Ask An Ex-Banker: Is the Finance Game Rigged Against Outsiders?

Q: A question for debate:

We all seem to get mad that the financial-industrial complex is repeatedly rigged for the Big Boys.  I’d suggest to you that the public should just give up on the wall street-banker/big bank/mutual fund industry as having any possibility of being fair to you or me.  Thus, it makes no sense to be mad at it.  Instead, people should invest the way their grandparents did: bonds, cash savings in a local bank or a hole in your backyard, real property, and (if they’re savvy enough) businesses or stocks that they understand.  –Michael G., San Antonio, TX

 

This is a really good question for debate, Michael, and I agree with some of the spirit of it.  I suspect millions of people have had a version of this thought, wondering if they’re the suckers at a rigged game and whether it’s time to take their marbles and go home – to bury their savings in the back yard or the local bank.  But while I’m sympathetic with the question, I disagree on the actionable consequences of your view.

I particularly like your suggestion, paralleling Michael Pollan’s food movement of the last few years,[1] to do only what your grandparents would recognize as investing.  There’s virtue in simplicity, and you could not go too far wrong that way.  Many of us have an imaginary Amish pastoral scene in mind as a balm on a particularly confusing day.  The horse-drawn buggy approach to financial life could be a good financial life.

I’m not willing to actually go along with the Amish pastoral investing life, however, either in my own life or for people who ask me my opinion on what they should do.

Mutual funds, to pick the most beautiful of the babies you’ve tossed out with the bathwater, are just like some of the other totally awesome things we love to complain about.  If you’ve got money to invest, with a few clicks or a simple phone call, you can own a piece of a wide swath of the world’s most successful companies.  At any point in your lifetime, should you choose, you can get your investment back with a similar amount of effort, with a day’s notice.  Real property investing doesn’t work that way.  CDs don’t work that way.  Private business investing doesn’t work that way.  Our grandparents had to wait for the end of their 6 months (or whatever time) period to get their cash out of CDs, or possibly years to liquidate their real estate or private businesses.

ETFs, the ADHD sufferer’s version of mutual funds, are similarly awesome, if used correctly.  You can even invest in a wider variety of instruments than mutual funds, including currencies, commodities, real estate, in addition to the opportunity to short markets and take on leverage.

As a recovering hedge fund manager, I also obviously maintain a soft spot in my heart for hedge funds as a way to access a still wider variety of investing strategies.  As a former mortgage bond salesman as well, I could similarly wax poetic about a whole universe of investment vehicles with an alphabet soup of acronyms that, like an Elizabethan sonneteer declaring his undying devotion, would make you long to  possess a super-senior CDO linked to a basket of credit default swap positions.  Ah, financial innovation…But I digress.  Where was I?

In sum, I’m actually a fan of financial technology, albeit with one important caveat that I think will link back to your original question, about whether the financial game is incorrigibly rigged for the Big Boys.

Not to be too John Kerry about it, but my answer is No, and Yes.

I infer that what you mean by “rigged” is the idea that insiders cheat in sufficient numbers to leave outsiders at a severe disadvantage when it comes to earning a fair and worthwhile return on capital.

I disagree.  In my fifteen years in the financial industry I saw no evidence of widespread cheating.  On the contrary, I can honestly say I trust “the system” in our country to treat outsiders far more fairly than any other industry I’m aware of.  I would also trust our system in the US better than any other country’s financial system, based on quite a bit of anecdotal and experiential evidence across borders.

Where I would blanket-statement agree on the rigged part for your average outside investor, however, is in costs.  The insiders depend on your ignorance of the cost of their product.

Most investment products designed in the past 50 years are compensation schemes for insiders.

Hedge funds are the most egregious example, of course, as knowledgeable insiders correctly and dismissively refer to hedge funds as ‘compensation schemes masking as investment vehicles.”

Products like retail ETFs, primary designed to encourage high-frequency day-trading, wrap up a casino-like product in an investing package, for the benefit of the house casino.

Even the mutual fund industry typically charges far more than is necessary to accomplish what are really simple tasks with minimal value-added.

