TIME Economy

The Real Way to Fix Finance Once and for All

Bull statue on Wall Street
Murat Taner—Getty Images

Changing the way financial institutions operate will require more than calculations and complex regulation

We live in an age of big data and hot and cold running metrics. Everywhere, at all times, we are counting things—our productivity, our friends and followers on social media, how many steps we take per day. But is it all getting us closer to truth and real understanding? I have been thinking about this a lot in the wake of a terrific conference I attended this week on “finance and society” co-sponsored by the Institute for New Economic Thinking.

There was plenty of new and creative thinking. On a panel I moderated in which Margaret Heffernan, a business consultant and author of the book Willful Blindness, made some really important points about why culture is just as important as numbers, particularly when it comes to issues like financial reform and corporate governance. As Heffernan sums it up quite aptly in her new book on the topic of corporate culture, Beyond Measure, “numbers are comforting…but when we’re confronted by spectacular success or failure, everyone from the CEO to the janitor points in the same direction: the culture.”

That’s at the core of a big debate in Washington and on Wall Street right now about how to change the financial system and ensure that it’s a help, rather than a hindrance, to the real economy. Everyone from Fed chair Janet Yellen to IMF head Christine Lagarde to Senator Elizabeth Warren—all of whom spoke at the INET conference; other big wigs like Fed vice chair Stanley Fischer and FDIC vice-chair Tom Hoenig were in the audience—agree more needs to be done to put banking back in service to society.

MORE: What Apple’s Gargantuan Cash Giveaway Really Means

But a lot of the discussion about how to do that hinges on complex and technocratic debates about incomprehensible (to most people anyway) things like “tier-1 capital” and “risk-weighted asset calculations.” Not only does that quickly narrow the discussion to one in which only “insiders,” many of whom are beholden to finance or political interests, can participate, but it also leaves regulators and policy makers trying to fight the last war. No matter how clever the metrics are that we apply to regulation, the only thing we know for sure is that the next financial crisis won’t look at all like the last one. And, it will probably come from some unexpected area of the industry, an increasing part of which falls into the unregulated “shadow banking” area.

That’s why changing the culture of finance and of business is general is so important. There’s a long way to go there: In one telling survey by the whistle blower’s law firm Labaton Sucharow, which interviewed 500 senior financial executives in the United States and the UK, 26% of respondents said they had observed or had firsthand knowledge of wrongdoing in the workplace, while 24% said they believed they might need to engage in unethical or illegal conduct to be successful. Sixteen percent of respondents said they would commit insider trading if they could get away with it, and 30% said their compensation plans created pressure to compromise ethical standards or violate the law.

How to change this? For starters, more collaboration–as Heffernan points out, economic research shows that successful organizations are almost always those that empower teams, rather than individuals. Yet in finance, as in much of corporate America, the mythology of the heroic individual lingers. Star traders or CEOs get huge salaries (and often take huge risks), while their success is inevitably a team effort. Indeed, the argument that individuals, rather than teams, should get all the glory or blame is often used perversely by the financial industry itself to get around rules and regulations. SEC Commissioner Kara Stein has been waging a one-woman war to try to prevent big banks that have already been found guilty of various kinds of malfeasance to get “waiver” exceptions from various filing rules by claiming that only a few individuals in the organization were responsible for bad behavior. Check out some of her very smart comments on that in our panel entitled “Other People’s Money.”

MORE: The Real (and Troubling) Reason Behind Lower Oil Prices

Getting more “outsiders” involved in the conversation will help change culture too. In fact, that’s one reason INET president Rob Johnson wanted to invite all women to the Finance and Society panel. “When society is set up around men’s power and control, women are cast as outsiders whether you like it or not,” he says. Research shows, of course, that outsiders are much more likely to call attention to problems within organizations, since not being invited to the power party means they aren’t as vulnerable to cognitive capture by powerful interests. (On that note, see a very powerful 3 minute video by Elizabeth Warren, who has always supported average consumers and not been cowed by the banking lobby, here.)

For more on the conference and the debate over how to reform banking, check out the latest episode of WNYC’s Money Talking, where I debated the issue on the fifth anniversary of the “Flash Crash,” with Charlie Herman and Mashable business editor, Heidi Moore.

MONEY financial advisers

Breaking Up Is Hard to Do…With Your Financial Adviser

broken $ candy heart
Sarina Finkelstein (photo illustration)—Ashley Jouhar/Getty Images

Firing a financial adviser can be uncomfortable, but certain circumstances make it necessary.

Ending a relationship is never easy. You nurture it, get comfortable with it, and you learn what to expect. Sometimes you think about walking away because you’re just not sure it’s what you want. You wonder if breaking up is worth the hassle — and you decide to stick it out, telling yourself that next year will be better. But will it? Maybe not.

Should I stay or should I go? It’s a question people regularly ask, not just about their significant other but also about their hair stylist, their personal trainer, and, yes, their financial adviser.

The idea of leaving your financial adviser — and having to find a replacement — can be daunting. It involves a lot of research, paperwork, meetings, and time. Lots of time. All that and still no guarantee that this new adviser will be any better than the old one.

But things are changing. Consumers with money to save and invest now have more affordable, higher-quality investment options to choose from. As a result, more and more people are rethinking their long-term relationships with their financial advisers.

Four percent to six percent of U.S. investors change financial advisers in a given year, according to a 2014 survey by Spectrem Group, a firm that researches investors. The reasons for these break-ups vary, but ranking high on the list are a lack of communication, frustration with complex or hidden fees, and major life events such as death, divorce, or inheritance.

It was the death of a parent that started the ball rolling for one of my clients. A smart, savvy, and accomplished woman in her mid-30s, she juggles a demanding career, marriage and motherhood. When her father, a successful real estate developer, passed away unexpectedly, she and her sisters inherited money and securities. They also inherited his long-time financial adviser.

For years, her father had trusted this adviser to work in the family’s best financial interests, and she had no plans to end the relationship. The emotional loyalty factor made it hard to jump ship. Besides, she was only paying the typical 1% fee for decent portfolio growth.

