© 2015 Tom Madell, Ph.D.

July 2015

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Grow Rich Slowly

Naturally, many investors would like to find the right investment or investments that would propel them into prosperity as quickly as possible. Toward this end, some often seek out individual stocks, or alternatively, aggressive fund choices, often investing a high percentage of their overall portfolio where they expect it will have the best chance to appreciate rapidly.

Of course, such creation of quick wealth can occur, but realistically, only for a tiny percent of investors. However, since it always remains a possibility, some investors still will hew closely to strategies they hope will propel them into affluence in a matter of several years as opposed to the prospect of, at best, having to waiting for possibly several decades.

Even if the typical investor tones down somewhat this fast-paced attempt to race for the top, the objective of many investors remains one of striving to always shoot to maximize returns at all possible times. But strategies to maximize returns often mean maximizing one's level of risk as opposed to accepting the possibility of somewhat lower returns in order to keep potential portfolio-dampening returns, including negative ones, to a minimum.

More simply put, and especially apropos to today's investing environment, investors might be tempted to opt for maintaining large bets on investments that have "shot the lights out" over the last 5 or 6 years. Examples would be funds heavily weighted in healthcare or technology related shares (or even the S&P 500 index which currently has over one-third of its investments in these two sectors), vs. spreading out investments more broadly, to include other less currently well-performing areas.

(continued, page 7)

Changes to Our Model Portfolios

By Tom Madell

Note: Recently, this Newsletter was recognized as one of 5 expert mutual fund resources worth following offering free, and, in our case, particularly "unbiased, useful, and original advice."

The accolade comes from a writer whose own expertise has been featured in The Wall Street Journal, Barron’s, and USA Today, among other publications.


An important part of my Newsletters has always been each quarter's Model Portfolios. Lately, I have revisited old Portfolios to attempt to further confirm just how effective my recommendations were, going back all the way to Jan. 2000.

While these analyses are not complete, and therefore, I will not report in any detail what I have found, the good news is that, especially for stocks, my specific choices of funds and fund overweights vs. underweights (i.e. allocations) have again been shown to be highly successful as compared to investing in an appropriate mixture of weighted index funds. Obviously, this casts doubts on the view that an unchanging portfolio of index funds is going to be the best choice for investors. These results will be published at a later time.

Given these prior successes in my Model Portfolios, it might seem to be somewhat the wrong time to introduce some changes to how these Portfolios are presented. However, in an attempt to make investing in these Portfolios simpler for the average reader, I am making some relatively small changes.

Another reason to think about a change: Down through the years, we have observed that our more narrowly-defined and typically less diversified choices have been among the minority of funds we recommended that have more frequently had disappointing performances. (See our companion article in the left column on why we think it best for most investors to focus on more diversified and less aggressive funds, that is, those that are not highly specialized, and therefore, above average in risk.) So, in general, our more aggressive fund choices, while still included, are likely to be de-emphasized.

(continued on page 2 below)

Page 2

July 2015

(Changes to Our Model Portfolios , continued from page 1)

Overall Asset Allocations

As usual, first, we'll present our allocation recommendations for the overall broad asset classes of stocks, bonds, and cash.

Obviously, such allocations cannot be the same for all investors. While, generally speaking, relatively high allocations to stocks have produced better results than low allocations for long-term investors, not everyone is at the same "life stage" or has the same tolerance for possible losses which comes with high stock allocations. But readers should be made aware that my personal bias reflects a preference for the recommendations I show for "Moderate Risk Investors" as opposed to the other two risk categories of Aggressive Risk or Conservative Risk I refer to.

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 50% (50%)
Bonds 25 (25)
Cash 25 (25)

For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 65% (65%)
Bonds 12.5 (12.5)
Cash 22.5 (22.5)

For Conservative Investors

Asset Current (Last Qtr.)
Stocks 15% (15%)
Bonds 40 (40)
Cash 45 (45)

Comments on Overall Asset Allocations

As in the case of the April 2015 allocations, I am recommending no change from the prior three months.

The longer this bull market goes on, the harder it becomes for me (or anyone) to stick with these relatively low allocations to stocks. While thus far in 2015, the S&P 500 and the Dow really haven't moved that much, many diverse funds in a variety of categories, including managed funds, have had quite decent 6-month returns.