Fees to insiders in all of these areas remain stubbornly high and extremely difficult to track down for the average outsider.  In no other area of life do we willingly purchase a product costing many thousands of dollars without asking about the price of the product or attempting to price-shop the product.

I can’t emphasize enough how much of the inside game is devoted to convincing outsiders of the ‘special sauce’ of a particular investment vehicle.  Contrary to what the insiders want you to believe, simple would generally be better and low cost would be best of all.

I linked to this page before, but it bears repeating.  I have no link to this investment advisor, I’ve never met him, and I just found his stuff a month ago.  Do yourself a favor, print out pages 9-12, post them on your bulletin board, and refer to them frequently when considering where and how to invest.



[1] He famously advised people to avoid eating anything your great-great-grandmother wouldn’t recognize as food.  Incidentally, my great-great-grandmother ate a lot of Nutella.  In my own mind.

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Ask an Ex-Banker: Annuities!

Q: I am thinking about buying an annuity.  I want to generate dependable income,  BUT,  how do I make sense out of whether or not an annuity is a good investment in addition to providing a degree of comfort.  The tradeoff seems a big gamble,  i.e. how long I will live.  –Captain Bill H., Friendship, Maine.

A:  Apparently annuities are a growing segment of the retirement market, so Bill, your question is timely.

I thought it would be useful to explain how a banker thinks of an annuity.  By “banker,” I also mean to explain how your insurance company thinks of the annuity they’re offering you.

From the banker’s – as well as insurance company’s – perspective, an annuity is a great deal, and it’s not a gamble.  From your perspective, the story is more mixed.

HOW A BANKER OR INSURANCE COMPANY THINKS OF AN ANNUITY

First off, your insurance company – despite what your friendly insurance broker may tell you – does not offer you the annuity to “guaranty your financial health,” “generate dependable income,” “protect your loved-ones,” or to “make sure you have sufficient income in your retirement years.”  The insurance company, instead, is an investor maximizing its profit.  When considering an annuity, let’s always keep that in mind first.

Now, like all for-profit financial companies in the known solar system, your insurance company seeks to buy money cheaply and to sell money expensively.  This falls under the well-known investment activity: “Buy low, sell high.”

I do not mean to be obtuse when I write “buy money cheaply,” since to the non-financial person “buying money” may begin to sound like Orwellian tautology, but bear with me for a moment.  Financial people -including the people who employ your friendly insurance broker – definitely think of their business as buying cheap money and selling expensive money.

Now let’s briefly peek ahead at the Answer Key in the back of this blog: your annuity represents an opportunity to buy cheap money for the insurance company.

Ok, back to the main text of my answer.

All insurance companies need a massive pile of money to operate,[1] so they constantly evaluate the best ways of buying money.  When acquiring money, insurance companies have a choice of where to get their money.  I’ll run through the three main ways:

  1. Sometimes insurance companies acquire equity capital through the sale of shares to private or public stock investors.  In other words, the companies sell part of themselves to other owners, in exchange for money.  All publically owned insurance companies have done this.  Equity capital is typically considered extremely expensive money, so insurance companies do this only as a last resort.[2]
  2. Often insurance companies acquire debtor capital money, otherwise known as borrowing, possibly from a bank but more commonly in the form of a bond from institutional investors.  An investment grade insurance company[3] may be able to borrow $1 Billion for 10 years right now at, say, 4% in the bond market. This means the insurance company gets use of $1 Billion, it pays $40 million per year in interest for that privilege, and then it returns the $1 Billion in principal at the end of 10 years.  Since rates are historically low right now, and the institutional bond market is extremely efficient at providing capital to insurance companies, this is a great way for insurance companies to acquire money on the cheap.
  3. And finally, there’s rock-bottom cheap money: your annuity.[4]  Given all the costs of acquiring you as a customer[5] and servicing your annuity for your life, plus the retail nature (ie. small size) of the money you’re providing to the insurance company, you would expect this money to be VERY cheap indeed, to make it all worthwhile for the insurance company.  Again, remember, they don’t actually care about all the comforting things President Palmer talks about during the Allstate ads.  To provide you, the customer, with an annuity, it’s got to be really cheap money.  If it wasn’t super cheap, they would just borrow money from the bond markets.

