Are executives really worth their pay

I recently read an interesting book called Retirement Heist which discusses the past and future state of pension plans from private industry. This was an interesting read from a couple of perspectives:

• Participant in the plan. If you participate in a private pension plan this book describes ways in which a company can reduce and eliminate benefits from the plan. An interesting point made in the book is that companies can use retirement plan surpluses to enhance income. There is also an interesting discussion about medical benefits and how even a slight reduction in medical benefits can serve as a legal precursor for a benefit elimination. 
• Investor. The book points out that there rank and file pensions are treated differently than executive pensions. Executive pensions are not required to be reported immediately (as are rank and file pensions) and thus can be treated differently (benefits not eliminated ...). Thus executive pensions, which sometimes exceed the cost of the rank and file pensions can be more difficult for investors to discover and thus make analysis of total compensation of a company harder.

What I find interesting is the double standard for compensation. The mutual fund industry, lead by Vanguard, has promoted low cost fund management. This even includes index funds that are essentially managed by a computer and thus extremely low cost to run. I am not convinced as an investor that the large compensation afforded to top executives are warranted for large companies. It would be an interesting experiment (like in the movie trading places) to replace an expensive management team with a low cost management team and see whether the executives really earn their money.

Why California is losing jobs

I found it interesting to read about a trip by Gavin Newsom to Texas to talk about jobs for many reasons:

• There was a reference to business friendly climate -- less regulation and power costs. This is always good for business of course, but I didn't see the most important factor for starting a business, the cost of doing business. This is determined by many things like the cost of living (a business needs to acquire supplies and hopefully have employees who get paid). The cost of living also includes things like taxes where California has a high sales tax, income tax, DMV fees, property taxes [the rates are reasonable in the 1% range, however the overall costs of living driving the housing prices up and thus the property tax outlay is high]. There is already concern that federal income taxes are to high but when adding additional state only costs this reduces the competitive advantage of business. 
• Why is the legislature just now realizing that business is moving or deciding on states other than California to do business ? This trend has been happening for many years and there have been some major job / employer losses, why did it take this long to see that there is something wrong. Of course, just pointing out that something is wrong doesn't address the issue so I am hoping something will come of this. 
• It was interesting that Texas was selected to visit instead of Arizona and Nevada, both of which have enjoyed the increase in investments from being neighbor states to California. 

I know that answers to complex issues are rarely simple; however, I think states can learn from something the mutual fund industry (especially Vanguard) has known for years that the higher the cost of running the fund the better the fund manager needs to do to beat the market (and if you believe in the efficient market theory, then nobody ever continually beats the market). The best way to maintain a competitive advantage is to keep the cost of doing business low. Governments can do this by maintaining low tax rates (and also consider the cost of filing taxes -- more complicated means additional costs [flat taxes or revenue based taxes reduce the need for complex tax management].

What should the government do to improve the economy

I was recently reading "The End of Prosperity: How Higher taxes will doom the Economy -- If we let it happen" which makes a lot of interesting points about national and international economic policies. What I found most interesting was the Laffer Curve, which shows government revenue increasing as taxes are lowered. This is in direct opposition to many current policies where an increase in revenue is attempted via a tax increase. This generally does not work as it increases the incentive to avoid paying the taxes. This will result in tax planning (looking for tax loopholes) and also reducing growth (thereby lowering the tax bill).

The book does a nice job of presenting IRS income tax data to prove the point (you can see when a tax decrease was implemented, revenue increased). Lower tax rates benefit the economy by allowing people to keep more of their paycheck (and also businesses to keep more of their profits). The book makes some interesting comparisons showing other countries tax rates and their economic growth. The lower the tax rate the more growth the economy is experiencing.

Other countries have been adopting the low tax rates of the United States (and lowering them even further) to stimulate investment in the economy. The investment comes as companies are attracted to countries which are growing and have favorable tax treatment (as this decrease the operating expenses). This trend can also be seen at the state level where high tax states like California are seeing business and economic migration to states with low or no income tax (like Texas and Nevada).

I think we should follow the economic policies of presidents like Kennedy (who was the first president to adopt the lower taxes high revenue policy) and Regan by lowering taxes thereby making our economy more attractive for investments.

What to do in the current economy ?

I am not sure how anyone can miss the recent news about the economy. Between layoffs, bankruptcies and federal bailouts it seems the end is near. I heard a wide range of advice from financial pundits (including Charles Barkley, the former basketball player) that runs the gambit from practical to irresponsible. I figured I would share my ideas; but more importantly what I am personally doing.

As mentioned previously, I subscribe to the Random Walk theory, so if you have been investing via a 401(K) or just simply dollar cost averaging, continue to do so. I don't think trying to time the market is practical (so don't try to cash out and put the money back in at just the right time) and historically if you were out of the market for only a couple of the big rally days you miss a significant portion of the gains. The best course is to make sure your stock portfolio is diversified, the S&P 500 (or a total market) index fund will serve you well in the long run.