Then she did a little digging and some comparison-shopping, just for her own education, and discovered she was wrong. In fact, her adviser had invested her in an actively managed fund with significant fees. He also had recommended a new fund for her — one with a front-end load that took 5% off the top. When all was said and done, she was paying 2.3% in annual fees, not the typical 1%.

Not only was she surprised, she was furious. She felt like a trust had been broken, which is understandable. As she told me, if the financial adviser had disclosed all of the funds and fees up front, she might have reacted differently. But he didn’t, and that made it much easier for her to leave and take her retirement account with her.

So if you’re re-evaluating your adviser’s performance, consider what’s important to you and your financial goals. Do you want better communication, a lower risk factor, lower fees? Or is it just time to shake off the inertia? Whatever your reasons, if the relationship isn’t working for you, don’t be afraid to kiss it goodbye.

———-

Sally Brandon is vice president of client services for Rebalance IRA, a retirement-focused investment advisory firm with almost $250 million of assets under management. In this role, she manages a wide range of retirement investing needs for over 350 clients. Sally earned her BA from UCLA and an MBA from USC.

MONEY Warren Buffett

Warren Buffett Is Wrong About Whole Foods

Berkshire Hathaway CEO Warren Buffett enjoys a Dairy Queen ice cream bar prior to the Berkshire annual meeting in Omaha, Nebraska May 2, 2015. Dairy Queen is a Berkshire Hathaway company.
Rick Wilking—Reuters Berkshire Hathaway CEO Warren Buffett enjoys a Dairy Queen ice cream bar prior to the Berkshire annual meeting in Omaha, Nebraska May 2, 2015. Dairy Queen is a Berkshire Hathaway company.

Buffett’s recent dig at Whole Foods reveals misguided thinking.

[Editor’s note: This post originally appeared at Motley Fool.com; John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors.]

I think the world of Warren Buffett. That’s why I just travelled halfway across the country to soak up his wisdom at the 50th annual Berkshire Hathaway shareholders’ meeting. But despite his incredible track record, the Oracle of Omaha occasionally makes an investing mistake – and I believe he’s making one now with Whole Foods Market WHOLE FOODS MARKET INC. WFM -0.61% .

Let’s Go To The Videotape

Towards the beginning of the marathon Q&A session, The New York Times‘ Andrew Ross Sorkin asked Buffett if he was concerned that shifting consumer preferences toward healthier diets might endanger the economic moats of Coca-Cola COCA-COLA COMPANY KO -0.05% and Kraft Foods Group KRAFT FOODS GROUP INC. KRFT -0.87% . Here’s how Buffett responded:

I don’t think there will be anything revolutionary. Food and beverage companies will adjust to the expressed preferences of consumers. No company does well ignoring its consumers. I predict that 20 years from now more Coca-Cola cases will be consumed than today. Back in the late 1930s, Fortune magazine ran an article saying the growth of Coca Cola was over. When we bought stock in the 1980s, people were not enthused about [Coca-Cola’s] growth.

I am probably one-quarter Coca-Cola [big laugh from audience]…. If I had been having broccoli and brussel sprouts, I wouldn’t have lived as long. I would have approached every day like going to jail… Charlie [Munger] and I have enjoyed every meal we’ve ever had except when my grandfather made me eat those damn greens.

It’s amazing how durable [consumer brands are]. Berkshire Hathaway was the largest shareholder of General Foods from 1981 to 1984 – that’s 30-plus years ago. It was bought by Philip Morris and spun out as Kraft. Those same brands are popular today. Heinz goes back to 1869. The ketchup came out in the 1870s. Coca-Cola dates to 1886. It’s a pretty good bet that a lot of people will like the same things.

When I compare drinking Coca-Cola to something they would sell me at Whole Foods, I don’t see a lot of smiles on the faces of people at Whole Foods.

Right Answer, Wrong Approach

Buffett’s conclusions about the future of Coca-Cola and Kraft are probably correct. While consumer preferences have been shifting toward healthier fare, sugary and processed foods are still very popular and will likely remain so for the foreseeable future. And even if a wholesale change in consumer behavior does occur, Coca-Cola and Kraft are capable of adapting. Both companies have the scale advantages, distribution platforms, and marketing muscle to ensure their brands remain relevant for decades to come.

For me, the real issue was Buffett’s rationale. I sensed several behavioral biases that could be causing him to make a suboptimal investment decision.

Survivorship Bias

It’s true that Coca-Cola and Kraft successfully fought off challenges in the 1930s and 1980s. But so did Eastman Kodak, General Motors, and Woolworth’s. Competitive conditions are constantly evolving, and a company’s success several decades ago may not be a valid predictor of its ability to fend off competitors today. By focusing only on those companies that survived, Buffett may be overestimating Coca-Cola and Kraft’s odds of continued success.

Liking Bias

Buffett clearly enjoys Coca-Cola, both as a consumer and a shareholder. Furthermore, he is friends with many of the company’s executives, and his son Howard sits on Coca-Cola’s board of directors. These favorable feelings may make it challenging for Buffett to view the company objectively. We saw evidence of this phenomenon in action last year, when Buffett abstained from voting against an executive compensation program that he viewed as excessive.

Projection Bias

But for me, the biggest flaw in Buffett’s thinking concerned the parting shot he took at Whole Foods.

Because Buffett eats like an unsupervised six-year-old, he incorrectly assumes that most consumers share his eating preferences. This fallacy is probably supported by his choice of dining partners, including Munger, who plowed through an entire box of peanut brittle during the shareholder meeting. But I’ve been to the Omaha Whole Foods, and I saw a store full of happy customers buying premium-priced organic produce. Buffett’s bias against healthy eating is likely causing him to underestimate the appeal of Whole Foods’ brand.

So, Should Berkshire Buy Whole Foods?

There are legitimate reasons not to invest in Whole Foods. The grocery business is intensively competitive, with thin margins and no barriers to entry. Buffett knows this firsthand, as his grandfather owned a grocery store in Omaha where Buffett and Munger both worked as young men. Furthermore, Berkshire recently lost $444 million by investing in Tesco, the leading grocer in the U.K.