But, in spite of the gains (on top of those from 2014) we don't believe in chasing what may have already past. Rather, our allocations are designed to reflect our best estimate of how good returns will be in the future, ranging over the next 5 years or so. While it may be frustrating to see returns continue to charge ahead while we are admittedly somewhat underinvested in stocks, we expect our patience will eventually be rewarded as stocks correct while our non-stock choices prove to provide a relatively safe haven. Also, eventually, cash and bond positions, can provide ample "fodder" for increasing our stock investments once stocks again provide more highly attractive, lower-priced entry points.

Now let's look within both our Model Stock and Bond Portfolios and also describe the particular changes to how we suggest one can follow our recommendations, at least for the great majority of our readers.



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July 2015

Model Stock Fund Portfolio

The following table shows all our specifically recommended funds. More detailed comments follow the table.


Our Specific Fund
and Allocation
Recommendations

Fund
Category

 Recommended
Overall Category
Weighting Now
(vs Last Qtr.)

-Fidelity Low-Priced Stock (FLPSX) (10%)

   Mid-Cap/
   Small Cap


    10% (10%)


-Vanguard Europe (VEURX) (10%) (M)
-Vanguard Pacific Idx (VPACX) (10%) (A)
-Tweedy, Browne Global
  Value (TBGVX) (5%) (C & M)
-Vanguard Emerging Markets Idx
  (VEIEX) (5%) (A)
-DFA Internat Small Cap Value I
  (DISVX) (2.5%) (A)
 (See Notes 1 and 2.)

 International 


    32.5 (32.5)


-Fidelity Large Cap Stock (FLCSX) (10.0)
-Vanguard 500 Index (VFINX) (7.5)

   Large Blend 


    17.5 (17.5)


-Vanguard Growth Index (VIGRX) (7.5)
-Fidelity Contra (FCNTX) (5.0)
    Large
    Growth

    12.5 (12.5)


-T Rowe Price Value (TRVLX) (7.5) (M)
-Vanguard Windsor II (VWNFX) (7.5) (M)
-Vanguard US Value (VUVLX) (5.0) (A)

    Large
    Value


    20.0 (22.5)


-Vanguard Financials ETF (VFH) (5.0) (A)
 (New)
-Vanguard Energy (VGENX) (2.5) (A)
 (See Note 3.)

    Sector


    7.5 (5)

Notes:
1. Stock or bond funds with (C) are particularly recommended for Conservative investors; likewise, (M) for Moderate; (A) for Aggressive.
2. Highly similar ETFs (exchange traded funds) of the same category can often be substituted for any index mutual fund shown in this table; e.g. Vanguard FTSE Europe ETF (VGK) can be substituted for Vanguard Europe (VEURX).
3. We are eliminating Vanguard Utilities ETF (VPU), Vanguard Energy ETF (VDE), and Vanguard Precious Metals and Mining Inv (VGPMX), that were included in our last Portfolio.

Observe the change in how we are presenting our recommendations now: Instead of only showing one recommended category weighting such as 32.5% for International funds, we are breaking that overall weighting into an individual weighting for each of our specific fund choices within a category.

This enhancement allows you to see which of the shown funds we would put the most weight on. Since many investors don't necessarily have the bandwidth to own several funds within a category (or multiple funds within your overall stock portfolio), you can now see which fund(s) we recommend putting the highest emphasis on. So, in this quarter's Model Stock Portfolio, the two International funds we feel have the highest return potential in the years ahead are Vanguard Europe and Vanguard Pacific, each at a 10% recommendation of the stock portfolio.

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July 2015

Across the entire stock portfolio, there are also an additional two funds recommended at the 10% level, Fidelity Low-Priced Stock and Fidelity Large Cap Stock. This suggests that if you only wish to own a total of 3 or 4 funds, not all of the 15 we currently recommend, you would select from among these four because they are the ones with the highest weightings.

As we have be doing in the past, we tend to denote which funds we think might be preferred by Moderate Risk investors vs. those that might be better suited for Aggressive or Conservative investors. Since we rate Vanguard Pacific as most suited for relatively aggressive investors, if one were picking a total of just 3 funds to invest in, and did not want to take on a higher degree of risk, one might eliminate this fund from the above group of four, leaving just three.

Comments on Specific Funds

Mid-/Small-Cap stocks continue to be one of the most overvalued categories of funds which gives us considerable caution. However, as noted at other times, Fidelity Low-Priced Stock (FLPSX) is a highly diversified fund that can invest in large as well as smaller cap names. Its emphasis tends to be toward Value stocks rather than the highly overvalued growth side. In comparing FLPSX with its somewhat equally compelling Fidelity "brother," FCNTX, also a Model Portfolio fund, we would give the edge to FLPSX, again attributable to valuation concerns.

