Q. What’s the latest on financial reform?

A. Last week the Senate passed major financial reform legislation that is in now being reconciled with a bill passed by the House last year. Once the differences are ironed out, it will be signed into law.

The legislation, not without controversy, contains a number of provisions intended to try to reign in banks, set up new regulatory agencies and avoid future taxpayer-funded bailouts. Among other things, the legislation would:

- Create a council of risk regulators tasked with preventing the failures of massive companies which could threaten the entire financial system;

- Establish a consumer protection division for financial products;

- Allow the government in extreme scenarios to seize and close down failing financial companies in order to protect taxpayers from future bailouts;

- Call for a one-time audit of the Federal Reserve;

- Force most derivatives to be traded on exchanges, where regulators will have more transparency and power to oversee them.

On Wall Street, most of the angst revolves around one particular aspect of the proposed reform. The Senate version of the bill directs regulators to restrict banks from proprietary trading – currently a huge source of profits for the banks. Whether or not the banks are forced to spin off, or completely separate from, their derivatives trading business remains to be seen. The Street and its lobbyists appear to be trying quite hard to derail this provision.

In general, the changes in the proposed legislation seem to imply that our financial system was sound, but the credit crisis and Great Recession were caused by a lack of regulation and oversight. As a result, the legislation will reduce the size of the industry’s profits, but will not address the size and/or political power of Wall Street. Read into that whatever you may.

One particular part of the reform that I was particularly glad to see dealt with the credit rating agencies. A system where the banks getting rated pay the firms doing the rating is hard to defend. The end of that practice alone is something to be noted.

A. It’s been a strange, tough few weeks in the stock market. From the crisis in Greece to the Gulf oil spill and the bizarre 1,000 point “flash crash” in the Dow, there are plenty of reasons the market seems uncertain.

Take inflation. Two months ago, inflation was the most predominant concern among many investors. You’ll remember inflation is a general rise in the price level of various goods and services that can be caused by an increase in the supply of money. You may also remember that both the Federal Reserve and the federal government recently pumped huge amounts of money into the economy to recover from the credit crisis and ensuing recession. So with inflation such an obvious risk, why, then, are some investors starting to become concerned about deflation again?

Well, an odd thing happened while we were waiting for inflation to show up. The Euro, the primary currency of Europe, began to fall in value as a result of the recent bailout in Greece. As the Euro falls, the value of the U.S. dollar increases – at least on a relative basis. And because commodities like oil, gold and grains are priced in the dollar in international markets, a stronger dollar means you can buy more of that commodity for the same buck, so commodity prices tend to drop. Except, well, for gold, which usually moves in the opposite direction of the dollar, but has instead recently reached a record high.

Confused yet? So is the market. It can be hard to stay on top of it all. Here’s the thing, though – you don’t need to in order to be a successful investor. In fact, instead of worrying about all this volatility, some investors actually welcome it. Buying high quality, high return companies at prices well below what they’re really worth offers you the best chance to grow your wealth long-term – regardless of the inflation rate. So if you’re tired of the noise, I’d encourage you to think about becoming a value investor. There’s plenty of room.

A. Five years ago, if you asked me to name two arcane financial subjects that I’d probably never hear discussed in a diner in the Keys, I’d have said ‘credit default swaps’ and ‘trading algorithms.’ During lunch at Mangrove Mike’s in Islamorada a year ago, however, I first overheard someone mention swaps. If that shocking 1,000 point drop in the Dow Jones last Thursday was any indication, you may soon become familiar with the term “high frequency trading,” too.

High frequency trading or HFT is many things – including another example of how Wall Street is more interested in being a casino than a steward of wealth. Simply put, HFT is stock trading done by blazing fast computers at Wall Street firms – some of which are located literally right next to the computers that drive the NYSE and NASDAQ. The powerful algorithms on these HFT machines can create and change orders for stock in milliseconds. It is believed that a handful of HFT firms now account for half of all trading volume on the nation’s stock exchanges.

The problem is that through loopholes in the rules, high-speed traders get an early glance at how others in the market are trading. Seems odd, no? After all, if you learn a big secret about a company, trade on that secret, and then make money a month later, it’s considered insider trading and you’d go to jail. When HFT firms get to peek at the buys and sells of others in the market and then make their own trades split seconds later, however, it’s condoned and encouraged by the major stock exchanges. Not only that, HFT machines routinely take advantage of slower traders…or, in other words, us.