But Whole Foods is not your typical grocery store. As the largest retailer of natural and organic foods in the U.S., Whole Foods is commonly perceived by consumers as offering healthier and higher-quality fare. Thanks to its strong brand, Whole Foods can charge premium prices for its products, which enables the grocer to post atypically high sales per square foot, gross margins, and return on invested capital.

Whole Foods possesses many of the characteristics that Buffett loves to see when evaluating investments. It has strong and sustainable competitive advantages, a clean balance sheet, a dedicated and shareholder-friendly management team, and attractive growth prospects. With a P/E ratio of 30, shares don’t appear especially cheap at the moment, but this strikes me as a reasonable price for such a high-quality business. If Buffett could look past his hatred of healthy eating, I suspect he might agree.

MONEY retirement planning

These 4 Rules of Thumb Can Screw Up Your Retirement

boat wrecked on beach
Getty Images

Rules of thumb are often partly true—but the part that's wrong can wreck your portfolio. Here's what you need to know.

Retirement planning can get complicated, so we often fall back on rules of thumb, or “heuristics” as economists call them. That approach may work sometimes—and is certainly better than doing nothing—but it can be dangerous too. Here’s what you need to know about four largely-but-not-completely true tenets of retirement planning.

1. Save 10% a year and you’ll be fine. The appeal of this oft-repeated precept is that 10% is a nice round number that’s achievable for many people. And stashing away 10% of your salary may very well lead to a secure retirement—if you start doing so in your early 20s and never miss a year for the next 40 years.

Problem is, many of us don’t get as early a start on our savings effort as we’d like. Indeed, when researchers for TIAA-Cref asked pre-retirees last year what they wished they’d done differently to prepare for retirement, 52% said they wished they’d started saving sooner. And even if you do get that early start, any number of unforeseen events—a layoff, an illness or injury, an unexpected expense—may prevent you from sticking to your regimen, or even force you to dip into your retirement savings.

Considering that many of us may get a late start or run into disruptions along way, a better strategy is to shoot for a higher savings target, say, 15%, more if possible. That will give you a little wiggle room in case you fall short some years. Better yet, rev up a good retirement calculator periodically, and plug in the amount you have saved and the amount you’re setting aside each year to see whether you’re doing enough. Making small adjustments as early as possible will spare you from having little choice but to save at a painfully high rate late in your career in order to achieve a secure retirement.

2. Your spending drops dramatically in retirement. The problem with this statement is that it might be true—or it might not. The consensus is that spending tends to drop after one retires (and then rebound a bit later in life, according to a study by Morningstar head of retirement research David Blanchett). But there’s also a wide variation around the norm (spending generally drops off less for wealthier retirees, for example). So depending on the particulars of your situation, you could end up spending less, the same or more than you did before you retired, or even more.

So how do you deal with such ambiguity? My recommendation is that unless you have a really compelling reason to believe otherwise, you should save during your career as if you’ll need at least 80% of your pre-retirement income when you retire. Shooting for less requires less saving. But if you underestimate the amount you’ll need and turn out to be wrong, you’ll have to downscale your standard of living, which isn’t an adjustment most people like to make. Once you’re within 10 to 15 years of retirement, you can then start doing an actual retirement budget. An online budget worksheet like the one in Fidelity’s Retirement Income Planner tool can help you get a good handle on the expenses you’ll face, and you can update your estimates as you near and enter retirement. There will always be unexpected expenses and surprises. But you’ll be better prepared to handle them if you do some serious thinking about your retirement spending before you leave your job.

3. Smart investing can make up for anemic saving. There’s a temptation to think that we can compensate for a weak savings effort by shooting for higher investment returns. But that’s wishful thinking. Sure, earning 8% a year for 40 years instead of, say, 7%, will give you an extra $295,000 at retirement, assuming you start out earning $40,000 a year, get 2% annual raises and contribute 10% of salary until you’re 65. But higher returns aren’t just something you can plug into a spreadsheet and then expect to materialize. Other than focusing on low-fee investments, the only way to boost returns is to take more risk, and that makes your retirement accounts more vulnerable to market downdrafts. What’s more, if your high-risk strategy backfires, you could even end up worse in the long-run than had you followed a less aggressive one.

A better approach: Save at an adequate rate so you can set an investing strategy that jibes with your risk tolerance and that makes sense given the forecasts for low rates of return in the years ahead. That doesn’t mean you can’t take prudent risks. During most of your career when growing your nest egg is important, you’ll probably want to devote most of your savings to stocks. But as you get closer to and enter retirement, you become more concerned about preserving the savings you’ve accumulated, so you’ll likely want to scale back on equities. For a guide to reasonable stock-bond allocations, you can check out the Vanguard target-date retirement funds for someone your age. Bottom line, though, is that saving (and once you’re in retirement, spending) drives retirement success, not investing.

4. You won’t outlive your savings if you follow the 4% rule. Back when the stock market was generating long-term annualized returns of 10% or so, this rule worked, kind of. It didn’t guarantee your money would last at least 30 years in retirement, but the success rate for people who followed it were high, say, 90% or so. But with investment pros like Portfolio Solutions’ Rick Ferri forecasting far lower returns for stocks and bonds in the years ahead, that success rate has declined a good 10 percentage points or more. As a result, some experts suggest that an initial withdrawal of 3%, or even less, is more appropriate in today’s market.

But there’s another problem with the 4% (or even 3%) rule that doesn’t get as much attention. Even if you succeed in not running out of money, following it could leave you with a big stash of cash late in retirement if the markets do well. Not a problem, you say? Well, that extra cash is money that you might have enjoyed earlier in life if you hadn’t been restricting your withdrawals.

I recommend you start your retirement with a reasonable withdrawal rate—say, 3% to 4% if you want your nest egg to last 30 or more years—and then monitor how you’re doing by plugging your savings balances and projected spending into a retirement income calculator that uses Monte Carlo simulations to assess how long your nest egg might last. You can then make small ongoing adjustments as needed, perhaps cutting back on withdrawals if your nest egg’s value has plunged or loosening the purse strings if a booming market has boosted the balance of your retirement accounts.

