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--- Begin Message ----Caveat Lector- Gary North's REALITY CHECKIssue 310 January 16, 2004 LAKE WOBEGON INVESTING All the women are strong, all the men are good looking, and all the children are above average. Thus has Garrison Keillor described Lake Wobegon since 1985. His politically correct categories -- strong women, good looking men -- hardly anyone remembers, but the heart of the matter, children's performance, everyone remembers: the children are all above average. "Ha, ha," we think. "How silly. My children really are above average, but not 50% of the children up there in Lake Wobegon." It turns out that 90% of the employees of the tax- funded education establishment in the United States graduated from Lake Wobegon High School, attended Lake Wobegon Junior College, and graduated from the University Minnesota, Lake Wobegon Campus. In his 1989 report, "How Public Educators Cheat on Standardized Tests: The Lake Wobegon Report," West Virginia physician John Jacob Cannell reported that 70% of all students and 90% of all schools were at or above average according to standardized test results. http://speakout.com/activism/opinions/2856-1.html There are two major explanations: (1) the people who devise the tests structure them so that more than half of the students achieve results above a score of 50; (2) teachers "teach for the test" and in other ways cheat on the test. Cannell continued his investigation. Posing as a superintendent, he contacted a testing company. A saleswoman implied that scores for the poor rural district whose name he used would be above average if they used one of the company's older tests, and that their scores would go up every year. http://www.heinemann.com/shared/onlineresources/E00360/lake_wobegon.pdf The Lake Wobegon phenomenon has invaded every nook and cranny of American life. Nowhere is it more embedded, or more ignored, than in investing. LAKE WOBEGON INVESTMENT STRATEGIES Most Americans investors think they are living in a suburb of Lake Wobegon -- not the nicest one, of course, where the rich people live, but in an upper middle class section of town. Small as Lake Wobegon is, only a few of its residents have ever taken a drive through the entire town. They have spent almost no time in the homes of other residents. They have never discussed investment strategies with others in a different part of town. Had they done so, they would have discovered a curious fact: 80% of the town's investors are investing in the same markets and the same companies. They also have the same exit strategy: sell their investments during their retirement years. Furthermore, only about 20% of the residents actually have an investment portfolio, other than their homes, most of which are heavily mortgaged. Everyone in the 20% group expects his portfolio to perform above average. Not way above average, of course. Twenty percent above average sounds right. Maybe 25%. Folks in Lake Wobegon aren't greedy. Something else: people in Lake Wobegon feel uncomfortable when they stand out in a crowd. They are all agreed that conformity can be taken too far. Yes, they rejoice in diversity. Diversity is the American way. It's just that they prefer to participate in America's diversity in ways not too different from the ways that their neighbors are participating. When selecting their place in society's bell-shaped curve, most Americans want to be close to the point where the clapper is attached to the bell, not down at the sides where the clapper strikes, making all that noise. Yet when selecting their ideal location in America's economic curve, wherein investors reside heavily on the right-hand side, they don't want to be in the middle of a bell-shaped curve when they retire. They want to be above average. They want to be in top 20%. In fact, they want to be in the top 50% of the top 20%. In shirt, they want to be above average within the top 20%. This isn't as easy as it sounds. But people whose children are all above average think it sounds easy enough. "Buy low. Sell high." "Buy stocks and hold." "Stocks always go up in the long run." "Buy a stock market index fund and hold." "Compound interest is the eighth wonder of the world." --- Advertisement --- Earn up to 668% With the Secret That Will Squash al Qaeda's Plans The atrocities of Sept. 11 are nothing compared to al Qaeda's new plot... a devious plan to send the U.S. economy and dollar into an absolute death spiral!But in the midst of this crisis, a handful of savvy investors are quietly taking positions in an incredible New Secret Currency that is likely to skyrocket 332%... 668%... or more even if the dollar falls... Here's what you need to know about this overlooked threat -- and how you can cash in. http://www.agora-inc.com/reports/OST/ListenToThis/ ----------------------- HOLD 'EM, FOLD 'EM, OR RUN? Investing is not the same as gambling, but Kenny Rogers' "The Gambler" nevertheless lays down the basics in both endeavors. There comes a time to fold 'em. There even comes a time to run. Beginning on the Monday following Friday, August 13, 1982 -- the day the Mexican government nationalized the banks and threatened default on its debts -- the Federal Reserve System under Paul Volcker started inflating in earnest. The U.S. stock market moved upward, despite periodic fall-backs, until early 2000. Then it fell for over two years, but has now recovered most of its losses, unlike the Nasdaq, which is still under 50% of where it was on March 10, 2000. This has been a long time to hold 'em. People who came into their investing years (age 35+) in 1982 have no recollection of the misery suffered by those who came into their investing years in 1966. Stock market investors would have been wise to fold on February 6, 1966. A wise investor would have been out of the U.S. stock market from that day until August 16, 1982. That is a long time to stay out of a market. Those who got out and stayed out were few: investors. Those who never got in and stayed out were many: the general public. The wise man put a down payment on a home in 1966. He still owns that home, but it is now paid off. Or is it? The wisest investors bought lots of homes, rented them, and let renters pay off their mortgages. "The easist way to become a millionaire is to borrow a million dollars and