2. The neuroscience of happiness.

3. First impressions of the Facebook IPO filing.

4. Chuck Akre on the search for compounding machines.

5. Cigarettes, alcohol or checking email: which is hardest to resist?

6. The downside of investing safely.

And the best sentence I read this week, from here:

“On Monday night, Blake Griffin dunked so hard on Kendrick Perkins that the Mayan apocalypse was called off.”

2. Why must a captain never leave a sinking ship?

3. Apple’s Massive Numbers and Some Context.

4. The End of Mutual Funds is Coming.

5. Sorry, Einhorn. It was textbook insider trading. And, um, soccer is football.

6. The Random Financial Advice Generator.

Insider trading is “rampant and routine and this criminal behaviour was known, encouraged and exploited by authority figures in several investment funds.”

So sayeth the US attorney for Manhattan. More on the FBI’s Operation Perfect Hedge can be found here in this FT article. And this one.

I have an investor who is concerned this particular era on Wall Street has become just like the 90′s in professional baseball. He believes both major league ball back then and the current scene on Wall Street resemble social experiments that began with the question, “What sort of behavior would you be willing to engage in if we threw tens of millions of dollars at you?”

In baseball, the answer seemed to be, “I will repeatedly inject myself in the butt with copious amounts of steroids.”

On Wall Street, the answer seems to be stuff like this.

Hard not to agree with him.

1 – Bill Miller, former media darling and Morningstar Mutual Fund Manager of the Decade, is calling it quits.

2 – This is a screenshot from the Bloomberg website this morning. I drew the red boxes.

Which is it, people?

Even editors get flummoxed, apparently.

Stay calm out there.

Courage comes in many different forms – and to be clear, when it comes to investing, courage ranks near the bottom of the list when it comes to defining that term in an absolute sense. As I write from the comfort of my air-conditioned office on a tropical island, I am very aware that there are a number of heavily armed 22 year olds standing watch on my behalf in parts of the world I hope to never visit. So let’s be sure to keep this in perspective.

Nonetheless, the market over the last few weeks has required some courage from the long-term investor. And I once again find myself reminding my own investors that if they can summon that courage, I will do my best to make sure they are adequately rewarded for doing so.

Fear and panic is everywhere out there right now. But it is overblown. I have all of my own money still in the market because (a) valuations are very compelling and (b) the most likely scenario looking ahead is (still) that the U.S. economy will muddle through, Greece will get its latest bailout tranche, and American businesses will continue to slowly drag the rest of us out of this mess. There won’t be a “Lehman event” in Europe, if for no other reason than because everyone expects there will be a Lehman event in Europe.

In the meantime, there are excellent opportunities out there – if you can summon a little steel. Not a lot, mind you. Just a little. And if prices go down more, we will buy more of them.

That all sounds cliched and foolish, I suppose, to traders and armchair economists, but so be it. You can have the next three months. I’ll take the next three years.

This is not 2008. Bonds – not stocks – are forming the next big bubble. 10-year Treasury TIPS bonds paid a negative return not too long ago. Think about that: a guaranteed 10-year negative return. The dividend yield alone on the S&P 500 is more than 2%. U.S. companies are squeezing record profits through productivity gains. And though the U.S. economy staggers and stumbles, nearly half of sales by the largest U.S. companies are from overseas – some of which are, believe it or not, doing okay these days.

It is always a difficult time to invest. Always. Over time, however, valuations will matter. They always do.

And as Ben Graham also wrote, “Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”

Stay in the game. This, too, shall pass.

“Going Rogue: Share Traders More Reckless Than Psychopaths, Study Shows.”

Read the entire article here.

Apparently traders are giving psychopaths a bad name…

#1. We’ve been here before. Not fiscally, I mean, but in terms of public frustration. To wit – the old speech below. I took a few liberties to update it, but otherwise you may find it resonates. Tip of the hat to whoever can name the speaker. There is a big hint in point #2.

“I promised you a president who is not isolated from the people, who feels your pain, and who shares your dreams and who draws his strength and his wisdom from you.

During the past three years I’ve spoken to you on many occasions about national concerns, the energy fiscal discipline crisis, reorganizing the government, our nation’s economy, and issues of war and especially peace. But over those years the subjects of the speeches, the talks, and the press conferences have become increasingly narrow, focused more and more on what the isolated world of Washington thinks is important. Gradually, you’ve heard more and more about what the government thinks or what the government should be doing and less and less about our nation’s hopes, our dreams, and our vision of the future.