How cheap is cheap?  I just went on my own personal preferred insurance company/bank’s website[6] and applied for a $100,000 annuity.  I’m 40 years old and applied for a lifetime monthly annuity, with a (fairly typical) 20 years of guaranteed payments.[7]  In exchange for my upfront $100,000, the company offered $358.39/month for the rest of my life.  The company guarantees that, even if I die suddenly, the first 20 years, or 240 monthly payments, will be paid to my heirs, for a guaranteed payment amount of $86,013.60.

Now, if you’ve been following closely up until now, you’ll already know that I set up my answer to Bill’s question as a less than ringing endorsement for annuities, but the actual quote allows us to see exactly how good or bad the annuity opportunity is in pure financial terms, for both the insurance company and the annuity buyer.[8]

The insurance company will never tell you the cost of borrowing money from their perspective, but I will share with you what their cost would be for my specific annuity.

If I live my expected[9] additional 37.8 years to the ripe old age of 77.8 then the insurance company’s cost of money is 2.79%.[10]  Another way of thinking about the calculation is that I would earn 2.79% annually on my $100,000 for the next 38 years if I am lucky enough to live that long.  If I’m unlucky, and live fewer years, then my insurance company effectively borrows money at substantially less than 2.79%, possibly below a 0% cost of funds.  In that early death scenario, they get money that’s cheaper than free!  Equivalently stated, the % return that I receive on my annuity could be negative if I die before my expected time.[11]

If, instead, I live as long as I expect to live, that is to say, until age 100,[12] then my return can be as high as 3.84%, and the insurance company’s cost of funds is equivalently 3.84%.  Notice this is still below the 4% they can expect to pay to borrow money in the bond market, making an individual annuity worthwhile to them even if I far exceed my life expectancy.

Let’s take another example.  Let’s say Bill, the original questioner above, is a 70 year old man, who can expect an additional 13.7 more years, according to the Social Security actuarial tables, living to the wise old age of 83.7.  I applied online to my same insurance company as a 70-year-old man,[13] willing to take just 10 years of guaranteed payments (a reasonable scenario rather than the 20 years of guaranteed payments that a 40 year old might want.)  For his $100,000 annuity premium, Bill could expect to receive $597.19/month for the rest of his life with 120 guaranteed payments.

What is the insurance company’s cost of funds in this case, and conversely, Bill’s expected return?  If Bill lives to his expected life-span, he would receive a total of $98,536.35, or less than he paid upfront for the annuity, for a negative return on his money.  In other words, under a reasonable baseline scenario, the insurance company acquires money at a negative rate of interest.  That’s better than free!  That’s awesome.  If you’re a death-eating, snake-tattoo-on-your-arm annuity provider, of course.

Now, if Bill also lives, as I’m sure he expects to, until the ripe age of 100, he can expect a much improved 5.92% return on his investment, while the insurance company conversely incurs an expensive cost of borrowing from Bill, at 5.92%.  However, the insurance company has wisely balanced the probability of free money under an ordinary scenario (Bill lives to his expected life span) versus the very remote probability of maxing out at 5.92%, if Bill hangs on to this mortal coil for a whole century.

Now, I have few rules in life, but one of them is that when you can acquire money somewhere between free and 5.9%, with the probabilities skewing much closer to free, well then you should acquire as much money that way as possible.  And figure out what to do with it later.  Like, for example, build massive skyscrapers with your money.  In a related piece of news, has anyone else noticed that insurance company skyscrapers dominate most major US city skylines? Your death, plus your neglect, help make this happen.  I’m just sayin’.

 

 OTHER FACTORS BESIDES RETURN/COST OF FUNDS – SAUSAGE MAKING

In addition to the cost of money for an insurance company, it’s worth understanding another reason insurance companies seek to provide annuities.  Most annuity providers are also life insurance companies.  This makes sense in the same way that a sophisticated slaughterhouse might provide both premium sausage meat and processed hog food, as one customer’s premature death is balanced by, or better said, hedged by, another customer’s unfortunate longevity.