International funds appear to have the best potential compared to other fund categories going forward. Both Europe and Japan share nearly equally in this positive potential. The main difference is that Europe is more diversified and more likely to follow a clear growth path; Japan is a little more iffy since the culture of investing is not as firmly established there and has experienced so many missed opportunities and missteps.

Both Vanguard Europe (VEURX) and Vanguard Pacific (VPACX) are good ways to play recoveries in these regions, although both funds have been hurt greatly in the last year due to losses in the euro and yen, lessening returns for US investors. In the longer run, these currency issues should cease to be a big determinant of returns and both funds should reward long-term investors. Alternate funds, such as those offered by WisdomTree (Europe Hedged Equity ETF (HEDJ) and Japan Hedged Equity ETF (DXJ) ) might be substituted but only by quite aggressive investors willing to bet that euro and yen weakness will continue unabated.

Tweedy, Browne Global Value (TBGVX) is a hedged fund that has done better than most International funds in the last year without the drag of the above-mentioned currency losses. (Note: There is no similarity between a "hedge" fund and a currency "hedged" fund such as TBGVX). However, the fund has adopted a very conservative stance this year with a large cash position helping to cause it to trail its competitors. Some investors may also not like its high expense ratio (1.36%). However, we still view it as an attractive long-term holding with a solid team of managers. A more conventional but more aggressive growth-oriented International fund without TBGVX's hedging would be Vanguard International Growth (VWIGX).

In our opinion, Vanguard Emerging Market Fund (VEIEX) is also a good choice at this juncture. However, with a big position in China (29%), our other International recommendations are more in keeping with our Moderate Risk bias.

We recently added a recommendation for DFA International Small Cap Value I (DISVX), starting this past Jan. Since then, the fund has returned about 13% (through June 26). We believe this fund is a good portfolio diversifier since our above funds International funds are otherwise all large cap.

Fidelity Large Cap Stock (FLCSX) is a somewhat unknown fund as compared to our above other two Fidelity choices above. Yet the fund's 10 year track record, achieved by a single manager, is outstanding. We like its well-diversified approach. We also think its sector choices are better choices than an unmanaged S&P 500 fund which must most heavily weight already highly price-appreciated companies.

We have long included Vanguard Growth Index (VIGRX) in our Model Portfolios. However, there is what we consider a problem in its over 8% weighting in Apple stock. Very long-term holders are probably still on firm ground, but FCNTX is a good possible alternative for investors wanting a manager to make stock selections as opposed to merely investing in an index including stocks in approximately the same proportion as its market capitalization weighting in its underlying index.

There are, in our opinion, several nearly equally good Large Value funds to recommend. Vanguard US Value (VUVLX) has been an excellent fund over the last several years with its current team of managers. However, we are a little concerned that it currently invests approximately one-third of its portfolio in mid-/small- and micro-cap stocks. As we mentioned above, we prefer large cap stocks based on valuation issues. So long as the smaller stocks keep doing so well, this fund should excel but we hope the managers will adjust this position, if and when necessary.

We also especially like T. Rowe Price Value (TRVLX) which also has this issue, but to a lesser extent (recently had about 23% in primarily mid-cap stocks).

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July 2015

Perhaps the strictest adherer among our choices to the Large Value mandate is Vanguard Windsor II Inv (VWNFX). Since Large Value has underperformed most other categories in recent years, VWNFX reflects this. However, it should be well-positioned once Large Value re-asserts itself in the years ahead which we believe it will. Incidentally, a fund highly similar to VWNFX is VWNDX (the original Windsor Fund), which has a better 5 year performance record than VWNFX. It may be a toss-up between the two funds right now, but we'll stick with VWNFX given our view it has a slightly better sectors' positioning going forward.

We have added a recommendation for Vanguard Financials ETF (VFH), a fund we did well with several years ago, but which has returned to being within one of the more undervalued categories of funds. As a sector fund and therefore quite undiversified as compared to the overall market, we would regard it mainly for Aggressive investors. In fact, since Financial stocks are a big part of all of our recommended Value funds, one might view it as unnecessary for the average investor.

We are maintaining a small position in Vanguard Energy (VGENX), but again, just something to be considered by more Aggressive investors. Its portfolio seems to be better diversified than the Vanguard Energy ETF (VDE) which we are dropping.