I know, of course, being president, that government actions and legislation can be very important. That’s why I’ve worked hard to put my campaign promises into law — and I have to admit, with just mixed success. But after listening to the American people I have been reminded again that all the legislation in the world can’t fix what’s wrong with America. So, I want to speak to you first tonight about a subject even more serious than energy fiscal discipline or inflation. I want to talk to you right now about a fundamental threat to American democracy.

I do not mean our political and civil liberties. They will endure. And I do not refer to the outward strength of America, a nation that is at peace tonight everywhere in the world, with unmatched economic power and military might.

The threat is nearly invisible in ordinary ways. It is a crisis of confidence. It is a crisis that strikes at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our own lives and in the loss of a unity of purpose for our nation.

The erosion of our confidence in the future is threatening to destroy the social and the political fabric of America.

The confidence that we have always had as a people is not simply some romantic dream or a proverb in a dusty book that we read just on the Fourth of July.

It is the idea which founded our nation and has guided our development as a people. Confidence in the future has supported everything else – public institutions and private enterprise, our own families, and the very Constitution of the United States. Confidence has defined our course and has served as a link between generations. We’ve always believed in something called progress. We’ve always had a faith that the days of our children would be better than our own.

Our people are losing that faith, not only in government itself but in the ability as citizens to serve as the ultimate rulers and shapers of our democracy. As a people we know our past and we are proud of it. Our progress has been part of the living history of America, even the world. We always believed that we were part of a great movement of humanity itself called democracy, involved in the search for freedom, and that belief has always strengthened us in our purpose. But just as we are losing our confidence in the future, we are also beginning to close the door on our past.

In a nation that was proud of hard work, strong families, close-knit communities, and our faith in God, too many of us now tend to worship self-indulgence and consumption. Human identity is no longer defined by what one does, but by what one owns. But we’ve discovered that owning things and consuming things does not satisfy our longing for meaning. We’ve learned that piling up material goods cannot fill the emptiness of lives which have no confidence or purpose.

The symptoms of this crisis of the American spirit are all around us. For the first time in the history of our country a majority of our people believe that the next five years will be worse than the past five years. Two-thirds of our people do not even vote. The productivity of American workers is actually dropping, and the willingness of Americans to save for the future has fallen below that of all other people in the Western world.

As you know, there is a growing disrespect for government and for churches and for schools, the news media, and other institutions. This is not a message of happiness or reassurance, but it is the truth and it is a warning.

These changes did not happen overnight. They’ve come upon us gradually over the last generation, years that were filled with shocks and tragedy.

We remember when the phrase “sound as a dollar” was an expression of absolute dependability, until ten years of future inflation began will begin to shrink our dollar and our savings. We believed that our nation’s resources were limitless until 19732008, when we had to face a growing dependence on foreign oil the effects of a stunning lack of fiscal, political and monetary discipline.

These wounds are still very deep. They have never been healed. Looking for a way out of this crisis, our people have turned to the Federal government and found it isolated from the mainstream of our nation’s life. Washington, D.C., has become an island swamp of idiots. The gap between our citizens and our government has never been so wide. The people are looking for honest answers, not easy answers; clear leadership, not false claims and evasiveness and politics as usual.

What you see too often in Washington and elsewhere around the country is a system of government that seems incapable of action. You see a Congress twisted and pulled in every direction by hundreds of well-financed and powerful special interests. You see every extreme position defended to the last vote, almost to the last breath by one unyielding group or another. You often see a balanced and a fair approach that demands sacrifice, a little sacrifice from everyone, abandoned like an orphan without support and without friends.

Often you see paralysis and stagnation and drift. You don’t like it, and neither do I. What can we do?

First of all, we must face the truth, and then we can change our course. We simply must have faith in each other, faith in our ability to govern ourselves, and faith in the future of this nation. Restoring that faith and that confidence to America is now the most important task we face. It is a true challenge of this generation of Americans.

We are at a turning point in our history. There are two paths to choose. One is a path I’ve warned about tonight, the path that leads to fragmentation and self-interest. Down that road lies a mistaken idea of freedom, the right to grasp for ourselves some advantage over others. That path would be one of constant conflict between narrow interests ending in chaos and immobility. It is a certain route to failure.

All the traditions of our past, all the lessons of our heritage, all the promises of our future point to another path, the path of common purpose and the restoration of American values. That path leads to true freedom for our nation and ourselves. We can take the first steps down that path as we begin to solve our energy fiscal discipline problem.