In short, when it comes withdrawals, as well as the other three tenets cited above, a rule of thumb may be a decent starting point, but you’ll have to exercise some creativity, flexibility and common sense to get you the rest of the way.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY stocks

How Microsoft Became a Market Darling, in Two Charts

Microsoft CEO Satya Nadella
Jim Young—Reuters Microsoft CEO Satya Nadella speaks at the Microsoft Ignite conference in Chicago, Illinois, May 4, 2015.

CEO Satya Nadella has turned an aging tech giant into one of the hottest stocks on the market.

On Tuesday, Salesforce.com saw its shares skyrocket as rumors spread of a possible Microsoft acquisition. While Bloomberg has said no deal is imminent, a Salesforce sale would make a lot of sense for a company that has staged an improbable comeback through a newfound focus on cloud services. (Our sister publication Fortune.com made just that case a few days ago.)

When Satya Nadella was named Microsoft’s CEO on February 4, 2014, he was taking over an aging tech giant long known for muddled priorities and a fear of any internal innovation that could challenge the dominance of its Windows operating system. Since then, Nadella has given his company a clear objective—even killing off established but musty brands like Internet Explorer. As the Economist noted in April:

Mr. Nadella’s biggest achievement so far is that he has given Microsoft a coherent purpose in life, as it enters its fifth decade. He sums it up in two mottos. One is “mobile first, cloud first”: since these are where the growth is going to come from, all new products need to be developed for them. The other is “platforms and productivity”.

On the cloud side, Microsoft’s business has been flourishing. Profits from the cloud—that is, software and services available via the Internet—more than doubled in the past quarter, and revenue has increased to $6.3 billion.

Investors are liking the new clarity too. Microsoft’s stock price has surged under its new CEO. Since Nadella took the reins, Microsoft shares are up over 30%, 10 points ahead of the S&P. In comparison, Microsoft’s stock dropped nearly 12% during Ballmer’s tenure and underperformed the market.

Here’s Microsoft’s stock performance under Ballmer:

ycharts_chart
Microsoft’s share price growth compared to the S&P 500 while Steve Ballmer was CEO.

And here’s its performance since Nadella started:

ycharts_chart (1)

This magical-seeming recovery is still a short-run thing—we’re talking a bit more than year. But Wall Street seems to have Nadella’s back for now. Earlier today, the Wall Street Journal‘s “Heard on the Street” column praised the company’s cloud efforts and called its stock one of the cheapest ways to gain exposure to cloud business. Just a few hours later, as though to confirm the endorsement, Salesforce.com shares jumped on merger news.

MONEY Small Business

New Ways to Invest in Small Businesses

Cafe owners
Getty Images

When nonprofessional investors are able to put money into small businesses, everyone can benefit.

I met with Paul on Tuesday. He is the CFO of a business start-up. He’s not sure if the next phase of his company’s financing is going to go through. Although he believes in the business model and the mission of the company, some days he thinks he won’t have a job in three weeks.

I met with David on Wednesday. While he’s a great saver and earns a decent buck, he isn’t wealthy. He wants to invest in small companies so much that we’ve set up a “fun money” account, which is 10% of his otherwise well-diversified, passively managed portfolio. “Fun money” is specifically set aside so that he can make individual investments he believes in.

Because of the way small business investing is structured in this country, the likelihood of Paul and David connecting has been infinitesimally small.

This drives me mad.

It’s not just these two who are missing out. Because small companies drive job and economic growth, the economy of the country loses when Paul and David don’t connect. And because the current system of funding is biased, some small businesses are a lot less likely to get funding despite their worthy ideas.

Recent developments could change all this.

To raise their initial start up money, small business owners typically first use their savings, and then appeal to their friends and family. Next, they go to banks. If they get big enough and have certain ambitions and contacts, they can get venture capital funding or private equity funding, which is what Paul was waiting on.

These sources of capital are all enhanced if you are affluent and well connected. Do your friends and family have extra money to invest in your business? Do you know anyone you can talk to at a bank? What about impressing people in the venture capital world? A lot of people with good ideas are shut out.

Enter the Internet. Raising money got a lot easier.

The Power of Reward Sites

With reward sites, startups with good ideas raise money in exchange for rewards.

Sesame, which opens doors remotely from smartphones, raised over $1.4 million on Kickstarter.com. The reward here was a chance to order the device.

Then there is Lammily, Barbie’s realistically proportioned cousin, whose designer raised almost $500,000 through Tilt.com. The reward for funding Lammily was the chance to pre-order the doll, and sticker packs with stretch marks, cellulite, freckles, and boo-boos.

The reward sites show that companies can raise large amounts of money through small contributions from a large number of people. Research suggests that Kickstarter.com reduces company funding gender bias by an order of magnitude and reduces geographic bias as well. Reward sites cater to consumers who love new products and want to support new ideas.

You may get first dibs on a cool new doll, but sending money to a reward site isn’t investing.

The Risks of Private Equity

Traditionally, to get private equity funding, you have to sell to accredited investors — the richest 1% of the population, roughly speaking.

Accredited investor regulations were set up in in the wake of the 1929 crash, when a lot of people got ripped off because they invested in dubious enterprises. The idea was that people with a high level of wealth are sophisticated enough to understand investment risk. Unfortunately, this leaves the Davids of the world — investors who are sophisticated but wealthy — shut out of these types of investments.

Private equity placements are not always a great deal. When I’ve looked into them for clients, I’ve concluded they are expensive, risky, and difficult to get out of, even if you die. The middlemen who offer these and the advisers who sell these seem to be the ones most likely to make money. The best deals I’ve looked at weren’t hawked by sales people or investment advisers, but came through clients’ friends and family.

The rise of Internet portals set up to connect small companies with accredited investors has the potential to cut down on intermediary costs. Still, the sector remains small.