have your renters pay it off." (Jack Miller) Home by home, Jack borrowed a lot more than a million dollars. His renters have now paid off the debt. But most people don't want to hassle with renters. They want to buy something once, hold it, and sell it when it gets to the top. Anyway, that's what they say they want to do. In fact, they don't. Most stock market investors buy close to the top and sell close to the bottom. Studies have shown that people who buy high-load (commission) stock mutual funds have done better than people who buy no-load funds. Why? Because it costs too much to trade in and out of high-load funds, so buyers of high-load stock funds really do buy and hold. >From mid-1982 until early 2000, that investment strategy did very well. The investing outlook fostered by the 1982-2004 era, which has been the era of the no-load mutual fund, has been set in slow-hardening emotional concrete. This is why the set-back of 2000-2002 had no lasting impact on conventional stock market investors. There was never any major sell- off. The downward move was produced by sales at the margin. The large pensions funds stuck with the program. What changed above all in the stock market, 1982 to today, was the increase in the price/earnings ratio and, even more true, the price/dividends ratio. Both ratios have moved upward and have stayed high. Investors no longer pay attention to earnings (profits) and dividends. They care only about capital appreciation. They are not convinced that capital appreciation rests in the final analysis on the profitability of capital. So, the increase in the price of the shares since 1982 has come more from buyers bidding up prices than from increases in the productivity of the underlying capital assets. This is Lake Wobegon investing. It rests on the belief that more than half of stock market investors will be able to sell their shares when they retire, yet this will not push down the price of the shares. Considered as a class, American investors are net buyers, not net sellers, of certain classes of assets -- assets approved by the Securities & Exchange Commission and other regulatory agencies. These assets are approved for sale by brokerage houses. They are approved for purchase by mutual funds, especially retirement funds. Money flows into these markets from those few working people -- 20% of Americans -- who have significant investment portfolios. Of course, the net value of most of these individual portfolios would not support their owners for two years at their owners' existing salaried lifestyles and debt loads, even assuming that their owners could sell them at today's asset prices without causing a panic, which is impossible. Stock market investors dream of the One Big Move Upward, which will enable them to sell out at the top -- about three days before millions of their baby boom cohorts start to retire in 2011. This is why the setback of 2000-2002 made no lasting impression on investors. The stock market's price/earnings and price/dividend ratios did not change much. The dividend return on stock mutual funds remained close to zero after fund expenses. The holders know that they cannot possibly live on the dividends generated by their funds. They know by now that they will also not be able to live on the return paid by CD's, money markets, or passbook savings accounts. They have no idea what they will invest in when they retire. They know only that Social Security ($1,200 a month, maybe) will not sustain their lifestyles. Yet they do not acknowledge emotionally the lifestyle implications of this fact. They do not fold 'em while they can and put the money into capital assets that will support them in retirement. The Lake Wobegon mindset is universal among the top 20% of income-earners. For about 20% of this 20%, this assumption is valid. They are rich or very rich. Millions of them own their own companies, which will probably survive. But for 80% of this 20%, this assumption is suicidal. As for the bottom 80% of Americans, they expect to be sustained by taxes levied on the top 20%. As for government employees, they expect as a class to skim off at least 50% of the taxes generated, as usual. After their retirement, they expect government pension programs to sustain them. These funds, being run for ex- government employees, will outperform other funds. MUSICAL CHAIRS In the child's game of musical chairs, there is only one winner. Everyone else loses. If you think Americans are not enmeshed today in the mentality of the game of musical chairs, watch two or three "reality" TV shows this week. They are all variants of musical chairs. "The Apprentice," where the winner will be in some loose way working for Donald Trump for a year, there were 215,000 applicants. This was a lottery for college graduates. These are the capitalists of the future. Picture a crap game, where the best and the brightest of America are rolling the dice. "Baby needs a new Lexus!" For more sophisticated viewers, who watch only PBS (or tell their friends they do), the hottest show is "Antiques Roadshow." There are several versions of it -- rather like NBC's versions of "Law and Order." The shows run several times a week on our local PBS station. They are tooth- fairy shows disguised as historical artifacts educational shows. The tip-off is that none of the people who bring antiques to be evaluated by experts is ever told, "This is a fake. It's worth about five bucks." The show leads to every woman's dream: to find The Big One at a garage sale for five bucks. In Lake Wobegon, all of the garage sale trinkets are worth more than you paid for them. In Lake Wobegon, all of the retirement portfolios will generate middle-class lifestyles. In Lake Wobegon, everyone can buy low and sell high. In Lake Wobegon, old people don't move in with their children. In Lake Wobegon, nobody winds up like Art Carney in "Harry and Tonto." CONCLUSION There comes a time to move out of Minnesota and head for Florida. There comes a time to move out of Lake Wobegon. Everyone plans to move out of Lake Wobegon someday. The home sales will accelerate in 2011. People in Lake Wobegon don't sell their homes now, rent, and use the money to buy a rental property in Florida. Find your version of Florida. It's time to start shopping. There are still some good deals out there. If everyone were