Energy Fiscal discipline will be the immediate test of our ability to unite this nation, and it can also be the standard around which we rally. On the battlefield of energy fiscal discipline we can win for our nation a new confidence, and we can seize control again of our common destiny.

In little more than two decades one decade we’ve gone from a position of energy independence budget surplus to one in which almost half the oil all of the money we spend comes from foreign countries, at prices rates that are going through the roof floor. Our excessive dependence on OPEC debt has already taken a tremendous toll on our economy and our people. This is the direct cause of the long lines political rhetoric which have made millions of you spend aggravating hours waiting for gasoline something good to come on TV. It’s a cause of the increased inflation and unemployment that we now face. This intolerable dependence on foreign oil debt threatens our economic independence and the very security of our nation. This energy fiscal discipline and political leadership crisis is real. It is worldwide. It is a clear and present danger to our nation. These are facts and we simply must face them.”

Point #2. That speech was given here:

Things somehow still worked out okay.

Point #3. Timeless advice from an old coach: “Don’t poison your mind with crap.”

I have zero interest in politics. I am not interested in “trading” this market. There is a lot about both politics and trading that is indistinguishable from cowardice.

I am not in the business of guessing which way the stock market will go this week. I am in the business of buying cheap assets. Two different things – completely. And assets are cheap when things look grim. All else is secondary.

Before buying cheap assets, it’s important to do the work. And it’s always best to start that work assuming that the market has things right. But for a number of reasons – see points 1 and 2 above – this is not one of those times.

When buying, it’s important to know there is one variable that you simply cannot control: how long it will take others to recognize the value of those assets. It could take days. It could take years. Either way, it’s wise to prepare yourself to be very patient. Then being wrong makes you happy. Not so the other way.

So when buying cheap assets, you are making important decisions without knowing one key aspect of the eventual outcome in advance. On Wall Street, this is called “risk.” In my house, though, this is called “being an adult.” Again, two different things. Completely.

And as per my last letter, some words from a coach of a different kind:

“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.”

Stay thrifty out there.

Vanity Fair also continues to show the white shoe mags how it should be done – although you can skip the first few pages of Michael Lewis’ latest article on Germany. He seems a bit too obsessed with, er, things I do not care to know more about.

In any case, here is Taibbi’s latest:

“Is the SEC Covering Up Wall Street Crimes?”

Spoiler alert: the answer is “Sure seems like it.”

With Justice Clarence Thomas writing for a 5-to-4 majority, the Supreme Court has made it much harder for private lawsuits to succeed against mutual fund malefactors, even when they have admitted to lying and cheating.

The court ruled that the only entity that can be held liable in a private lawsuit for “any untrue statement of a material fact” is the one whose name the statement is presented under. That’s so even if the entity presenting the statement is a business trust — basically a dummy corporation — with no assets, while its owner has the cash.

The facts of Janus Capital Group v. First Derivative Traders are outrageous. Janus Capital Group created and manages the Janus mutual funds through a business trust. For years, Janus Capital Group, through the Janus funds, worked with at least 10 hedge funds to “market time” — letting them trade rapidly in and out of Janus funds to benefit from delays in updates of asset prices and enjoy guaranteed profits. In 2004, Janus Capital Group admitted its wrongdoing and made a $225 million settlement.

While Janus Capital Group engaged in this improper trading through the Janus funds, the funds’ prospectuses assured that they had policies to prevent market timing. When a complaint from the New York State attorney general became public, the price of Janus Capital Group’s stock dropped by 23 percent. Some shareholders sued Janus Capital Group and Janus Capital Management, which oversees the business trust and funds, for making false statements that led to the drop.

Justice Thomas’s opinion is short and, from the mutual fund industry’s perspective, very sweet: Janus Capital Group and Janus Capital Management were heavily involved in preparing the prospectuses, but they didn’t “make” the statements so they can’t be held liable. Only the business trust set up to hold the funds can be held liable, though it has no assets of its own to compensate plaintiffs in the lawsuit. Which means that there is no one to sue for the misleading prospectuses.

There is no doubt that Janus Capital Group is responsible. It used legal ventriloquism to speak through the business trust and Janus funds. Janus Capital Management does everything for the funds, which have no employees. As Justice Stephen Breyer writes in dissent, “The relationship between Janus Management and the Fund could hardly have been closer.” For the majority, though, it is far enough apart to let the mutual fund industry and possibly others off the hook.