In 2012, President Obama signed the JOBS act, which directed the Securities and Exchange Commission to devise rules opening up small business investing to non-accredited investors.

Some organizations didn’t wait for the SEC to issue the rules. Instead, they dusted off exemptions in the securities legislation that most of us have ignored for 80 years.

States Get Into the Act

Some states have picked up on crowdfunding to boost their economies. Terms vary, but generally investors are subject to investment limits and companies are subject to a cap on raising money. Each individual, for example, might be limited to investing $10,000; each company might be limited to raising $1 million. Both investor and company are generally required to reside in the state.

This is music to ears of people who want to invest locally. The first successful offering using this type of exemption was in Georgia in 2013, where Bohemian Guitars raised approximately $130,000 through SparkMarket.com.

Other Exemptions

Village Power is another example of raising money using an exemption. This intermediary helps organizations set up and fund solar power projects. Village Power coaches their community partners to use an exemption in the SEC rules, which allows for up to 35 local, non-accredited investors.

New Rules Open Doors

New rules issued March 25 by the SEC removed a lot of the barriers for companies raising money and for non-accredited investors.

Companies will be able to raise up to $50 million. Non-accredited investors are welcome to invest, sometimes with limits — 10% of their net worth, say, or 10% of their net income.

Although Kickstarter has said that it won’t sell securities, other fundraising portals, such as Indiegogo, are looking into it.

And if all goes well, Paul, David, and I can start looking for the new opportunities in June of 2015.

———-

Bridget Sullivan Mermel helps clients throughout the country with her comprehensive fee-only financial planning firm based in Chicago. She’s the author of the upcoming book More Money, More Meaning. Both a certified public accountant and a certified financial planner, she specializes in helping clients lower their tax burden with tax-smart investing.

MONEY Tech

How Twitter Tried to Convince Us That It’s Doing Really Well

The Twitter logo is shown at its corporate headquarters  in San Francisco
Robert Galbraith—Reuters

Stop falling for this tech bubble trick.

2014 was a very unprofitable year for Twitter TWITTER INC. TWTR -0.22% . The company reported a net loss of $578 million on $1.4 billion of revenue. Even the free cash flow, which benefits from adding back Twitter’s massive $632 million of stock-based compensation, was negative, a loss of $120 million. The fourth quarter was no different than the full year, with both net income and free cash flow soundly negative.

Despite these sobering numbers, Twitter recorded record quarterly profits, according to CEO Dick Costolo:

We closed out the year with our business advancing at a great pace. Revenue growth accelerated again for the full year, and we had record quarterly profits on an adjusted EBITDA basis.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Twitter’s adjusted EBITDA backs out another major expense: stock-based compensation. On an adjusted EBITDA basis, Twitter earned $141 million of profit in the fourth quarter, and $301 million of profit during the full year. Adjusted EBITDA nearly quadrupled in 2014.

If you look at the earnings reports of big, profitable technology companies, you’re unlikely to find EBITDA mentioned at all. I looked at the latest earnings releases for Microsoft, Apple, Intel, Cisco, Facebook, Qualcomm, Oracle, IBM, and Google. How many times do you think EBITDA was mentioned?

Not even once.

There’s a good reason for this: EBITDA is a mostly useless number. EBITDA was a popular metric during the dot-com boom of the late 90s, and I’m seeing it touted in an increasing number of earnings releases today, largely by unprofitable tech companies like Twitter.

A common argument for using EBITDA is that depreciation and amortization are non-cash expenses, and by backing those out, you get something that’s supposed to represent a company’s real cash flow. Warren Buffett, in his 2000 shareholder letter, pretty much kills this argument:

References to EBITDA make us shudder — does management think the tooth fairy pays for capital expenditures?

EBITDA accounts for the earnings generated by a company’s assets without accounting for the cost of those assets. Depreciation may not be a cash expense, but it is a real expense, and ignoring it produces a number that carries little meaning. Charlie Munger puts it best:

I think that, every time you see the word EBITDA, you should substitute the word “bullshit” earnings.

To see why EBITDA can be so misleading, let’s start a business.

The power of EBITDA

I’m going to start a fictional food truck business. I’ll buy one truck in the first year, then add an additional truck each following year. Each truck costs $50,000 and has a useful lifetime of five years, generating a $10,000 depreciation expense annually.

It turns out, I’m not very good at selling tacos out of a truck. Each food truck I own consistently generates $100,000 in annual revenue, but it costs $90,000 to operate, including food costs, wages, etc. Add in the depreciation expense, and my operating income per truck is zero.

No matter — I want to build a food truck empire. I borrow money each year from the bank to open a new food truck and replace any that need to be replaced, paying 6% interest. After 10 years, with 10 food trucks in operation, things are either going very well or very poorly, depending on which numbers you look at.

In year 10 of my food truck business, the company generated $1 million in revenue, a tenfold increase compared to the first year of operation. It was also a record year for profitability on an EBITDA basis. EBITDA came in at $100,000, 10% of revenue, and it has increased every single year. EBITDA also easily covers the $45,000 of annual interest payments.

That may sound great, but net income in year 10 was a loss of $45,000 thanks to the interest on all of those loans. Free cash flow is also negative, since I spent $50,000 expanding my food truck empire and another $50,000 replacing one of my existing trucks. The company is hemorrhaging cash and, unable to even pay the interest on its loans, is on the verge of bankruptcy.

Calculations and chart by author. Free cash flow ignores effects of changes in working capital, but including this would make free cash flow even more negative.

EBITDA has managed to make this unsustainable, money-losing company look like a success story. Not only does EBITDA ignore the cost of the food trucks, which are required to generate any revenue in the first place, it also ignores interest, which is a real cash expense. EBITDA is in no way equivalent to cash flow.

Putting lipstick on a pig

Twitter’s adjusted EBITDA not only excludes depreciation and amortization, which totaled $208 million during 2014, but it also excludes $632 million of stock-based compensation. More than 40% of Twitter’s expenses are completely ignored in an effort to produce a number that makes the company appear profitable.