If you are also a real estate investor (like I am), you might want to consider both the action being taken by the government both in the US and around the world. The housing market is vital to the economy, both for the economic stimulus and because it provides people shelter. In my opinion, the foreclosure will help the rental market as there will be more demand for rental properties. Also, the tightening of credit will force more former buyers into renters. The location mantra will still hold and properties in areas that will have a net migration of people will not fare well. There has been a lot of interest in buying investment properties in some areas, where vulture investors are buying bargain properties. This is a positive sign as there is money on the sidelines waiting for the right deals.

I am not an Oracle, so it is impossible to predict what will happen to the markets given the complexity but there are a lot of considerations:

• Given the recent increase in gas prices (hopefully people won't forget after the recent fall), I suspect the innovation in automobiles and public transportation (see the California initiative to build high speed rail between Northern and Southern California) will drive at least a partial recovery. This was the first time in a long time that people were actually changing their driving habits based on the significant gas prices. This is what caused the lease terminations for SUVs and low mileage cars. Reducing the dependence on foreign oil has a positive impact on the economy (think about where the money goes for $100 barrel of oil). Electric car fuel could be produced within the US, using solar, wind, geo thermal, and perhaps even nuclear power. This would provide more spendable income for individual households by reducing the monthly gasoline bills.
  
• Changes to executive compensation. The recent economic downturn has shed some light on excessive executive pay, there have been many recent articles like this one. AIG is not alone. I am firm believer in tying compensation to performance, just like the individual contributors.
  
• Health Care. The Obama administration has health care as one of the goals. This may change the landscape for drug companies and large health insurers.
  
• Retirement of baby boomers. The social security system is starting to feel the baby boomer retirees making the claims. There has been talk about privitizing social security (that would be an interesting investment in the stock market, might not be a bad idea) but I suspect the challenge will be to make sure this stays solvent without a massive budget deficit or tax increase. I have seen estimates of 40% vacancies which should help with the unemployment numbers (assuming retirees have saved enough to retire).

The best advice is to hold your course. Don't hole up and think the world is coming to an end but don't spend like it is either. Continue with a well diversified investment strategy (if you don't have one start a 401(k) or buy your first house). If nothing I have said yet has made you feel any better, consider this all you hear about on TV is the financial apocolypse is near, so the more you hear this the more you should start distancing yourself from the herd. If you wait until you only hear positive things, it will be late. You will be buying high and then later selling low.

Suggestions on how to improve property management agreements

One of the complaints with property management agreements is the incentive structure is not always consistent with the landlord. Here are some common fees and whether they have property manager and landlord interests aligned:

• A monthly fee based on the rents collected. The landlord and property managers interests are aligned. 
• A maintenance oversight fee. The property managers interest is to achieve the highest fee which could lead to inflation of the repair price. 
• Resigning fee less than the advertising fee for finding a new tenant. In this scenario, the financial motivation would be to find a new tenant as the property manager could potentially get the advertising fee as well as the oversight fee for repairs (if any). An unscrupulous property manager could promote turnover leading to increased maintenance and repair costs. 

A goal would be to have property management agreements align interests with landlords. For example, an incentive based bonus based on the year over year operational costs would provide additional incentives for reducing repair costs and turnover. 

Working with Property Managers

Real Estate for most investors requires securing tenants to rent the property while waiting for the property to appreciate. One way to manage a property is to employ a property manager to find tenants, collect rent and oversee repairs. The concept of a property manager is considered by some a necessary evil as the investments don't necessarily present themselves where it is practical to self manage (or if you are like many investors don't have time to do this yourself).  In case you need to use a property manager, here are indicators of a good property manager:

• Available and responds promptly to your desired communication medium. I like to use email because of its asynchronous nature
• Has relationships with repair vendors. Some property management companies do their own repairs. This is not necessarily a red flag, but you want to make sure the repair costs are reasonable. One thing to be aware of is that many property management contracts charge a fee for overseeing repairs, so make sure the repairs costs are not artificially inflated. 
• Perform periodic property inspections. This can help detect problem tenants early. 
• Own their own investment property. This will help them think from an investor perspective. 
• Advertise effectively for the market. Craig's list is effective in markets like Phoenix. 
• Distribution of rent. Some property managers offer direct deposit which will save a trip to the bank and the mailing time.
• Relationship with a collection manager. Occasionally you may have tenants who break the lease, move out without paying, or damage the property. Turning them over to a collection agency can help you recover some of the money as well as possibly impacting the tenants credit. 

Real Estate Investing

Real Estate investing is also a very popular vehicle for investing. Real estate investing provides several ways to make money:

• Appreciation - this is the difference between the price you paid for the property and the price you get when you sell.


• Depreciation - The non technical definition of depreciation is the amortized value of the non land value of your property. Property requires maintenence, so you are able to depreciate (one thing to be careful of here is that your income deteremines how much depreciation you can claim on your taxes) the structure over the amortization schedule. The value you get from depreciation is deducted from your taxes (so you can get the value*tax rate) so you can realize this before you sell, but when you sell the depreciation taken is added on to the basis.


• Rent - The expense of maintaining investement properties can be offset by rental income. If the rental income exceeds your monthly expenses, then this is referred to a cash value property and you will have income from this property.


• Equity - this is the amortized portion of your debt service. The equity you build is your money, once the loan is paid off or a cash out refinancing occurs

Real Estate is a somewhat more hands on investement as you actually own the property and have to be more involved than in equities where you need to just write a check.