Disclaimer: My investors and I own shares of Neutral Tandem. This post in no way constitutes investment advice. Commentary on this blog should never be relied on in making an investment decision.

You congratulate yourself. You’re a mutual fund picking expert. You’ve been happy with your returns, but the validation you get from seeing your pick publicly confirmed by such a prominent publication is even better.

And then, like clockwork, the fund’s returns start to stall.

What happened?

The ‘mutual’ in mutual fund began to work against you.

One definition of ‘mutual’ – and the one used in the fund industry – is ‘shared interest’.

In this case, you began to ‘share’ the fund’s management with other investors…all those hyperactive folks who read about your fund on the cover of a magazine and bam, next day, moved all their money over there.

Mutual funds have certain rules that they must abide by. One is that they can only have a certain percentage of their assets in any one investment. And as the new money flows into a mutual fund, the manager has to invest all of that new cash.

What does he do? Well, once he exhausts putting money towards his ‘great’ investment picks (the ones you made out on so well on in years past), he has to move down a notch to his ‘really good’ investment picks. Then the ‘good’ ones. Then his “ok” ones. Then the blaze lackadaisical. Or something. The point is that all those new investors can quite literally begin to dilute the performance of your mutual fund.

And this ‘shared’ downside to mutual funds doesn’t come into play just when there’s good news about the fund.

If a fund or even the overall market experiences a short-term downwards blip for whatever reason, the herd investors often run for the hills. This forces that mutual fund manager to liquidate investments to pay out all that cash. And for you, my dear long term investor, this is bad. It’s actually exactly what you don’t want to happen – selling when prices are down. Nobody makes money that way.

So whether good news or bad news, when it comes to mutual funds, you’re often stuck in the same boat as a lot of other investors that you probably wouldn’t want to be with…if you’d only had the choice.

While there are some good funds out there run by true stewards, with a few exceptions, most mutual fund companies long ago abdicated their real fiduciary duties. Mutual funds are, in short, a good idea gone wrong. As John Bogle once said in reference to mutual funds, “The scandal is not what’s illegal. It’s what’s legal.”

Here are ten things all investors should know before investing in mutual funds.

1. Expense ratios don’t tell the true cost.

A mutual fund’s expense ratio represents the cost of owning that fund. The expense ratio is made of numerous different costs and has become the standard way by which funds’ costs are compared. Unfortunately, it does not include all of the costs that are relevant to investors. Expense ratios often understate the true costs – sometimes dramatically.

Expense ratios ignore three key costs to investors – trading commissions, taxes and sales charges.

According to the Investment Company Institute, the average expense ratio for a domestic actively managed fund is 1.46%. That does not include, however, an average of another 0.27% in fees eaten up by trading commissions. Sales charges, or loads, can also cost up to another 5% in fees. A Morningstar study also found that the average mutual fund investor’s after-tax return is almost 2% per year less than the advertised pre-tax return.

In total, the actual costs to mutual fund investors could be an additional 2.3% to 7.3% on top of the stated expense ratio.

That is simply a huge difference.

2. Other investors can hurt your returns.

Mutual funds are giant pools of money. Upon investing, your money is effectively poured into the same pool that contains billion dollar investments from large institutions. In theory, this is a good thing, as it enables small investors to benefit from the cost savings offered to large institutions. In practice, it doesn’t work quite so smoothly.

When large investors want to take cash out of a mutual fund, the fund’s manager may have to make costly and unprofitable trades to quickly raise that cash. For very large funds, the act of selling a fund’s holdings to raise that cash can depress the share prices of those stocks held by investors still in the fund.

To add insult to injury, those investors who don’t cash out will bear the costs of the considerable tweaking a mutual fund needs to do to its pool after large investors leave. The net effect is that the returns of long-term investors are hurt by the decisions of other investors in the fund.

3. Your fund might be playing favorites.

A mutual fund typically accumulates a position in a company by buying shares in increments through a series of transactions. It is up to the mutual fund company to allocate those differently priced shares equitably among all its investors. To constantly allocate the lowest-priced shares to the biggest investors would be unfair to the little guys.

Despite plenty of company policies, it’s apparently hard for some fund companies to treat all investors fairly. After all – remember that little scandal back in 2003?

4. Turnover and taxes can be a real drag.

Turnover is the percentage of a fund’s holdings that change over a year due to buying and selling. The turnover of the average actively managed mutual fund is approximately 85% (or perhaps even higher, as per this post).