Why the loopholes? The exchanges say to “create liquidity,” or to ensure that large investors can buy or sell positions quickly. As you might have guessed, though, the exchanges also earn fees for allowing sneak peeks.

Did a HFT glitch cause the historic crash of last week? Officially, it remains to be seen. Candidly, though, I’ve got a hunch.

Q. What exactly is going on in Greece?

A. This week a leading ratings agency lowered the credit rating of Greece to junk status. Combined with a bigger than expected budget deficit and a widespread worker strike, that has created considerable uncertainty in the financial markets.

Investors should pay attention to Greece. A massive joint bailout of Greece by the Eurozone countries and IMF has already been announced, but it is unclear when that money will actually show up. In the meantime, investors fear a bad precedent should Greece ultimately default on its debt since Portugal, Spain and Ireland are also in poor fiscal shape.

Greece simply spent too much the last few years, financing that spending by issuing debt to foreigners. Rather than paying interest on that debt outright, however, Greece basically refinanced its interest payments each year by issuing new debt. In a sense, the country has been constantly taking out home equity loans to make its monthly mortgage payments. If you’re saying that sounds short-sighted, you’re right. If you’re thinking there may be a lesson to be learned here at home, you’re also correct.

Despite the stock market’s reaction to Greece’s woes, most of the possible outcomes from this situation will likely have only a minor direct impact on U.S. stock market investors. To be clear, there is a potential very bad scenario if multiple European countries default on their debt. As I write, however, the odds of that occurring appear remote.

There are plenty of other reasons to keep an eye on the indirect effects of Greece’s woes, however. The debt crisis in Greece is an indicator of the state of the European economy, which is recovering much slower than the U.S. Europe is obviously an important market for many U.S. companies, too, and those companies could see difficulties in the months ahead, potentially delaying their recovery.

For now, there are two takeaways for individual investors. First – think “debt is bad, thrift is good.” The second is that international investing, even in Europe, may not be all that it’s hyped up to be.

Cale Smith is the portfolio manager of the Tarpon Folio. More info can be found at www.islainvest.com and www.caleinthekeys.com.

Q. What exactly did Goldman Sachs do to get into such trouble?

A. Late last week, the country’s premier investment bank Goldman Sachs was accused of securities fraud in a civil suit filed by the Securities and Exchange Commission. The SEC claims Goldman created and sold a complicated mortgage investment that was covertly designed to fail.

The investment that Goldman sold to investors was called a synthetic collateralized debt obligation, or CDO, which is essentially a bet on another bet tied to a bundle of very low quality mortgages. Goldman appears to have tricked investors into believing the CDO was being managed by people who wanted mortgage holders to keep making their payments, when in reality it was secretly created by a hedge fund that was the world’s biggest short-seller in the subprime mortgage market. Those guys badly wanted the mortgage holders to default, and they did. Investors lost over $1 billion, while the short-seller made a profit of $1 billion.

Why would Goldman do this? Fees – both from their own role in structuring the deal, as well as those paid by the hedge fund for other services it may have had Goldman provide. Whether or not Goldman made money by actively betting against the same bad CDOs they secretly helped create remains to be seen.

The case is significant for a number of reasons. The first is – and there is really no pleasant way to put this – the SEC has been a consistently horrible regulator for quite some time now. Pursuing this case against Goldman may mean the agency has finally found a spine. It also means the odds of serious financial reform just increased dramatically because Goldman can no longer push back.

This case highlights a major flaw in the business models of Wall Street banks, too. Namely, they treat their customers atrociously. The ultimate outcome of this case is in some ways immaterial. Everything you could ever want to know about how dishonest a big Wall Street bank can be is summarized in this case. And it is far more damaging than a lawsuit could ever be.

Q. What’s going on with financial reform in Congress?

A. As you have probably heard by now, there is a significant financial reform bill currently making its way through Congress. The House passed its proposed reform bill at the end of last year, and the Senate will take up its own version at the end of this month. Prepare for heavy spin.

As one Senator memorably said a year ago in the midst of the credit crisis, “The banks are still the most powerful lobby on Capitol Hill. And frankly, they own the place.” So I think it’s notable that some fairly serious reform efforts have survived thus far.

The reform of our financial system is an issue that should be bigger than politics. The massive bailouts of “too big to fail” Wall Street banks were deeply offensive to just about everyone, regardless of political beliefs. They demonstrated at a shocking level the unholy alliance that has grown between politics and finance over the last few decades. In what may be one of the great ironies of our time, it turned out that Wall Street banks were bad for free markets.