A good rule of thumb for all investors to follow: Always question the numbers management wants you to see. Companies make up all sorts of non-GAAP, adjusted figures in an attempt to make things look better than they really are. Sometimes, these figures are perfectly reasonable. Other times, like in the case of Twitter’s magical adjusted EBITDA, they’re not.

As Warren Buffett said during the 2002 Berkshire Hathaway annual meeting:

People who use EBITDA are either trying to con you, or they’re conning themselves.

Remember that the next time you’re looking at an earnings report.

MONEY Warren Buffett

15 Things to Expect from Warren Buffett’s Annual “Woodstock for Capitalists”

Berkshire Hathaway CEO Warren Buffett talks to reporters while holding an ice cream at a trade show during the company's annual meeting in Omaha, Nebraska May 3, 2014. Warren Buffett's Berkshire Hathaway Inc on Friday said quarterly profit declined 4 percent, falling short of analyst forecasts, as earnings from insurance underwriting declined and bad weather disrupted shipping at its BNSF Railway unit.
Rick Wilking—Reuters

A look at what promises to be a memorable annual meeting.

Saturday is the day. That is, Saturday is the day.

That’s right, I’m talking about the Berkshire Hathaway annual meeting, which brings tens of thousands of investors to Omaha to hear what CEO Warren Buffett and his brilliant co-pilot Charlie Munger have to say about Berkshire, the economy, the stock market, and… well, just about anything else under the sun.

There are certain things that Buffett-watchers can expect every year from the meeting, but every year’s meeting is a bit different. And this year promises to be particularly memorable, as it marks the 50-year anniversary of Buffett and Munger at the helm of Berkshire.

So what exactly should we expect from this year’s edition of the Woodstock for Capitalists? Let’s see…

1. What do you think about the stock market?

I’m guessing the question won’t come in quite that form, but there will be some question during the hours-long Q&A session with Buffett and Munger that gets to their views on the current state of the stock market. We can expect the response to be a combination of their traditional wisdom that emphasizes how investors are buying a piece of a business (not a piece of paper), that long-term ownership is the way to go, and that low-cost index funds are the best bet for many investors.

But this ain’t the normal mealy mouth corporate-speak annual meeting, so don’t be surprised if Buffett and Munger offer direct views on the state of the market. After all, in Berkshire’s annual letter in 1999, Buffett was very clear about his view that valuations were inflated:

Our reservations about the prices of securities we own apply also to the general level of equity prices. We have never attempted to forecast what the stock market is going to do in the next month or the next year, and we are not trying to do that now. But, as I point out in the enclosed article, equity investors currently seem wildly optimistic in their expectations about future returns.

And then, in the 2008 letter, he was equally clear about the bargains that he and Charlie were seeing:

Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

2. What’s up with that new number?

Buffett and Munger’s benchmark of choice for many years has been the change in Berkshire’s per-share book value versus the one-year change in the S&P 500 index. This year, a new number appeared on the first page of Berkshire’s letter: the one-year price change in Berkshire’s stock.

On the one hand, this shouldn’t be all that surprising. For years now, both Buffett and Munger (more so Munger), have explained that the changing nature of Berkshire’s business – that is, away from an insurance-heavy operation to a more diversified conglomerate – make the per-share book value calculus less meaningful.

In this year’s letter, Buffett noted that:

Market prices, let me stress, have their limitations in the short term. Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge.

At the same time, going by the “classic” benchmark, Berkshire has underperformed in five of the past six years. I’d be surprised if somebody didn’t try to call out the duo on the apparent convenient timing of the new performance gauge.

3. You bought what at Berkshire?

One thing that Berkshire investors that attend the meeting can expect every year is a cornucopia of Berkshire-subsidiary products on offer, from Dairy Queen Dilly Bars to NetJets private-jet leases. Seriously, Berkshire investors get their shop on. Here’s what Buffett had to say about last year’s Berkshire rendition of Supermarket Sweep:

Last year you did your part as a shopper, and most of our businesses racked up record sales. In a nine-hour period on Saturday, we sold 1,385 pairs of Justin boots (that’s a pair every 23 seconds), 13,440 pounds of See’s candy, 7,276 pairs of Wells Lamont work gloves and 10,000 bottles of Heinz ketchup.

My personal goal is to buy something that will make my wife say…”You bought what at Berkshire?”

4. Kraft…

Buffett likes his “elephant hunting” and he did some for Berkshire in late March. Pairing up once again with Brazilian private equity firm 3G Capital, Berkshire agreed to buy Kraft Foods for around $50 billion. The Economist was none too impressed with the deal, writing:

Warren Buffett says he likes to buy companies that are easy to understand and are performing well. His latest deal, the $50 billion acquisition of Kraft Foods that was announced on March 25th, passes only one of those tests.

The article continues to clarify that while Kraft’s business is easy enough to comprehend, its recent performance hasn’t been terribly tasty.

My fellow Fool Alex Dumortier wasn’t as pessimistic, noting the incredible success that 3G has already had with the last team-up acquisition, H.J. Heinz. To be fair, The Economist did note that 3G “is the closest thing the consumer-goods industry has to a miracle-worker.”

The bottom line, though, is that the price tag for Kraft wasn’t especially cheap and the business isn’t thriving, so a “what’s up with that” question is bound to come.

5. “I have nothing to add.”

Charlie Munger is famous for curtly quipping “I have nothing to add” during the meeting when… well, when he has nothing further to add. On our live chat we will be sure to let you know every time Munger delivers his well-known line.

And for a fun Berkshire-inspired game that even the kids can enjoy: Eat a See’s Candy (or two) for every “I have nothing to add.”

6. …but then, there’s plenty to add.

Though Munger’s “I have nothing to add” is well known, it’s likewise known that when he does have an opinion on something he’s not afraid to share it. We can certainly expect that there will be plenty of this during the meeting as well.

Charlie on ethanol (2008): “The policy of turning American corn into motor fuel is one of the dumbest ideas in the history of the world.”

Charlie on gold (in a 2012 CNBC interview): “Gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939, but I think civilized people don’t buy gold, they invest in productive businesses.”