That means the average mutual fund holds a stock for just 10 months. That constant buying and selling takes a big toll on returns due to commissions and spreads. In addition, high turnover effectively forces more yearly capital gains taxes onto fund investors, further impacting returns. Turnover and taxes can be the long-term investor’s worst enemies.

5. Beware the closet indexers.

A “closet index” fund charges high fees for a generic portfolio that acts like the broader stock market. In other words, you’re paying unnecessarily high fees. You could buy an index fund for similar returns with much lower fees.

How to spot these funds? The number of stocks held is a good place to start. How much added value can there really be when a fund manager invests your money in the 137th stock in his fund?

6. Fund classes are confusing on purpose.

You may have noticed that many mutual funds come in different classes. Class A shares typically have a heavy upfront sales charge and a low annual fee. Class B shares have a delayed sales charge. Class C shares have low sales charges but high annual fees.

The mutual fund industry loves multi-class structures. It enables them to sell their funds through the widest possible network of brokers. Investors, however, should be wary. Having different fund classes implicitly suggests that one is right for you when in reality, a no-load or index fund likely makes much more sense.

7. Most managers don’t eat their own cooking.

Less than half of all mutual fund managers actually own a single share in the funds that they run. If a fund’s manager does not believe in the fund, or if they are not willing to pay the same costs and taxes as their investors, why would you ever consider investing in that fund?

8. Mutual funds pay their costs with your money.

Inflated commissions, soft dollars, revenue sharing…you might be shocked to learn how funds spend the money you send them to invest. The most outrageous is called a 12b-1 distribution fee, which can range from 0.25% to 1.0% of your assets. This fee is used to pay for marketing, advertising and distribution.

In other words, you are quite literally paying for the ads and commercials your fund runs to try to sell itself. How does this help investors already in the fund? No one seems to know.

9. You may pay taxes after a loss.

The IRS requires mutual funds to distribute capital gains and dividends to its investors. By passing all tax obligations onto the investor, the fund itself is afforded special tax status. But investors may owe taxes on those distributions even if they don’t sell a share – and, surprisingly, even after a decline in value.

So what’s worse than seeing your fund drop by 50% in 2008? Having to pay taxes on that, too.

10. Once a mutual fund has your money, it’s outta there.

The mutual fund industry continues to grow despite effectively ignoring the vast majority of its customers. In the end, most people find it too much trouble to switch funds, and the fund companies know this.

But if you’re fed up with Wall Street, you might be interested in learning more about Spoke Funds. I built my portfolios differently to avoid all of these issues – plus a few more. You can learn more about the portfolios I manage at my firm’s site, IslaInvest.com, and you can learn more about Spoke Funds® here.

And did I leave anything out in the list above?

Update: Ben points out that I may be dramatically underestimating the internal trading/commissions costs of mutual funds as cited above. He says Edelen, Evans, & Kadlac’s 2007 study “Scale Effects in Mutual Fund Performance: The Role of Trading Costs” likely has better data – and they put the costs I estimated to be .25% at 1.44%, instead. Egads.

So, for the record, my answer to that question is, “I’m not afraid of China, and you shouldn’t be, either.” Here’s why:

It’s true that at current rates the gross domestic product of China will surpass the United States in the next ten years.  The IMF actually predicts this will happen in 2016…but it also seems to be overlooking a potential bubble in China that some very smart people are betting will soon end.

In any case, while the exact date may be subject to debate, the inevitable result doesn’t seem to be. While that rankles my big ole American ego a little, and makes me long for the days when the U.S. actually, uh, made stuff, the more rational side of me doesn’t see a wealthier China as being a fundamentally negative thing. The funny thing about countries becoming rich is that they also seem to become more stable, presumably because a wealthy, comfortable society doesn’t want to start picking fights or creating trouble. They’d rather stay focused on trying to become even richer – by creating more new stuff, and improving all the old stuff. The rise of China is really not our loss anymore than a decline in Germany would be our gain.

Now, having said that, I actually don’t see a truly rich China on the horizon. Not where it matters most, anyway – on a per capita basis. While it appears China’s total GDP will be equal to the United States’ by 2020, or possibly a few years sooner, the country’s per capita GDP will still be a fraction of ours at that time. Right now every American produces an average of $42,517 in economic value, while the average citizen of China produces just $2,802. We’re insanely more productive – all the more amazing, really, when you consider how much reality TV we watch. But while some of the major coastal cities of China look wealthy and modern, the inland is rife with poverty.