I think it’s also important to understand that Wall Street banks didn’t get to be so big because of their economic advantages – they got there because of subtle political ones. What also should be kept in mind, however, is that regulation can unequivocally make the risk in the system worse. And it doesn’t make any sense to leave financial reform up to the same regulators who just failed us all so miserably.

I think Teddy Roosevelt had it right. The big banks should be broken up – not because that alone will guarantee our financial system will be safer, but because it will end this dangerous mix of politics and finance that nearly led to the collapse of the most advanced economy in history. One year later, the surviving Wall Street banks that helped cause the crisis are even bigger and more powerful. And until we address “too big to fail,” we’re really just kicking the can down the road.

A. You may be the kind of person who likes to dabble in stocks. Perhaps you buy a few shares without doing research just because it gives you a thrill. Or maybe you have a small amount to invest and can’t see the point of putting in 40 hours of research to buy $50 worth of shares.

While I don’t want to discourage anyone from investing in stocks, one of the prerequisites should be that you understand how to read a company’s financial statements. If you don’t, that’s a pretty good sign you need some help when investing. If you can read the financials, there are a handful of things you can check fairly quickly that will help identify certain red flags. Below are seven of them. They are not fool-proof ways to spot fraud by any means, but they can be useful in abbreviated reviews.

1. A company’s earnings should be consistent with its operating cash flow. The two won’t be equal but they should move in the same direction and to a similar degree. Watch out if earnings grow much faster than cash flow for an extended period of time.

2. Be skeptical if current assets other than cash are growing. Keep a close eye on increases in inventories and/or accounts receivable compared to sales.

3. Make sure you understand the rationale behind any impairments or write-offs that are particularly large or recurring.

4. Any accounting policy changes should be explained simply and in a straightforward manner.

5. Depreciation and amortization practices should be consistent among competitors. Deferring these expenses over longer than usual periods of time is one way to artificially inflate profits.

6. Watch for dramatic changes in reserves against bad debt. This can signal deterioration in the quality of current assets.

7. Understand how the company makes money. If you can’t explain this to a five-year-old, it may be a fairly complicated business – and that could mean there is more room for management to play games with the financial statements.

Q. What should I know about a company’s cash flows?

A. The third financial statement that stock investors should become familiar with is the statement of cash flows. Inflows and outflows of cash are the heartbeat of any business, and investors, like company managers and lenders, should examine them closely.

The statement of cash flows is critical because an income statement does not give a complete picture of the company’s most important resource – cash. That is because of differences in timing between accounting transactions and related cash collections or payments. For instance, a company might ship a product and record revenue in March, but not receive a cash payment for it until May. Because of various “noncash” items, income statements don’t tell the whole story.

The statement of cash flows tracks cash across three areas of the business – operations, investing and financing. The most important section to focus on is “cash flow from operations,” which tells you what cash is provided by normal business operations and how much cash is used by the business. Consistently positive cash flow from operations is a sign of a healthy business. Negative operating cash flow, however, means a business is bleeding cash and will eventually need to either borrow money or sell shares simply to stay afloat. Neither are a good sign.

In contrast, a negative number in the “cash from investing activities” section is fairly common and for most growing companies, it is generally okay. Growing companies need to invest more in physical equipment to sustain their growth. The figures in the “cash from financing activities” section usually oscillate between negative and positive. Consistent cash flows from financing activities, however, indicate the company is depending excessively on the stock and bond markets to run its business.

At this point, let’s step back a bit. As you can probably tell by now, there are plenty of ways companies can play games with their own financial statements. The statement of cash flows is one place to catch them. Next week I’ll give you some other places to quickly check for accounting shenanigans prior to investing.

Q. What do I need to know about a company’s income statement before I invest?

A. In short – as much as you can stand. A balance sheet contains items that usually don’t merit spending hours on. However, an income statement, also called a profit and loss statement or “P&L”, is a different story. You should try to learn everything you can about a company’s income statement to really understand how the company makes money.

You’ll recall that a balance sheet is a snapshot in time, telling us how well a company is managing its resources. The income statement, together with the cash flow statement I’ll discuss next week, forms more of a moving picture that tells us how well a business is managing its operations.