7. So, um, what up with Clayton Homes?

When you’re as large as Berkshire, you’re bound to find yourself in the crosshairs of controversy. That’s doubly so when you’re run by a CEO who says things like “we can afford to lose money — even a lot of money. But we can’t afford to lose reputation — even a shred of reputation.”

In the past, Berkshire has come under fire in the annual meetings for the disruption of salmon spawning by a dam owned by Berkshire subsidiary Mid-American Energy, as well as its ownership of PetroChina stock, which a shareholder proposal described as “the dominant international player in Sudan’s oil sector.”

This year, the heat will likely come from concerns over Berkshire’s manufactured-housing company, Clayton Homes. In early April, The Seattle Times published an article titled “The mobile-home trap: How a Warren Buffett empire preys on the poor.” The article alleges that while Buffett rails against shady mortgage practices, the company that he owns – and praised in this year’s shareholder letter – is “trapping many buyers in loans they can’t afford and in homes that are almost impossible to sell or refinance.”

8. The Berkshire movie

Every year, the meeting begins with a movie. That’s right, a movie. Well, it’s really sort of half-movie and half-advertisement for Berkshire brands and holdings (Coca-Cola COCA-COLA COMPANY KO -0.05% and Geico always seems to have prominent placement). What the movie lacks in plot and clear structure, it makes up for in cheap laughs and cameos.

Who will pop up in this year’s iteration? I’ve got my fingers crossed for Left Shark.

9. Tell us more about this car thing

Could it be that Jay Leno now has an Omaha billionaire that he can talk cars with?

In early March, Berkshire closed on the acquisition of Van Tuyl Group — one of the U.S.’s largest auto dealerships — and promptly renamed the group Berkshire Hathaway Automotive. Prior to the acquisition, Van Tuyl reportedly had $9 billion in annual sales, but Buffett wants to see the new subsidiary grow further. In late March he went on CNBC and said:

We’ve heard from a lot of dealers and we’ll hear from more, I’m sure. I’d be very surprised if five years from now, we’re not a whole lot bigger.

Berkshire also purchased $560 million in Axalta stock from Carlyle Group. While Axalta is a diversified coatings business — which fits in with Berkshire’s vast industrial holdings — its primary market is transportation. Axalta holds the No .1 worldwide position in supplying coatings for auto-repair shops and is No.2 when it comes to manufacturers of cars and light trucks.

And lest we forget, it was just in 2011 that Berkshire coughed up $9 billion to buy Lubrizol.

What’s next for Buffett’s burgeoning auto-empire? I’d certainly be interested to hear what the Oracle sees ahead for the industry.

10. Zombies in Omaha

The crowd at the CenturyLink Center in Omaha is expected to top 40,000 this year for the 50thAnniversary meeting. Any shareholder can attend the meeting, but none can purchase preferred seating. What does that mean? The same as every year: Investors will line up bright (technically, it will still be dark) and early to try to secure the best seats and the best views of Buffett and Munger.

This means that if you happen to be in Omaha on the weekend of May 2, but aren’t part of the Berkshire hoopla, don’t fret, those aren’t actually zombies wandering around Farnam Street and Dodge, they’re just exhausted Berkshire investors.

11. Entschuldigung Herr Buffett, aber was ist nächste für Sie in Deutschland?

As the Geschäftsführer for The Fool’s German-language website (Fool.de), I have a special interest in this one.

On February 20 of this year, Berkshire announced that it was acquiring German motorcycle-gear business Detlev Louis Motorrad. Buffett called the deal a “door opener” and crowed that “I like the fact that we have cracked the code in Germany.” Wie cool.

Buffett followed up with an interview with Handelsblatt, Germany’s answer to The Wall Street Journal. In the interview, Buffett said:

We are definitely interested in buying more German companies. Germany is a great market: lots of people, lots of purchasing power and Germans are productive. We also like the regulatory and legal framework.

I wholeheartedly agree and would be very interested to hear: Also dann, was jetzt Herr Buffett?(So then, what now Mr. Buffett?)

12. Just give us a hint

Every calendar quarter, large investors like Berkshire are required to deliver a so-called 13F filing to the Securities and Exchange Commission that shows their stock holdings. Berkshire last filed in mid-February, and we’ll likely see the next filing in mid-May – conveniently after the annual meeting.

In the last 13F filing, we found out that Berkshire had shed all of its holdings in ExxonMobil EXXONMOBIL CORPORATION XOM -0.79% – Buffett later explained to CNBC, “We thought we might have other uses for the money.”

Will there be any big moves this quarter? I doubt we’ll find out at the annual meeting, but that doesn’t mean that the question won’t be asked.

13. Run like the wind

If you’re a runner, you may be familiar with the Brooks running-shoe brand. If you’re a Berkshire shareholder you may know that Berkshire owns Brooks. But did you know that for the past couple of years Berkshire and Brooks have put on a 5k race the day after the Berkshire meeting?

The runners that come out for the “Invest in Yourself 5k” are no joke — last year’s male winner finished in a blazing 15:52. For the rest of us, it’s a matter of just trying to shake off a sleep deficit and an over-indulgence in See’s Candy. But, then again, what better way to burn of a few of those candy calories than by running a few miles?

Better still: Runners get a Berkshire-ized Brooks t-shirt and a finisher’s medal with Buffett’s smiling mug on it.

14. Want another question that won’t be answered?

Buffett’s successor: Who will it be? We won’t find out at the meeting, but it’s another “not to be answered” question that I expect to hear.

15. Oh right, the Berkshire business meeting

Believe it or not, sandwiched into all of the Buffett and Munger-y goodness of the Berkshire meeting and weekend is an actual business meeting. According to Berkshire’s annual meeting info, the business meeting will be held from 3:45 to 4:15 on the day of the meeting. In the years that I’ve attended the meeting, I can’t recall the business meeting lasting more than 10 minutes.

Then again, my perception of time by that point in the day has usually been compromised by the peanut brittle.