And this is where I believe China’s previous policies could finally catch up to it. Because around the same time that China’s GDP catches up with ours, it also appears the Chinese will, to be blunt, begin to die off. Demographically speaking, I mean. It’s just math, yet this seems to be curiously under-reported.

Population experts will tell you that if the women in a country have on average less than 2.1 babies, then the population of that country will shrink – unless it’s offset by higher immigration. How’s that relate to China? Remember the country’s long-standing One Child policy. Plus, communism and open borders aren’t exactly sympatico.

So largely because of that low “fertility rate” and an expected future decline in its working age population, China’s economy is going to begin to have a major demographic problem in about five years. While pundits never seem to tire of telling us that China will soon reach a population high of 1.4 billion people…they never seem to mention that the number begins to fall off a cliff right after that. And don’t confuse population with productivity, either.

As anyone who has stayed awake through Macroeconomics 101 can tell you, long-term economic growth depends on three things, really: capital, ideas, and population. And as a few population experts have quietly been trying to explain, because of that dramatically shrinking working-age population, it’s quite likely that China is going to get old before it gets rich.

Think I’m nuts? Look at Japan, which in the early 90′s seemed destined to overtake the U.S. economy, too. What happened? The Japanese ran into problems with both supply and demand in the macro sense. First, demand for goods and services in Japan collapsed when the Japanese real estate and stock market bubble burst, then the country found itself unable to recover due to serious supply issues caused by a low birth rate, aging population and essentially zero immigration.

China should take heed: a shrinking workforce is going to crimp your economy eventually, no matter how many people you start out with. And if your economy overheats too close to the point at which your working-age population begins to decline, then your problems could compound in a decidedly unfavorable way.

So, U.S. investors should relax about China. There is not only no real reason to invest in Chinese companies, but this could also prove to be the exact wrong time time to start.

Turnover in Tarpon has averaged 58% a year. That turnover is considerably higher than I’d like, all things being equal. In contrast, the Gecko Folio has averaged turnover of closer to 20% per year. Nonetheless, I am okay with the turnover in Tarpon to date – for three reasons, really.

The first is that, thanks to window trades at our custodian FOLIO, we don’t pay a dime in commissions. Zero, zilch, bupkus. So the trading I’m doing is not eating away at our returns at all due to commissions.

Also thanks to FOLIO, I have pretty granular control over the tax lots of the shares my investors and I own. This topic is worth a few posts all on its own, but those will have to wait. For now, my point is that I am buying and selling in as tax-efficient a way as possible. So the amount of our returns that is getting eaten up by the IRS is as small as possible.

The third reason I’m okay with it is because that turnover is really the result of a high-class problem: Tarpon doubled in value in its first thirteen months. I try hard to buy shares in good companies when they’re cheap, and I sell them when they reach what I think they’re worth. Full stop. So I view that turnover in Tarpon as a reflection of the valuations of the companies we own, or more specifically, the gaps between value and price closing pretty quickly to date. That said, try as I might, I don’t anticipate those gaps narrowing as quickly in the future as they have the past three years, so our turnover should be less from here on out. In any case, I think it’s important to differentiate between turnover that is a consequence of a disciplined selling process, as opposed to trading just to trade. Like, say, mutual funds seem to do.

Estimates on the average mutual fund turnover vary. Here is a slide I used at my annual meeting a few weeks back that referenced some studies that indicated average mutual fund turnover was 89% a year. (Also note the impact of high turnover on returns.)

As mentioned here, though, there is another analyst at Morningstar who believes the average turnover ratio for actively managed domestic stock mutual funds is 130% a year. And since we know the vast majority of mutual funds fail to outperform the market, I think it’s safe to say that they’re not selling because the shares they own have gone up a lot.

So as much as I gnash my teeth about buying and selling, I can’t help but see those consistently high turnover numbers and ask:

Is that really investing, or is that gambling?

I believe actively managed mutual funds have crazy-high turnover because they are chasing returns, pure and simple. They are trying to hop on the latest hot tip, or trying to juice just a little bit of return out of a stock by riding momentum upward. Or something else. Frankly, I have a hard time explaining exactly what those guys are trying to do most days.

Getting more return isn’t a bad thing, of course, but there are big hidden costs to all this activity for mutual fund investors.