What do I mean by this?  A life insurance policy allows the insurance company the opportunity to collect regular, moderate – typically monthly – premiums.  For that opportunity, the insurance company has the obligation to pay out a substantial lump sum upon the death of the insured person.  An annuity is the mirror image of a life policy.  The insurance company has the opportunity to collect a substantial lump sum up front, and then takes on the responsibility, or liability, to pay out regular, moderate – typically monthly – premiums.  When the life insured customer dies, the insurance company “loses.” When the annuity customer dies, the insurance company “wins.”  When a company can offer both life insurance and annuities simultaneously, it creates an efficient kind of perpetual sausage-making machine in which money can be continually bought cheaply and sold expensively.

A rash of deaths causing a string of sudden life-insurance payouts can be compensated by a release of the obligation to pay ongoing annuity income to the newly dead.  It all works out nicely.  If you’re an insurance company.

 

SHOULD BILL GET AN ANNUITY?

Now that we know the range of investment returns we can expect on an annuity, does it make sense to purchase an annuity, Bill’s original question?

The answer to Bill’s original question is obviously more complex than can be understood in terms of cheap money and expensive money, even if that’s the primary lens of a banker or an insurance company.

The appropriateness of an annuity for any individual owes quite a bit to the individual’s appetite for risk.  To return to geometry class, picture the XY axis where X shows an arrow of increasing risk and Y shows an arrow of increasing return.  The annuity represents one of the lowest risk and return assets you can possibly acquire, pretty much right next to the 0,0 point on the graph, just above and to the right of straight cash.

If you don’t mind providing free money to insurance companies, and you quite like the idea of cash-like returns, then annuities could be just the thing for you.  When you think of if that way, annuities are a perfectly reasonable cash substitute.  Despite S&Ps recent warning, State and Federal regulators manage to make the insurance industry a safe place to park funds for life, as long as you understand a) that the return will be terrible and b) the insurance/annuity provider will never, ever, tell you the return you are getting.  That information, if disclosed, would embarrass them.  And it’s hard to build skyscrapers when you’re feeling embarrassed.

 

For more on annuities and using the mathematics of discounted cashflows to evaluate them, please see this post:

Discounted Cashflows – Using the math to evaluate an annuity.



[1] Like a bank, the main requirement for operating an insurance company is to have a pile of money.  None of the other functions and requirements for operating an insurance company matter much if you don’t start with a pile or money and then maintain it at all times.  Once that pile of money shrinks, it doesn’t matter how good you are at the rest of the things that go into being an insurance company, you’re out of business.

[2] Like for example how Credit-crunch-poster-child-insurance-company AIG sold $17.4 Billion worth of shares in 2012, because, well, how else are they going to get money?  No one wanted to give them money anymore since they were a root cause and casualty of the 2008 Credit Crunch.

[3] I acknowledge “investment grade insurance company” is a bit of a redundancy in the US context, since non-investment grade insurance companies are generally not allowed to operate, but rather are put into a special receivership status by federal or state regulators, and their portfolios allowed to run off over time.  Sometimes this takes decades.  I have invested in annuities like this via my investment business, but I digress.

[4] It may not have been apparent to you as an annuity customer until now, but essentially you’re lending money, just like a bond, to the insurance company.  Instead of a $1 Billion loan in the form of a bond, you might turn over $100,000 up front in the form of an annuity.  But then – just like a bond – the insurance company has an obligation to provide regular payments back to you in exchange for use of your money.  One great aspect of this loan-in-the-shape-of-an-annuity, is that the loan isn’t limited to, for example, 10 years, like a bond.  In fact, the loan is forever.  You see, the really cool thing about your loan/annuity, (from the insurance company’s perspective) is that they never have to pay you back the principal!  You just die, and they keep the $100,000 of your money!  Seriously, how great is that? The answer is: very great, as long as you’re an insurance company.

[5] Advertising, monthly statements, fund transfers, investment disclosures, customer service for your lifetime, plus all those drinks your insurance broker provided you at the Golf Club…none of this comes cheap people!