MONEY Fast Food

Why Chipotle Mexican Grill Going GMO-Free is Terrible News

Chipotle restaurant workers fill orders for customers on the day that the company announced it will only use non-GMO ingredients in its food on April 27, 2015 in Miami, Florida. The company announced, that the Denver-based chain would not use the GMO's, which is an organism whose genome has been altered via genetic engineering in the food served at Chipotle Mexican Grills.
Joe Raedle—Getty Images

Avoiding GMO foods might be a bad decision over the long run.

Some time ago, I wrote about the need for investors to adopt scientifically responsible investing practices. Apparently, Chipotle Mexican Grill CHIPOTLE MEXICAN GRILL INC. CMG -1.09% never read it.

On the quest to use “great ingredients,” Chipotle Mexican Grill removed from its menu most ingredients derived from genetically engineered crops. While “great” and “genetically engineered” aren’t mutually exclusive, the company’s press release and GMO website make emotional arguments to appeal to a loud minority of consumers and destroy its own logic in the process.

Truthfully, most customers will never taste the difference in ingredients or care to look into the company’s claims, but increased prices could unwind any perceived benefits in ridding the menu of genetically engineered ingredients. As could any public backlash from claims that don’t quite add up. All of that could negatively affect investors in the long run.

Will burritos become more expensive?

According to Chipotle Mexican Grill, the answer is an emotionally charged “no”:

While GMO advocates point to higher costs associated with producing non-GMO foods, Chipotle’s move to non-GMO ingredients did not result in significantly higher ingredient costs for the company, and it did not raise prices resulting from its move to non-GMO ingredients.

It helps to take a closer look at the ingredients that were replaced and exactly what they were replaced with. Given the prevalence of genetically engineered corn (94% of America’s harvest) and soy (93% of America’s harvest), it makes sense to either avoid corn and soy altogether, or find the 6% and 7%, respectively, that neglect to take advantage of biotech tools. Chipotle Mexican Grill elected to deploy a combination of those strategies. After all, it’s mighty difficult to make a flour tortilla without corn flour.

Here’s a breakdown of the new ingredients and those they replaced:

Old Ingredient New Ingredient Use
Corn flour (from genetically engineered corn) Corn flour (from non-genetically engineered corn) Tortillas
Soy oil (from genetically engineered soybean) Sunflower oil (no genetically engineered varieties exist) Frying chips and tortillas
Soy oil (from genetically engineered soybean) Rice bran oil (no genetically engineered rice varieties exist) Mixed into rice, used to fry vegetables
Soy oil (from genetically engineered soybean) Canola oil (from non-genetically engineered canola) Tortillas

So, will these ingredients be more expensive than their predecessors? It depends on the agricultural yield of the crops compared to genetically engineered corn and soy (the former would be lower), the cost of seeds (the latter will be higher), and the cost of inputs (the former will be higher). It’s a complex economic equation, although market prices do point to higher costs for Chipotle Mexican Grill.

In fact, The New York Times reports that using canola oil to make tortillas may result in “slightly higher” prices this year. The ability to pass costs to consumers should allow the company to keep margins relatively intact, but that may not last forever.

That leads us to ask: If the company could experience higher costs for its inputs, why did it decide to remove ingredients from genetically engineered crops?

#ChipotleLogic

Chipotle Mexican Grill launched a website to explain its rationale behind shunning biotech crops from its supply chain. Three reasons are listed:

  1. Scientists are still studying the long-term implications of GMOs.
  2. The cultivation of GMOs can damage the environment.
  3. Chipotle should be a place where people can eat food made with non-GMO ingredients.

The last reason is perfectly fine (although I would have chosen different language). Unfortunately, the logic doesn’t quite work out for the first two.

The company claims that there is no scientific consensus on the environmental and human health of cultivating and consuming biotech crops, citing a single petition signed by 300 scientists. A recent Pew research poll found 412 scientists that thought genetically engineered foods were “generally unsafe.” The only thing is, the other 3,336 scientists polled, representing 88% of the survey, said the opposite.

The company also said more independent studies are needed, since “most research was funded by companies that sell GMO seeds.” Yet, the Genetic Engineering Risk Atlas, a publicly funded non-profit, found that half of the studies on biotech crop safety randomly selected were independently funded.

The second claim is the most ridiculous. Chipotle Mexican Grill backs it up by calling out the overuse of pesticides, namely glyphosate, even calling attention to the World Health Organization’s recent designation as “probably carcinogenic to humans” (in the same category as emissions from frying oils and working as a barber). Why doesn’t this logic hold up?

It’s worth pointing out that “non-GMO” doesn’t mean “organic.” The sunflower, rice, and canola crops that contribute oils to the company’s new menu will still use pesticides and synthetic fertilizers, likely more than the crops they replaced. In some cases, that includes herbicide mixtures that use glyphosate. For instance, in California alone, over 222,000 acres of sunflower were treated with pesticides in 2012, including over 11,500 acres using some form of glyphosate.

It gets even more interesting. While the company was able to use canola oil instead of soy oil to make its flour tortillas, canola oil is a registered insecticide with the U.S. Environmental Protection Agency (link opens a PDF). In other words, this is a true statement: Chipotle Mexican Grill removed from its menu ingredients from genetically engineered crops to instead serve its customers an insecticide.

Of course, Chipotle Mexican Grill may be quick to point out that scientists state canola oil is safe for human consumption. And isn’t that exactly the point?

What does it mean for investors?

Investors may cheer the move by Chipotle Mexican Grill as an innovative step to respond to consumer concerns about food. But it could result in higher food prices for customers in short order. Perhaps the costs get passed along without any reduction in customer count, but costs can only be passed along for so long before people seek alternatives, and the company’s margins are negatively affected.

Additionally, rather than foster misinformation with emotional arguments to become the first fast food chain that avoids ingredients from genetically engineered crops, Chipotle Mexican Grill could have stood with science (like the Girl Scouts did) to position itself as a brand that provides a platform for a sensible middle ground for an even broader population. When the need for publicity trumps the need for making sound business decisions, I would hesitate to own shares.

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