The first cost is indirect but important – research. Ever wonder why high-turnover growth funds that hold 150 stocks have higher expense ratios than low-turnover value funds that own shares in just 20 companies? One reason is that it costs a ton to analyze all of those stocks. A mutual fund has to hire or assign a small army of researchers to sift through all the companies that they invest in. And if every share that a mutual fund buys in January has been sold out of the portfolio by December, that means those research costs are through the roof. Investors are effectively paying for that through higher fund fees.

The opportunity costs here are also huge. While that manager is chasing short-term returns, perhaps trying to earn a quarterly bonus, he’s passing up on genuine investment opportunities that may pay massive returns to a more far-sighted investor. For a manager replacing all of his portfolio each year, the best investment doesn’t get his attention – the flashiest investment does.

The other relevant direct costs are commissions and taxes. Every trade related to that 130% turnover costs you money in commissions you pay (surprise!) and results in a taxable transaction of some sort. While far too few of those trades end up leading to a capital gain, many of them still do. And all that churning ain’t happening with an eye on what’s best for your taxes, folks.

My point is that it’s not what you make on the funds you’re invested in – it’s what you keep. And if you’re invested in mutual funds, then the odds are good that you’re keeping less than you think.

Like most of Lewis’ work, I found it interesting, and thought you might, too. To be clear, I do not believe it will be prophetic…there’s already too much fearmongering in the media going on about this tragedy. And at the risk of pointing out the obvious, last week’s quake did not hit Tokyo. So take his conclusions with a grain of salt. Just some things to think about in a way that only Lewis can convey.

Also, I have been actively buying in Tarpon this week. May be more to come. So, back to the cave.

In the meantime, a reminder that fear is the friend of the long-term investor…

The book breaks down our emotions into several categories. The big one is greed – or more specifically, the observation that humans enjoy the anticipation of something more than actually acquiring something. This feeling is hardwired into our brains, for every single one of us. It was built into our brains genetically many, many moons ago, and actually helped us survive as a species. Now, though, the instinct hurts us – at least as far as investing goes.

Zweig speaks of Mark Twain. Twain wrote about greed in his excellent story “The $30,000 Bequest,” which was about a happy couple who learn of an inheritance, dream of the riches they’ll have…and then die from grief when it doesn’t materialize. But the author himself never really seemed to learn the lesson he was teaching.

Mark Twain spent his life bouncing from one get-rick-quick scheme to another until his later years – when he was broke. Why? Zweig thinks it dates to Twain’s early adulthood, when he was a miner, and a big ole’ silver find that didn’t quite turn out for him.

Bad for Twain, but great for American literature, I suppose.

Zweig wrote, “Twain must have been driven to relive the visceral excitement he had felt in 1862 when he hit that giant silver vein in Virginia City. That memory kept his anticipation circuitry in overdrive whenever he though about money. The result was a lifelong, compulsive craving for the big score that sent Twain on wild swings from wealth to debt to bankruptcy and back again.”

How does Zweig say to avoid this in our lives?

“Lock up your mad money and throw away the key”. Also, “control your cues” – meaning learn what turns you on in the investing sense, and then to find a way to “think twice” before acting on any of those impulses. In other words be less like Pavlov’s dog, and more like a rationale investor.

Or, as Ben Graham used to say, “Buy stocks the way you buy groceries, not the way you buy perfume.”

In the time it takes the average American to read this paragraph, the average stock will have been purchased, and then sold. The average holding period for a stock, according to a prominent economist and college professor who studies the market, is now 22 seconds, roughly the time it takes the average person to read about 90 words. That means in the four or five minutes someone dedicates to this article, some market sharpy will make 15 trades.

Other tidbits:

High frequency trading is estimated to account for as much as 70% of the trades on Wall Street.

That 22-second holding period is actually an improvement. In 2009, the average holding period was 20 seconds.

And, finally, this quote from an analyst at Morningstar, which is the big old silver lining to all of this madness:

…”In a way, it may well be that the shorter-term focus means greater opportunities for those with a longer-term focus. If all of the money is trying to extract every last penny from short-term news, that may well mean that there is time-period arbitrage by focusing on the long-term, recognizing that you are not going to day-trade in a manner superior to that of the hedge funds. You’re trying to figure out who the winners will be five or 10 years out, and that’s a different matter, one that the hedge funds could not care less about, which means that it’s a much safer place for the average investor to be.”

And when you put “time-period arbitrage” into the stock market de-jargonator machine, it comes out as:

“Less trading, more fishing.”