[6] I do all my banking and insurance with USAA because their customer service absolutely rocks.  It’s leaps and bounds better than any other major customer service business I’ve ever dealt with.  Regardless of their customer service awesomeness, I believe their annuity quote to be typical.  Let this footnote serve as my unsolicited highest endorsement of USAA, although there’s no absolutely no tie between me or Bankers Anonymous and USAA.  But I kind of wish there was.  USAA, hit me up, I could be your President Palmer.   Call me, maybe.

[7] Just to walk you thought the thought process if you’ve never applied for an annuity, its common to request an annuity quote for lifetime payments with some period of payments guaranteed to avoid the “I bought the annuity today for a big premium but got hit by a bus next month” problem that most annuity buyers would never be able to overcome.  So, typically you buy lifetime payments and the annuity/insurance company agrees to pay your designated heirs at least some year’s worth of payments if you die suddenly.  For a relatively young person a 20year guarantee is not atypical.  A much older person might choose a shorter guaranteed payment period, like 5 or 10 years guaranteed.

[8] Incidentally, I’m 99% sure that insurance companies never provide a % return estimate for annuities of the type I’m providing in the main text paragraphs to follow.  So the fact that I’m providing this clear-headed financial return analysis may be largely attributed to two factors: a). I’m your best friend, and b). Insurance Companies are not your friend.

[9] Have you ever wondered what your expected lifespan is, as well as your probability of death in any given year?  The Social Security administration has the answers.   Not only am I your best friend, but I can predict your date of death as well.  Weird.  It’s like I have special powers.  Anyway, you’re welcome.

[10] How did I get this % interest rate?  I’m kind of glad you asked.  Join me a little way down the financial rabbit hole.  I got there by applying a single Discount Rate to a formula for figuring out the present value of all the expected future cash-flows.  What is a Discount Rate?  That’s the single % rate I can apply to all the future cash-flows of an annuity which add up to $100,000 (my original annuity cost).  The formula for each single cash flow is “Nth Annuity Payment” in the numerator divided by a denominator of (1+Discount Rate/12) raised to the power  of the Nth payment.  I know this makes absolutely no sense if you haven’t already worked with the formula before, but my wife made me put it in here.  I’ll tell you what, how about some curious and astute reader sends me a note asking me to explain discounted cash flows and I’ll do a whole post about it sometime soon.  Is that a deal?  In the meantime, trust me that this is how every bank and insurance company evaluates the amount they’ll pay you for your annuity.

[11] If you have a paranoid frame of mind, you can see how the annuity provider begins to resemble a financial vulture, hoping for your premature demise so they can get free money.  Does the flapping of their wings smell like death to you as well?

[12] In the year 2072, I’m comforted in my old age by my bedside Rihanna clone – scientifically engineered to remain 24 years old.  I die quietly in my sleep on our hovercraft, while she lullabies “SOS” until a pass to the next world.

[13] Let’s just agree to call me Harrison, shall we?

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Interview Part II: A Member of the 1% on Mitt Romney and the Death of the American Dream

Please click above to listen to full interview.

I continue the conversation with Jim, a member of the 1% who made his career in advertising to the high-end consumer, and who has studied the stratification of America professionally.  We spoke about the problem Mitt Romney will have portraying himself as a “Job Creator,” the disappearance of the American Middle Class, and the implications of that disappearance for the publishing business.

Click here if you would like to listen to Part I of this interview.

Jim: My name is Jim, and I’m a former publisher of a major, national, luxury magazine.

Mike: Thank you for joining Bankers Anonymous this morning.

On Mitt Romney as a “Job Creator”

Mike: I liked what you said in an earlier conversation about the trouble that the nominee Mitt Romney is going to have in arguing that he is a job creator, and I just thought you summarized in a funny way basically what the Democratic argument is going to be against him as a Bain Capital guy, which has gotten some press – after you said it of course.  Do you mind telling me your thoughts on that – the problem of Mitt Romney as a job creator.

