recent trends and likely potentials. Those rating the bonds also consider what are called bond covenants, which might put their owners first in line (or perhaps lower) for payment in the event of the issuer’s bankruptcy.  Because these agencies gave high ratings to undeserving bonds during the run-up to the severe 2008-09 financial crisis, governments, financial-professionals, investors, and others now rely less on their determinations.

How to Invest

 Whether an individual invests in bonds will depend heavily on what there other assets look like and a number of other considerations particular to them, their nearness to retirement and their comfort with risk just to name a couple of them. There are a great number of vehicles available for those who what to invest in bonds.  Buying them outright is sometimes difficult for the average investor because they are sold in large blocks.  But many mutual funds make bond investing straightforward and convenient for even small investors.  Future posts will go into these considerations in detail.



Bond Math Made Simple

 Almost all bonds are issued with the interest indicated as a dollar payment at semi-annual intervals.  This amount is called the coupon, named after the tickets once attached to the old paper certificates that owners would clip off in order to claim their interest payment.  Say you bought $1,000 worth of a bond that paid $50 a year.  It would be referred to as a 5 percent bond because the indicated annual dollar payment would amount to 5 percent of the $1,000 purchase price.  This last figure is also often referred to as its “face amount” or “par”because that number once appeared on the face of the old paper certificates. It would pay you that $50 a year, $25 every six months, until the bond matures, when the issuer would return to you the $1,000 you paid for the bond.

Here is the relationship stated in a simple equation:

(semi-annual payment) × 2 = Annual payment                                                                                                                                        (annual payment in the secondary market ÷ face value) × 100 = annual percent interest.

In this example:

$25 every six months = $50 a year                                                                     ($50 ÷ $1000) × 100 = 5%

As supply and demand for bonds fluctuate in the secondary market, the changing price alters the calculation.  If a surge in demand drives up the price of a bond, an investor might have to pay $1,100 to buy the $1,000 face amount of this bond.  Financial jargon would describe the bond as selling at a 10 percent premium to par, because the $100 difference is 10 percent of the original $1,000 face, or par, amount.  Because the bond still pays $25 twice a year, that $50 a year is a smaller percent of the purchase price: to be exact, 4.5 percent.

(50 ÷ 1,100) × 100 = 4.5%

This rate is called the “current yield” — the fixed dollar amount paid each year as a percent of the purchase price.

Of course, the issuer will only repay $1,000 at maturity and not the $1,100 paid by the buyer in the secondary market.  To get a full picture of the bond’s return, the investor must also consider this $100 loss when the bond matures.  That means the overall percent return is really a little less than the 4.5 percent current yield.  Financial people use a complex formula to build this consideration into the percent return on the bond, what they call the “yield to maturity.”  There is no need here to go into the details of those calculations except to note that the more distant the maturity date, the less imposing the ultimate loss is and so the less significant is its impact on the calculation of yield to maturity.

This all works in reverse, if supply-demand fluctuations in the bond market reduce the price of the bond below par.  In this case, the fixed $50-a-year payment of our example would produce a current yield above the initial 5 percent.  If, for instance, a lack of demand drives down the price of our $1,000 face amount bond to, say, $900, a 10 percent “discount” in financial jargon, the “current yield” would come to 5.6 percent

 ($50 ÷ $900) x 100 = 5.6%

Because you bought the bond at a 10 percent discount, the $1,000 paid at maturity would also net you an extra $100 at that future date.  The “yield to maturity” would then exceed 5.6 percent.  How much would depend on the length of time from the purchase of the bond to its maturity date.








What Do Hedge Funds Hedge?

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The answer is: very little, at least these days.  The term does have historical origins, but it otherwise it misleads. Whatever the name’s applicability, hedge funds have a perennial popularity, seeming to carry associations with wealth and sophistication.  In reality, they differ so much from one another that they hardly count as an investment style.  What they have in common is less their approach to investing than their legal structure and costs.

Where Did Hedge Funds Come From?

 Hedge funds have been around for a long time.  The first fund appeared in 1949.  Its founder, Alfred Winslow Jones, had great confidence in his ability to distinguish good stocks from bad, but he doubted anyone’s ability to forecast the direction of the overall market.  It frustrated him that he could pick the best stocks in the world and still lose money if markets fell.  His answer: buy stocks that looked good, often with borrowed money — on margin in financial jargon (more on this in a coming post) and “sell short” stocks that looked bad. Selling short involves selling a security that you do not own for delivery sometime in the future. Investors do this in the hope/expectation they can buy at a lower price before they have to deliver.  By balancing the short sales against the buys, Jones’s portfolio did not depend at all on the ups and downs of the whole market.  Instead his portfolio’s performance reflected only his stock selections.  Because the short sales were said to hedge the buys, Jones called it a “hedged fund.”

What Are They Now?

Most of these funds have long since abandoned this rather cautious approach.  Instead, they invest in a great variety of sometimes-risky assets in order to get superior returns, many of which have nothing to do with hedging.  Unlike most mutual funds available to retail investors, hedge funds can and often do invest in less common investment vehicles, including, for instance, commercial real estate, financial derivatives (to be discussed in a coming post), and currencies, among others.  They often concentrate their investments rather than diversify them.  The funds also frequently borrow money to redouble their investment bets. This “financial leverage,” as it is called, can enhance their returns when things go well, but because they owe the money regardless of how things go, it can devastate fund performance when things go wrong.  Beyond this general description, there are too many different approaches to list here.

Here is why hedge funds can take greater risk than most retail mutual funds and other investment strategies:

  1. Nearly all hedge funds require a rather large minimum investment and insist that investors leave money with them for a minimum time, called the lock-up period.  The size of the minimum varies greatly from fund to fund, but no average investor would consider it easy.  The length of the lock-up period can also vary.  Sometimes it extends to year or more.
  2. Even after the lock-up period, most hedge funds only allow withdrawals at set intervals,quarterly, perhaps, or sometimes only semi-annually.