The term “earnings” on the income statement is synonymous with profit, and it’s hard to argue that you should invest in a business for any other reason than because of attractive, growing profits. Because of that, earnings are the most widely scrutinized financial metric that companies report. Management has some latitude when applying accounting principles in the income statement, so assessing the quality of those earnings is an important ability for a stock investor to learn.

There are no shortcuts to learning how to analyze an income statement. It can take some time, but I’ll soon publish a list of recommended books to help you start to learn as quickly as possible. It’s important to keep the big picture in mind, though, as per this quote from Warren Buffett, “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”

If I had two tips for investors regarding income statements, the first is to be wary of investing in companies with pension plans. Pension accounting can be the greatest form of earnings manipulation known to man. The second tip would be, “Profit is an opinion, but cash is a fact.” Next week I’ll talk more about cash flows.

A. You’re in luck, dear readers. There is simply no way to teach balance sheet analysis in a 350-word column. The official definition of “current liabilities” itself is 200 words long. My hunch is that many of you would rather get a hot poker in the eye, anyway.

Fortunately, there are many resources out there for the motivated investor – the best being Graham and Dodd’s Security Analysis. I’ll cover just a few highlights here.

And rest easy, math-phobes. There is only one equation you need to remember: Assets = liabilities + shareholders’ equity. Or, the stuff on the left must equal the stuff on the right, so the two sides “balance.” Hey, nobody hires accountants for their creativity.

The balance sheets of companies in the finance, utility and railroad industries are a bit specialized. Most retailers and manufacturers, however, use fairly consistent terminology and formatting. At a high level, then, on the left side are assets, or what the company owns; on the upper right side are liabilities, or what the company owes; and on the lower right side is shareholders’ equity, or what has been invested in the company. Liabilities are listed above equity on the balance sheet to remind you that the debtors have a higher claim on assets than stockholders. So don’t get too cocky. Also remember that a balance sheet is a snapshot at a given point in time, not a record of changes.

In his book, Ben Graham summarized a key point in balance sheet analysis: “The liabilities are real, but the value of assets must be questioned.” Except for cash, the value of assets is often up to management’s accounting philosophies. The value of liabilities is not subjective, however, and it’s usually not worth the effort to scrutinize shareholders’ equity. So to analyze balance sheets well, focus on assets.

While the balance sheet can be a strong indicator of the health of a business, it’s also backward-looking. It doesn’t tell much about future income. We’ll get to that next.

Q. How should I start learning about a company I might invest in?

A. Investors are fortunate that the SEC requires public companies to publish comprehensive financial information about themselves. Unfortunately, much of that information often looks like corporate propaganda. So while I’d suggest the first place you start learning about a company is by reading its annual report, it’s important to clarify the version I’m referring to.

To many investors, a company’s annual report is a color brochure full of pictures and platitudes that really don’t tell you anything at all. My advice? Throw that one out. Go find the company’s actual filings with the SEC instead.

All public company filings are available for free on the SEC’s “EDGAR” website. Go to http://www.sec.gov/edgar.shtml then click on “Company Name.” Enter a company name, and then look for “Form 10-K.”

The 10-K is similar to the glossy annual report, only it goes into much further detail. It comes without the pictures and platitudes. It looks boring and staid because, well, it’s a government document. When it comes to investing, that’s a good thing.

A 10-K should be an investor’s first source of information about a company. It contains a detailed, objective description of almost everything you would want to know about a business, including product lines, divisions, technologies, patents, customer base, and more. You’ll find information about the markets the company operates in, any legal proceedings it’s involved in, and even management’s own analysis of past results and future plans. Companies write them, lawyers review them, and the accountants bless them.

Form 10-Ks also include a company’s financial reports – in greater detail, over a longer time period, and with more complete notes than in the glossy version. You’ll find a balance sheet, which captures a company’s financial position at a point in time; an income statement, which shows the company’s performance over a range of time; and a statement of cash flows, showing company activity and performance in cash terms.

We’ll get to each statement in my next columns. To really know a company, you’ve got to look at all three.

Q. How should I think about risk when investing in stocks?

A. Risk is a highly theoretical, strongly debated topic when it comes to investing. I wrote a partially tongue-in-cheek answer to this question last fall, but I’ll try again without the lame humor.

When it comes to investing in stocks, Wall Street and academia have traditionally described risk using a metric called “beta,” which quantifies the movements of a stock’s price compared to both the market as well as the price of other stocks. The general rule of thumb is that a beta greater than 1.0 means the stock will fluctuate up and down more than the broader stock market, while a beta lower than that threshold means it will fluctuate less – or even in the opposite direction. By this logic, high beta stocks are riskier, and low beta stocks are safer.

