David John Marotta

Your investment appreciates in two ways. First, the value of the company appreciates by inflation, which generally has averaged about 4.5%. Second, the company has earnings that bring an additional 6.7% return. Sometimes a portion of these earnings is paid out in dividends. Other times the earnings are reinvested to grow the value of the company by opening more stores or buying other companies. Regardless of how the earnings are used, the total return in dollars is around 11.2%, about 6.7% over inflation.

Over the past few weeks we’ve been examining the investment science behind asset allocation. We learned that risk generally follows return. We learned that tilting small and value can boost returns. And we learned that blending investments near the efficient frontier can make even more efficient portfolios.

Crafting portfolio asset allocations is a combination of art and engineering. Just as a blending of colors can produce cerulean, so a blending of indexes produces a unique shade of risk and return. And these blended portfolios can be better than any of their components.

The capital asset pricing model (CAPM) approximates return as a linear function of beta. Beta is a measurement of how much an investment fluctuates in sync with the markets. For a stable bond, beta might be zero. The markets as a whole have a beta of 1.0. Volatile technology stocks might have an even higher [...]

In this series we are looking at the Fama-French three-factor model of investment returns. Any model of investment returns tries to predict an investment’s returns and volatility by factors that can be measured in advance of investing. The first factor, beta, taught us that the riskier, more volatile stocks on average have better returns. The second factor of investing is size as measured by a stock’s total capitalization. A stock’s capitalization is found by multiplying the current share price times all the outstanding shares of stock.

Modeling investment returns seeks to find an equation to predict your expected returns as much as possible. The one-factor model, called the capital asset pricing model (CAPM), was developed in the early 1960s. William Sharpe, Harry Markowitz and Merton Miller won the Nobel Prize in economics for this work. CAPM adds a single factor to the equation: risk as measured by standard deviation.

Nearly everyone is an excellent candidate for a Roth conversion this year. If you failed to convert money from an IRA to a Roth IRA last year, you missed an opportunity. Don’t make the same mistake this year. You can always undo part or all of a Roth conversion with what’s called a recharacterization, so you can’t convert too much.

Most investors do not have a balanced portfolio. They look for investments with little to no risk that still provide great rates of return. And by chasing this elusive chimera they miss the easy money they could make from having a good asset allocation in the first place and rebalancing it periodically. To have a balanced portfolio, you must know your asset categories and what percentage of your portfolio to put in each one. Without such a plan, your portfolio is automatically out of balance.

Financial resolutions usually don’t even last until the end of January. Making a permanent change in our behavior requires both time and a steely resolve. We can only develop financial character one action at a time. Here are seven practices to take you from pauper to prince or princess if you add one each year. Share your resolution with everyone you meet. You are 10 times more likely to act on a goal that you have articulated to someone else. Don’t wait until you have everything perfect to take ownership verbally.

Other than Ebenezer Scrooge in Dickens’s story “A Christmas Carol,” Tiny Tim is certainly the most memorable character. Dickens used the boy in the story to soften the hearts of both Scrooge and his readers toward the worthy poor. Although Victorian sentiments questioned the thrift or industry of the masses, a crippled, saintly child was obviously above reproach. In Dickens’s day, the disabled were feared because people believed they could be contagious.

Zynga was already the leading Facebook platform developer when it launched Farmville in June 2009. The idea was not original, but Zynga implemented it better and advertised it more than other companies. A year later Farmville had 80 million users, with most people coming back every day and representing about 10% of the Facebook population. If we celebrated our efforts at financial responsibility as much as we do Farmville, the savings rate in this country would rise significantly.

Studies show that people think about money as a pyramid similar to psychologist Abraham Maslow’s hierarchy of needs. Our first priority at the base of the pyramid is hand to mouth, meeting our physiological needs. Next we seek safety and security with enough money to support our health and well-being against accidents or illness and to save for infirmity in our old age. Having the money to meet these basic needs really does bring a certain degree of happiness.

Everyone worries about running out of money in retirement. Few people feel secure about government spending and Social Security. Even fewer retirees are confident about the future returns of the stock market. In the midst of this turmoil, especially after this past summer’s sharp drop, many investors wonder if they should put all of their investments into something safe and avoid the markets altogether.

My original attraction to libertarian ideals started in political theory and theology rather than in politics. This is not surprising because I did both part of my undergraduate work and three years of my postgraduate work in philosophy and biblical studies. Jefferson’s Declaration of Independence contains a very clear example of the mixture of Libertarian ideals with religious philosophy.

Last week I listed the first three reasons why I lean libertarian. First, centralized power in government corrupts. Less government power means less government corruption by special interests. Second, controlling another person’s life through force is inherently wrong. Third, government-supplied security is an illusion. By its nature, government cannot function in that role.

If you are tired of the continual government corruption and the senseless rules and spending, most of which fail to avoid mishaps, you may want to rethink your political philosophy. This isn’t a choice between good government and bad government. Much of government by its very nature does more harm than good.

Just because something costs a lot doesn’t mean it is an investment. Investments should appreciate at a rate that grows faster than inflation and gains purchasing power. And spending your money on noninvestments can jeopardize a plan to reach your goals of financial freedom.

Starting October 1, price controls were set by law on debit card swipe fees. Such populist well-intentioned legislation reduces economic freedom and slows economic growth. This situation has nothing to do with capitalism and everything to do with socialism. It seeks a state-directed and regulated economy serving the supposedly greater good of the nation. Such national socialism with the state seeking to control the economy is correctly called fascism.

Profound lessons can be learned from games like “The Settlers of Catan.” And the principles you learn can help you succeed for the rest of your life. Like Catan, the best games teach us principles in less than an hour that life teaches us much more painfully over years of calendar time.

This summer many things that should do better over a long-term investment strategy did not. This situation is not unusual for one quarter’s worth of time. Such a result only makes reversion to the mean much more likely in the coming quarters. It is always a good time to have a balanced portfolio. And you shouldn’t let a summer quarter’s correction ruin a brilliant long-term investment philosophy.

The restraint a good chess player must learn–slowing down to watch what one’s opponent is doing and may do, then planning ahead accordingly–is helpful in every aspect of strategic decision making. Perhaps the markets dropped precipitously. But what specifically did they do? What dropped the most? What can they do going forward? Perhaps they will drop more, or perhaps they will rebound.

CNBC’s million-dollar portfolio challenge begins next week. Participants can trade a fictional account of stocks and currency. Prizes are given over each of the 10 weeks, and then a grand prize winner is awarded a million.

Libertarians and economists both recognize that countries with more economic freedom experience higher gross domestic product (GDP) growth. That growth translates into higher stock returns for investors savvy enough to look for governmental fiscal restraint rather than government stimulus. While many economists acknowledge that freedom matters, few investment strategies take advantage of this fact.

If you look at Social Security as a system of taxation and redistribution, it takes from a single minority male worker and gives to married white women who never contributed. And if you look at Social Security as a forced retirement savings program, it produces such a terrible return we might as well invest in gold. Neither perspective is worth continuing. Social Security as we know it needs to be abolished.

A study by William Beach and Gareth Davis computed the cumulative effects of Social Security’s dismal returns. Imagine a community the size of Charlottesville, Virginia, of 44,000 young married double-earner couples in their 30s with each person earning the average wage and each couple having two children. That community loses $23 billion by receiving Social Security rather than what they could have saved in a private pension plan by retirement age using the same dollars.