Because of these arrangements, hedge fund managers share little of the concern common among mutual fund managers that sudden spates of withdrawal by panicky investors will force them to sell at inopportune moments. Hedge fund manages can consequently take risks that might enable them to wait out temporary market reverses.

Legal Structure

 The Securities and Exchange Commission (SEC) protects the general public from hedge fund risks by restricting the number of participants allowed into any fund, and also by limiting those participants to what the Commission calls “qualified investors.”  To qualify, you must demonstrate an annual income of at least $200,000 a year for the past two years and have a net worth of more than $1 million, excluding your primary residence.  Regulators believe that investors with these resources can more easily wait for their money and survive the potential loss implicit in the risks hedge funds frequently take.

Legally, hedge funds are set up as limited partnerships and often refer to their investors as “partners,” an arrangement that gives them tax advantages, especially because their profits are taxed at capital gains rates instead of the higher rates applied to ordinary income.  (A coming post will go into detail on taxes.)  Hedge funds also charge far higher management fees than do mutual funds or most other investment arrangements.  Hedge fund fee structures are often referred to as “two and twenty”: the fund charges 2 percent of the invested assets each year and 20 percent of any gains on them. This 2 percent is controversial because it is considerably higher than most retail mutual fund fees, and must be paid even if the portfolio suffers losses.  Because of their fee structures, tax advantages, and wide range of investment approaches, a common jibe in financial circles holds that hedge funds are compensation schemes for managers masquerading as an investment approach.


The Mysterious Allure of Bitcoin

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Bitcoin has had a wild ride.  It entered 2018 roaring up more than 280 percent from a little over $4,500 a coin late in 2017 to $17,429 by the first week of the new year.  By week two, it had fallen some 35 percent to $11,403.  From there it fell farther, some 48 percent, to $5,903 by late June, not much above where it was toward the end of 2017.  It then climbed some 42 percent to $8,424 by late July and then fell some 27 percent to $6,184 by the middle of August. It has bounced around near that price since.

The initial 2018 gain sparked much interest.  The word, Bitcoin, seemed to be on everybody’s lips.  CNBC reported on it almost hourly.  It was the first question from anyone who knew I was in the investment business – friends, relatives, the man behind the counter at the Madison Restaurant on Manhattan’s East Side, where I go for breakfast, the fellow at TSA who asked my profession.  I gave everyone the same warning, not about this particular investment but rather about anything that soars as fast as Bitcoin.  I also asked if they knew what Bitcoin was besides something that had gained value very fast.  When it became apparent that no one had the slightest idea, I could offer another warning: never invest in something you do not understand.

What is Bitcoin

Some say this is a new kind of money.  Some journalists call it a crypto-currency, apparently because it is created through an encrypted algorithm.  The U.S. Treasury classifies it as a commodity, though unlike tin or gold or wheat, it is created entirely through its algorithm.  I suppose we could call it a synthetic commodity.  It certainly behaves more like a commodity than money: During periods of enthusiasm, its price skyrockets only to fall precipitously in response to investor doubt.

Bitcoin and other similar but less famous creations are products of a remarkable mathematical innovation.  Referred to as blockchain, it can control the supply of something made entirely by people.  Its algorithms also allow participants to verify trades as well as Bitcoin ownership even as they ensure anonymity.  This is why the system is also often described a distributed ledger.  (The mathematics behind this system are complex, and even if I could master them, this is not the place to go into their intricacies.)

Suffice it to say that because of these characteristics Bitcoin and its blockchain competitors are described and often offered as substitute money.  The prospect of them as money has appeal to many.  Until the advent of blockchain, the only way to control the supply of money and verify ownership came through the centralized record keeping of the banking system, which in the United States includes the Federal Reserve, the Treasury (which itself includes the Office of the Comptroller of the Currency.)  These institutions might not know just who has cash in hand or what he or she is doing with it, but they do know to the penny how much exists and they control that amount of currency in circulation.  At the same time, the banking system knows who owns which account and how much is in it.  Blockchain, with its unique distributed ledger, offers an anonymous alternative. 

Its Use and Its Future

 Because Bitcoin and other crypto-currencies offer this anonymity, they are especially attractive to those who would rather not have their dealings recorded in any government-related system.  Blockchain currencies are untraceable, like $100 bills or gold bars, but they’re even more attractive because they have none of the clumsiness (or possible drama) of a suitcase full of bills.  They can move in the millions even billions through the Internet — an impossibility with paper money and gold bars, at least not with anonymity. It speaks to these qualities that Russian and Venezuelan officials have expressed hopes that such virtual currencies will enable their countries to end run American sanctions.

Many people forecast that Bitcoin and its kin will soon replace today’s national currencies – dollars, pesos, pounds, euros, and so on.  Bitcoin(s) could become money as long as everybody is willing to accept payment in them and believes them to be “safe.”  At the very least, that day will have to wait until Bitcoin leaves behind the wild price swings that have marked it so far.  To become a dominant currency Bitcoin must also jump significant political hurdles. Governments have no desire to lose control over their ability to create and verify the ownership of money.  Several countries, fearful of just such substitutions for their currencies, have already banned the use of Bitcoin and other crypto-currencies.  The United States, Japan, and the European Union have not gone this far — yet.  But should a day of reckoning arise, it’s a good bet that governments will impose control, and Bitcoin, whatever its future as a synthetic commodity, will fail as a substitute for money.  For the investor, then, Bitcoin becomes another potential addition to his or her portfolio, but one with more risk than many, and less predictability.