Here is the problem with that approach, however. It measures the fluctuation of stock prices, not business value. Rational investors should not be concerned with stock price changes – except when you can take advantage of them. The only thing that really should matter is how the stock price compares to the long-term value of the business.

Relying on beta can fly in the face of common sense. For instance, Google shares had a higher beta at $260 per share at the end of 2008 then at $700 per share at the end of 2007. Now, I ask you…when was the riskier time to buy?

To value investors, beta is useful only when it confirms something you probably already know – that the stock price is volatile because the company’s long-term prospects are, too. Otherwise, I think it’s better to think of risk in common-sense terms. Specifically, what are the odds that you’re going to lose all of your money, or see a permanent decline in your investment?

You should attempt to minimize that kind of risk every way possible – starting with sticking to companies with clear and consistent future prospects. But you’ll miss some great investment opportunities if you confuse volatility in stock prices with real risk.

A. I’d like to clarify two points for new readers. The first is that I believe that the majority of long-term investors are best served by investing in an index fund – a widely diversified, passively managed fund built just to match the performance of the whole stock market.

The second point is that if you’re going to build a focused portfolio containing a limited number of stocks, you either have to really know what you’re doing or find someone that does. One of my favorite quotes sums this up well: “Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

My own beliefs about diversification are the opposite of conventional Wall Street wisdom. In short, while diversification can play an important role in protecting overall wealth, I believe it is of limited use when you are trying to really grow a specific portion of your assets. It is simply a mathematical fact that the more stocks you own in your portfolio, the lower the odds are that you’ll be able to outperform an index fund.

In addition, putting your money to work in your best ideas also just makes more intuitive sense to me. If you own four stocks and one increases by 50% while the rest stay flat, your total portfolio will gain 12.5%. If you own 100 stocks and one increases by 100%, your portfolio is only up 1%. Why put money in your 76th best idea?

I believe you can reduce risk by deeply understanding the companies you invest in, as well as knowing their real value, not by spreading the risk across more companies. I see danger in owning too many investments because it becomes too hard to closely follow the progress of too many businesses.

So you probably don’t need to know more than a dozen companies really well over the course of your life to become wealthy. But you do have to know them very well.

A. I believe value investing is the only rational way to invest. Some analytical ability is required, but investing intelligently is not nearly as difficult as Wall Street would like you to believe.

There’s a central concept behind value investing that people seem to get immediately or it eludes them forever. The concept is that a publicly-traded company has two values – its actual or ‘intrinsic’ value, and the value the stock market assigns to it.

Intrinsic value changes infrequently, while stock market value can change every few seconds. By determining the intrinsic value of a company, and comparing it to the stock market’s assessment, we can buy small pieces of the best businesses which are the most underappreciated.

Purchasing shares only at prices far less than what they are truly worth is critical for two reasons. First, it protects you from permanent loss. This “margin of safety” concept is unique to value investing.

Second, buying well below intrinsic value presents the potential for substantial appreciation once the market recognizes the company’s true long-term value. And it rarely fails to do so.

Where is the proof that value investing works? In at least two places.

First is at the very top of the list of the world’s richest people. There you’ll find Warren Buffett, the most famous practitioner of value investing.

There is a simple math proof, too.

Say Corley buys shares in a company for 50% of their intrinsic value. The intrinsic value of the company then grows 12% per year by doing nothing more than retaining its own earnings. Even if it takes four years for the market price to reflect the company’s true worth, her investment will still have compounded at 30% per year.

Mathematically, two thirds of that return comes from the gap between market price and intrinsic value closing. Only one third comes from the business value growing. So growth is essential when looking for companies to invest in, but it’s less important than buying shares at a low price.

Hello again, island investors! I’m happy to say my column is back on a regular schedule.

I’d like to pick up by introducing myself to new readers in Key West and the Lower Keys. Last year this column ran for six months in the Upper Keys Weekly and was originally intended to answer questions about investing. I planned to give away a free T-shirt to anyone who emailed a question, which I would then answer in my next column. As it turned out, however, I got no questions from anyone except my mother. Zero. Zilch. Bupkus.