shopping, there wouldn't be. But residents of Lake Wobegon aren't in the market yet. Later. They'll shop later. ------------------------- Appendix 69 Abraham Case Study #310 comes from a systematic numbers-cruncher in a large corporation. This is not a home business. But the principles he discloses are universal. He begins with a description of the problem. Our company was in a position where sales were declining on key products, and we were inefficient and unprofitable. Upon examination, the focus in the company was on product development. It was not focused on selling, reselling, up-selling, new markets, profitability, quality, service, customer satisfaction, etc. Our positioning sought to differentiate the brand as up-market, but in reality, this was not generating premium pricing. Here is a classic case of missing what is under your nose. The focus was on positioning, but the pricing structure said, "not up-market." This led to confusion in the minds of its customers. It was also evident that our marketing strategy stood on one pillar -- direct sales through our field sales force, which is high risk. Why is it high risk? Because the cost per sale is very high. Labor costs are the largest costs in most large businesses. Skilled labor costs are highest of all. Initially, management's reaction was: 'That's the way our competitors do it and how it has been done in this industry for the last 30 years.' What the company needed was a way to differentiate itself, yet it wanted to work as its competitors did. In other words, "Let's be different by being the same." This is Lake Wobegon marketing. My position within the company is business analyst -- mainly with a focus on figures and financials. My work approach has completely changed over the last six months and for the better. Previously, I was focused on profit and loss, balance sheets, reducing operating costs, keeping margins up etc. This has now changed as I now spend all my focus on one thing -- customers. Their buying habits, their concerns, addressing what they really want. This is a complete new mindset approach. Incredible, isn't it? Focus on customers! What a breakthrough concept! The data were there, but no one had looked at them as a sales device. Senior Management's perception was that sales were not growing because we were not opening enough new accounts. Customer attrition rates were never measured in the company before. On analysing the data, it showed that we were generating new accounts at a rate of 30% per annum. However our attrition rates were running at 40%. Sales were stagnant, which meant that we were somewhat successful in generating extra business from our regular customers. One of our primary targets this year is to reduce attrition by 50%. We are well on target to achieving this and It's very simple how we are accomplishing this goal. We are constantly focusing our sales force on accounts that have not bought from us in more than two months (our average account of existing clients will buy every 4-6 weeks). This keeps our eye on the ball. Any such account that has not purchased in this time will get a sales letter and/or cold call arranging a meeting to discuss customer concerns, and offering a variety of promotions or buying options. The existing customer is the most likely person to buy again. By ignoring him, the company was letting money dribble through its fingers. So far, one of the most important parts of this process has been the automation of our customer management reports. Before these reports were cumbersome, provided limited information and were an end in themselves. Now, these reports feed automatically to our direct sales force providing information on attrition rates, new account rates, sales frequency, transaction value, last invoice date, profitability by customer and inactive customers by sector. These reports can now be generated quickly by almost anyone in the organisation. Information was being collected, but it was not being turned into revenue. Converting information into revenue is probably the most important of all entrepreneurial tasks. On top of this, we have also focused on our top accounts -- their characteristics and their buying patterns. In doing this, we also developed a new list of high potential prospects that are to be exclusively targeted. (I am working on developing a service business with a man in my church. He is a specialist in direct marketing. His company has enormous quantities of information in its data base. He focuses on locating the 20% of the clients who generate 80% of the revenue: a classic Pareto strategy. He is very well paid. If it weren't for the fact that the work now bores him, I would not have been able to get into a side business with him. But he has read Jack Miller and has studied with John Schaub, and he wants out of the golden manacles.) The major reason we walked away from business before was analysed and the main issue was price on certain products. Now, we are more inclined to compete on these price sensitive products, but on top of this we also sell our other more premium priced products in addition. The strategy here is to keep an existing client by offering him a better deal on a price-sensitive product, but then up-sell him. This recognizes that it's worth paying to keep an existing client, if you can up-sell him later. Don't lose him. But don't sell him only price- sensitive items. This constitutes a very simple but significant change in marketing strategy -- allowing us to keep up revenues and use ancillary products to generate profitability at the client level. . . More recently we have started to focus on adding more pillars to our marketing strategy. This has focused on adding complimentary products that we will make profit from and will increase our sales value per client. The strategy here is simple: find out what someone wants to buy and then sell it to him. To do this, you must pay close attention to what he has bought in the past. ------------- -- Been to the Daily Reckoning Marketplace Yet? -- If not, you ought to see what you've been missing. Want to read more from our regular contributors? This is the place to find it. We've collected some of the best financial advice and commentary available anywhere and presented it to you all in one place. 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