Jim: Sure.  I mean, when you’re an executive of any company – certainly I can speak for myself, in the publishing industry – whenever you have a good year, you aren’t looking to ‘create more jobs.’  You’re getting pressure from your investors, or your boss, or your corporation, or your partnership, to actually squeeze more profit out of whatever you’re doing.  And usually the fastest way to do that is to keep your head count down.  So this idea that given the chance to invest and spend you’re going to add a ton of people to your payroll is absurd.  In fact, you’re going to find ways to outsource all of that, to NOT hire that person.  So you don’t have to pay them health insurance, to have it done in Indonesia, or overseas, and to find ways to use technology to save costs.

So this idea of executives dying to create jobs is absolutely absurd, in fact there’s a tremendous amount of pressure from the top to, when you hit a certain profit level, to see if you can hit that same number, with less people.

Mike: Mitt Romney is the ultimate, he will become the symbol this Fall of the ultimate 1%er.  The difference between how he knows how things really work – which is like you just described: Investors need to cut jobs not add jobs – and what he needs to say to get elected…The gap is so wide that as you and I, [who] have been inside that world of the 1%ers…it’s extraordinary to hear what he knows must go on, and that he has done, and what he has to say in order to be elected.  It’s really an amazing gap.

Jim: Yeah, and I wonder sometimes this whole idea of repeating a mantra over and over and over again. He’ll give a speech in Iowa to a predominantly middle class group, and the language he uses over and over again I think you begin to believe your own press releases, and your own dialogue.

 

On the Disappearance of The Middle Class and the American Dream

Mike: One of the thoughts that has occurred to me in the Occupy Wall Street Movement and to some extent the Tea Party – mirroring them on the other side – is that as a country we have this idea of “everybody has a chance to make it” and we’re somewhat of an egalitarian society, and we don’t talk about severe income and wealth stratification as if it exists.  Everybody’s middle-class.  We have this illusion that everyone is middle-class.

And yet what’s changed is in fact these two movements are basically saying “No, there’s a group of elites who are permanent.  And we can’t access them, and they don’t care about us.”

And yet you were talking to elites about this idea long before it became part of the public dialogue.

Jim: I mean, what people don’t know is we have the most stratified income and wealth inequality of any democratic, industrialized country.

In the history of America the whole zeitgeist is “The land of opportunity, for everybody.”  The Horatio Alger myth: “If you work hard you can pull yourself up by the bootstraps and you become part of this top 10%.  I happen to not believe that that is as easy to do as it was before, for a lot of different factors which I can go into, or not go into.

Mike: the myth has gotten more mythical and less real over time.

Jim: very mythical.

Mike: it’s a very helpful myth.  It is a very good story that we tell ourselves.  But the question is: Is there a reality behind the myth?  And that’s unclear.

Jim: You know, you look at what the wealthy have done to drive up the cost of education at the University level.  I mean how many people can afford $35,000 per year minimally to go to these colleges, and end up in that top 1 to 10% unless your parents are already in that top 1 to 10%?  And remember, the number of jobs involving physical labor or simple mechanics and engineering just don’t exist.  That’s what drove the middle class in America.  And as corporations and executives try to cut costs, and thus to pay themselves more money, because most executives are paid on profits, they lay off the people, replace the people with technology, and then outsource everything else they can to another country.

So what do you do when you don’t create those big middle-class jobs that we used to have an America?  We have to educate the workers, and once again the system is rigged.  That unless you have enough money to educate your children, you’re at a serious disadvantage.  So, I think because of globalization and technology [I would say to] the people who continue to say “hey with a little hard work you too can do it,” that was true in almost every part of American history, but because of globalization it just simply is not a reality today.

 

On The Disappearance of the Middle Class As Seen in the Magazine Business

Mike: Yeah.  I want to ask you about the magazine business.  I think what you’re saying is that advertisers are saying, “No, we do care about at least the top 10%” – or at least people with access to credit – which is middle, and upper-middle [class] aspirational buyers.  But they rejected your idea of the stratification, not so much on this illusion of American equality but more just because they actually just believed [Middle-Class consumers] had money to spend, which was only based on credit.