Being the analytical type, though, I did not take it personally. There was a simple economic explanation obvious to anyone who has ever walked down Duval Street – there is already a staggering oversupply of cheap T-shirts being hawked in the Keys. Mine never had a chance.

That lack of questions turned into something even better than my original plan, though, because it gave me the flexibility to cover all sorts of topics. I wrote on everything from index funds to credit default swaps to inflation to psychological biases, and based on the comments I’d hear at Winn-Dixie, people seemed to enjoy it. So, next week I’ll start again.

Regarding my background – I am a portfolio manager at an independent firm I founded in 2008, Islamorada Investment Management. All I do is analyze stocks, I have zero ties to any Wall Street firms and all my family’s life savings are invested in the funds I manage. I cannot give advice on specific investments here, but I think I can help you learn how to think independently about investing. I’ve also taken a fiduciary oath, which among other things means that while my columns might be opinionated, they won’t be conflicted.

I have many opinions about the way Wall Street treats individual investors. As one of them, you really have two choices when it comes to your own financial future. You can either be a consumer of financial products, or you can learn to be a real investor.

This column is about the latter.

Cale Smith is the portfolio manager of the Tarpon Folio and Gecko Folio. His firm’s website is www.islainvest.com and his blog is www.caleinthekeys.com.

A. The most important thing you can do when buying individual stocks is to have a systematic approach you believe in and use consistently. Another way to avoid mistakes is by understanding investors’ common psychological biases. Here’s an example:

Together a bat and a ball cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost?

If you answered 10 cents, you choose the most intuitively obvious answer. It’s also wrong.

That question highlights one of a handful of psychological biases that work against investors. A relatively new field of study called behavioral finance examines those biases, including:

1 – Loss aversion. The pain we feel from selling a stock at a loss outweighs the pleasure of selling that stock for a gain of the same amount. When you are deciding whether to sell a stock, ignore the price you paid for it.

2 – Anchoring. All of us have the unfortunate tendency to rely too heavily or ‘anchor’ on specific numbers. Psychologists can easily change the results of simple questions, such as, “How old do you think Clint Eastwood is?” by posing an earlier unrelated question containing a completely irrelevant number, like, “What city is 70 miles south of us?” Don’t get fixated on selling only at a certain stock price.

3 – Confirmation bias. People have an innate tendency to feel smarter about a decision after others confirm it was a good one. Whether or not other people agree with you, though, is irrelevant to investment returns, and it can be harmful.

4 – Recency bias. Most people tend to assume that events of the recent past will continue on into the foreseeable future. The effect of a short-term change in a company’s fortunes can be easily over-exaggerated in the stock market. Thinking long-term when investing helps you avoid this tendency – and take advantage of it, too.

And the correct answer to that question above is that the ball costs five cents. Yes, really. Email me for more.

A. The value of the U.S. dollar affects everything from the stock market to gas prices to geopolitics. The dollar’s value is determined by its exchange rate, which compares our currency to that of other countries through open market trading. I will leave predictions about the value of the dollar to others, but it’s important to understand the effects of a falling dollar.

Several factors explain the dollar’s decline, but the most significant is that U.S. debt is approaching $12 trillion. Foreign investors who own our debt are concerned that our government will let the value of the dollar fall in order to decrease the value of our debt. This is also one reason foreign investors are diversifying their holdings away from dollars to other currencies and non-dollar denominated assets.

The news of a declining dollar is mixed. It’s good in that it makes our goods cheaper and more competitive overseas, which helps increase exports and boosts economic growth. A weak dollar is bad, though, because it eventually leads to inflation. Imports from other countries become more expensive here, so U.S. businesses raise prices on their customers.

One such import is oil, which illustrates one of the most noticeable effects of a falling dollar. Since oil is traded in dollars and the dollar has weakened, oil-producing countries raise the price of oil to maintain profit margins in their local currencies.

The recent decrease in the value of the dollar does not mean the United States is in decline, however. The dollar actually rose in value during the global recession earlier this year, primarily because the U.S. is still seen as a safe haven for investors. There are also only two other currencies capable of supporting the world’s cash reserves – the yen and the euro. Though the U.S. economy is in poor shape, it is significantly stronger than that of Europe or Japan, and our currency is still the most attractive.

So while we absolutely have to decrease our debt, the dollar is not going to collapse overnight, either.

A. Private equity is the modern name given to firms that in the 1980s and early 90s used to be called leveraged buyout funds, or LBOs. After a slew of companies bought by these funds went bankrupt, however, these firms adopted a more benign sounding label. Don’t let that fool you. Private equity is an intense, often brutal world.