So there you have it.

“Should all people offering investment services be held to a fiduciary standard?”

A fiduciary standard essentially means that folks in the investment industry would be held to a higher degree of accountability and, therefore, be held liable for bad suggestions. And yes, those “accountability” and “liable” things are what has got the big Wall Street firms in such a tizzy.

Put another way, a fiduciary is someone who is legally obligated to put his investors’ interests above his own – or that of his firm, for that matter. And I think I can speak for other fiduciaries when I say that I’m proud to have built my firm around that principle. You may not realize it, but the vast, vast majority of people who give financial advice are legally obligated to put their employer’s interests above their investors. So, you know, you’ll be taken care of right after all the bonuses are paid out.

Many investors hear that same question above and ask, “Aren’t those people already fiduciaries?”

The answer is: No, not by a long shot.

Many men and women wearing the title of financial advisor are actually treated under the law as salespeople. Known as registered representatives, they operate under a 1934 law that says they have to sell you what is suitable for you at that time. But like a real estate agent or a car salesman, once the sale is done and the commission is collected, their legal obligation ends. So while they may present themselves as advisors who will stick with you over the years, they are under no legal obligation to do so – and have no legal liability if they do not, either.

Furthermore – standby for another mutual fund rant – one of the the unintended consequences of the way the laws have been interpreted to date means that if a registered representative sells you a mutual fund, he is then effectively incentivized to not call you again afterwards, so that not only will he collect the upfront commission, but will also collect an on-going 12(b)1 fee.

If you don’t talk, after all, there is no legal requirement to re-assess that investment’s suitability for you again.

Kinda perverse, no?

That said, even if the rules promulgated under the new Dodd-Frank law do make registered representatives fiduciaries, don’t expect a new level of service. I’d expect lots of registered representatives to simply turn their backs on accounts from those in the ‘middle market’ – those households earning under $100,000 annually. Otherwise, the potential costs far outweigh the benefits.

That’s not just my own opinion, though. A recent survey by the National Association of Insurance and Financial Advisors reported that if the new fiduciary standard increased legal and compliance costs by 15%, then 65% of broker-dealers would only accept affluent accounts. Yikes.

So, regardless of the actual outcome of the debate, it would appear the financial planning options in front of the vast majority of the great American middle class could soon be either to (1) continue to receive potentially conflicted advice or (2) no longer have access to anyone that might help otherwise them.

Rock, meet hard place.

Fortunately, there is third option – it’s just one most investors aren’t aware of yet. More on this soon.

Since the equity market has got beaten up over the last 10 year period, for a few years now many individual investors began buying into bond funds to eke out at least a smidge of a return – something more stable than the stock market, but higher than bank rates. The largest bond fund out there, PIMCO Total Return Fund, has seen positive inflows for two years.

Why worry about this? Because, in short, I’m not sure most investors see the dangers of owning bonds. PIMCO Total Return, for instance, is one of the only bond funds offered in many 401(k) plans. So, while hard to quantify, I think it’s safe to say that particular fund may be where a lot of folks have put their money over the last decade.

The danger? As the Greek physicist Archimedes said, “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.”

A fundamental law of finance is that bond prices and yields move in opposite directions. If the Federal Reserve’s latest Quantitative Easing (QE) efforts are successful, the economic recovery will accelerate, and interest rates will rise (since the price of money increases to reflect more demand). New bonds issued post-QE will have to pay higher interest rates to attract investors. Since the vast majority of fixed income investors do not holding their bonds to maturity, once interest rates rise, many will then sell current bond holdings to buy newer, higher yielding bonds. This will lead to a decline in the prices of existing bonds – particularly in those bonds with the longest remaining time to maturity, or “long bonds.”

Now, all that said, even if you have zero knowledge of finance, if I told you interest rates are near historic lows, what would be your guess regarding what interest rates will do next? Right – which is where Archimedes comes in: with rates at such lows, the bond market is a very big lever indeed. Just a small movement in interest rates can bring bond prices down quite hard, and longer-term bonds could be driven into the ground. Shorter-term bond mutual funds should have a softer landing but will still drop.

PIMCO Total Return Fund has a duration of almost 5 years. Is that short enough to protect investors’ portfolios when rates go up? I’m not so sure. One good piece of news, however, is that the end of 2010 saw the first month of net redemptions from that PIMCO fund. So, here’s to hoping other investors realize the bond market may not be such a safe place after all.