Jim: Yes they believed they had money to spend.  And, yes they did have money to spend, but it wasn’t real money.  It was borrowed money.  And eventually, eventually the banks and credit card companies are no longer willing to lend it to them.  So they had no wealth creation, they had no income gains when adjusted for inflation, and once they didn’t have credit they felt their lifestyle change dramatically. And then they started to look at how unfair the system really was, and how bad the disparity has gotten.

Mike: You were appealing to luxury advertisers.  And your competition to some extent was trying to appeal to the middle-class, mass affluent, people with some disposable income.  Do you have any sense what happened to them?  Was that just an error they made, when we went into recession?   Are those magazines dead?  Hurting? Will come back? Do you know where they stand versus the magazines like yours that appealed only to the truly wealthy.  What’s the relative performance – do you know?

Jim: Yes, there’s definitely some evidence that the magazines that strayed from their original luxury mission – pure luxury with a pure editorial product that appealed to that top 1 to 10% – during the boom times when the aspirational consumer seemed to be spending as much on luxury as the affluent consumer a lot of these magazines chased that aspirational consumer.  Made their articles more accessible, dumbed down the editorial a little bit, and for a short period of time were very successful doing it.  They saw their circulations go up.  They saw their ad pages go up.  And unfortunately when it became clear that that aspirational consumer wasn’t going to be able to buy the products that were featured editorially, and featured by the advertisers in the magazines, a few of them actually went out of business.

You look at a magazine like Gourmet which had been exclusively for the high-end consumer, they became much more accessible: shortened the recipes, talked about value, talked about fast food, TV dinners.  I mean everything that would have been anathema 10, 15, 20 years ago.  And they’re actually out of business.  Another example would be House and Garden magazine which catered to the aspirational consumer – kind of just under the Architectural Digest super-affluent consumer – and they too went out of business because they got lost in the middle.

I think it’s very tough for any brand to target that middle-end consumer – whether it’s J.C.Penney or whomever else because it simply doesn’t exist.  You have two classes: the high-end and the low-end.

Mike: And that doesn’t seem to be changing anytime soon.  If you were to look what is the future of magazines or anybody appealing to the middle-class or the very cost-conscious consumer, it must be very tough times.

Jim: You know the magazines that cater to the Walmart consumer, or the CVS or the Target consumer, whether it’s Cosmopolitan magazine, Good Housekeeping, or Glamour , those magazines are doing very very well.  A lot of the editorial is the “Look for Less” or “How to Get that High-End Look For Less Money,” how to get that high end skin cream for less money.  “What are the products available at the lower end stores that still look like $1 Million Bucks.”  Those magazines are thriving, and at the very top-end magazines like Departures, and Robb Report and Architectural Digest are doing very well also.

 

Want to hear more from Jim?

Part I of the Interview with Jim is here.

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The Rise of the Machines

rise_of_the_machines

SkyNet made its mark on US stocks again this morning at the market open, as about a dozen companies saw their shares jump or plummet wildly in the opening minutes on the New York Stock Exchange, on exactly zero news, most likely due to computer-driven orders, and with no human input.

Outside of the specialized world of stock trading, many retail investors probably do not know that an estimated 80% of US stock trading volume is based on computer-programmed buy and sell orders.  In other words, 4 out of every 5 dollars flowing through stock exchanges has no human decision-maker behind it.  Stocks trade only a programmed response to preset algorithms.  At this point, SkyNet completely dominates stocks.

How did this come about?  High Frequency Trading firms (HFTs) seek to profit from predictable responses of some shares to the movement of other shares and market inputs, but HFT computers need to execute trading orders in fractions of seconds in order to benefit from their ability to see the immediate predictable future.  Since humans cannot act fast enough, the machines have been programmed to trade in their place.

When things in stocks get really screwy, as they did this morning, and as they did most dramatically during the 2010 Flash Crash, we’re reminded that the humans are no longer in charge.

Lobbyists for the HFT firms have already come back from the future and are visiting the offices of our Congressman one by one to eliminate any Sarah or John Conners that seek to regulate HFT’s role in US stock markets.

 

Please see related book reviews:

Inside the Black Box, by Rishi Narang

Flash Boys by Michael Lewis

Critique of Flash Boys by Pete Kovac

 

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