The most well-known private equity firms include companies like the Carlyle Group, KKR, and the Blackstone Group, while other firms like Goldman Sachs have private equity divisions. Private equity funds usually acquire whole companies or divisions of companies with the intent to fix them. Later, the fixed company will be resold, either to another company or to the public through an initial public offering.

In order to come up with the cash to buy a public company, a private equity fund will borrow a ton of money. Then it will use the cash flow created by the acquired company to pay the interest on that debt it just took on. Because the acquired company will have so much debt, its bonds are typically rated as “junk.”

Private equity funds flourished a few years ago due primarily to extremely low interest rates. Because borrowing money was ridiculously easy, private equity funds raised billions upon billions of dollars and bought up many companies, and even an English soccer team. 2006 saw a staggering $800 billion worth of private equity deals.

Ah, good times. That party ended, though, with the recent financial crisis and the ensuing Great Recession. Many companies bought by private equity firms and loaded up with debt now face some serious challenges in meeting their debt payments.

Private equity firms would like you to believe that by buying public companies and taking them “private,” they enable those companies to take the steps necessary to improve their operating performance without the hassles and glare of being in the public spotlight. There may be some truth to that, but as usual when it comes to Wall Street, take it with plenty of grains of salt.

A. While some research indicates that dividend stocks outperform the market, those studies are by definition backward-looking and far from practical. Academic research is often intellectually interesting but practically useless when creating a pragmatic investing strategy of your own.

Instead of relying on studies, let’s think like a business owner to answer this question. You as an investor are an owner in a company you hold shares in, and as such, a small percentage of the leftover cash that the company produces every year technically belongs to you. What would you like your company to do with it?

The company has six options for that cash. It could do nothing and let more cash accumulate, but investors that don’t earn much on their share of earnings tend to get ornery.

The company could use that cash to either make acquisitions or reinvest it in additional capital projects. If you’re like me, however, you may not be a fan of someone else spending your money on things you may not like. In most cases I’d rather stick to owning companies that don’t grow by acquisition or require a lot of capital.

That leaves three options for what you’d like a company to do with your cash. I’d argue they are each pretty similar. Whether a company pays a dividend, repurchases its own stock, or reduces its debt, it is creating value for you the owner. Whether you realize that value in the form of a dividend or see your equity stake increase “in the books,” each option has a different economic significance.

Dividends represent a bird in the hand, and some place a high value on that. However, companies that pay dividends are also signaling they are returning cash to their shareholders because they are unable earn high internal rates of return on it. That may not be the case for companies paying down debt or buying their own shares back.

So while dividends can be important, they might be less important than debt paydowns or share buybacks when it comes to maximizing returns.

Q. Who regulates the banks?

A. Banks are not simply assigned a regulator, as you might expect. Instead, they pick their own regulators through a process informally known as regulatory arbitrage. In essence, banks shop around to find the best outfit to oversee them. You may also find it ironic that regulators’ budgets are often determined by the number and size of the banks they oversee.

Let’s say your company were in the insurance business and wanted to get into banking. How would you do it? While there are many different regulators your existing business might work with, you would choose only one lead regulatory agency to work with as a bank.

Your options among the four federal regulators are as follows:

The Fed – This powerful institution’s main job is to set monetary policy, but it also oversees state-chartered banks and trust companies that belong to the Federal Reserve System.

FDIC – The Federal Deposit Insurance Corporation regulates state-chartered banks that do not belong to the Federal Reserve System and offers insurance to every bank. The FDIC has responsibility for the whole deposit insurance system and may seize unhealthy banks.

The Office of the Comptroller of the Currency – OCC regulates most of the big national banks. Read into that what you may. More pointedly, the OCC can preempt state rules, so those large banks can in many cases ignore state regulations.

Office of Thrift Supervision – OTS regulates thrifts and savings-and-loans, which are similar to commercial banks except they have requirements as to percentages of home mortgages or business loans held. OTS has looser capital requirements and less paperwork than the Fed.

All that said, regulators have overlapping oversight roles, so it can still be very difficult to determine which regulator actually has the authority over a particular bank. Bank of America, for instance, is big and diverse enough that its commercial banks are regulated by OCC, but it owns thrifts regulated by the Office of Thrift Supervision and its holding company is regulated by the Fed. And you thought credit default swaps were complex.