Model Bond Fund Portfolio


Our Specific Fund
and Allocation
Recommendations

Fund
Category

 Recommended
Overall Category
Weighting Now
(vs Last Qtr.)


-PIMCO Total Return Instit (PTTRX) (25.0%)
 (High minimum investm. outside 401k), or 
-Harbor Bond Fund (HABDX) (0.0%) (1K min.)
 Note: When possible, select PTTRX; HABDX is
 only recommended if you cannot met minimum.
-PIMCO Total Return ETF (BOND) (5.0%) (A)
-Metropolitan West Total Return Bond (MWTRX) (5.0%)

  Diversified 


    35.0% (35.0%) 


-PIMCO Real Return (PRRIX) (5.0)
 (High minimum investm. outside 401k), or
-Harbor Real Return (HARRX) (0.0%) (1K min.)
 Note: When possible, select PRRIX; HARRX is
 only recommended if you cannot met minimum.

 
  Inflation
  -Protected


    5.0 (5.0)

-Vanguard Intermed. Term Tax-Ex. (VWITX) (15.0)
 (Select only for taxable accouunts; also see Note below)
  Intermed.
  Term
  Muni.

    15.0 (17.5)

-Vanguard Sh. Term Inv. Grade (VFSTX) (7.5)

  Short-Term
    Corp. 


    7.5 (5.0)


-Loomis Sayles Retail (LSBRX) (5.0) (A)
 

  Multisector 


    5.0 (5.0)

-Vanguard High Yield (VWEHX) (10.0)

  High Yield 


    10.0 (10.0)

-PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX)
 (22.5)

  International


    22.5 (22.5)

Note: Select a fund, if available, that has your own state's bonds for double-tax exemption, such as, for example, the California Intermediate-Term Tax-Exempt Fund (VCAIX) if you live in California.
Page 6

July 2015

Comments on Specific Funds

A much discussed topic lately has been whether investors should continue to maintain investments in bond funds in light of what is now a near certainty that Fed controlled short-term interest rates will be rising soon.

While most bond funds highly likely won't be able to provide the kind of returns that investors find particularly attractive, well-selected funds should be able to outperform cash. Investors should also take into account that if and when stock returns start to underperform investor expectations, bonds may be the beneficiaries.

There has been much controversy, in particular, about one of our mainstay Model Bond Portfolio selections, PIMCO Total Return Instit (PTTRX). Of course, the fund has had a great past track record, but all that has come into question now that the manager who achieved that record, Bill Gross, has left the firm under conditions that suggest that perhaps PIMCO has lost its way.

But the way we look at it, PIMCO is now better off without Gross, and now has some of the best available managers (as a team) at the helm. While Gross's performance at his new employer, Janus funds, has been undistinguished, PTTRX continues to hold its own against the competition. Another bond fund, PIMCO Total Return ETF (BOND), run by the same managers as PTTRX, is doing even better than PTTRX. Therefore, it is highly worthy of consideration by Aggressive investors.

Metropolitan West Total Return Bond (MWTRX) is another broad-based fund to possibly consider.

PIMCO Real Return (PRRIX) is another fine PIMCO fund. The reason for our low allocation is that so long as inflation is expected to remain low, inflation-protected bond funds will likely have a hard time delivering good results.

Municipal bonds are still one of the best bond fund choices for your non-tax-deferred account because you get a comparatively decent Federal tax free yield with relatively low risk. Vanguard Intermed. Term Tax-Ex. (VWITX) currently yields 1.88% which is the equivalent of earning 2.61% on a fund which is fully taxable if you are in the 28% Fed tax bracket. In today's low rate environment (which could last for another year or more in spite of Fed rate increases), it would be hard to earn 2.61% without investing in a long-term bond, creating considerable potential for deteriorating returns as rates rise.

We are raising our allocation to Vanguard Sh. Term Inv. Grade (VFSTX) slightly. Although one will hardly ever pocket noteworthy returns in this fund, we think it is a very good alternative to cash. Specifically, a return of maybe 1 to 1.5% is better than the perhaps 0.375 to .0.625% return we expect from money market accounts when interest rate rises are factored in over the next year.

We continue to recommend a 5% allocation to Loomis Sayles Retail (LSBRX) for Aggressive investors. This is based mainly the excellence of its primary manager down through the years, although the fund might not be a particularly good diversifer in the event that stocks underperform, due to its emphasis on lower rated bonds that can correlate a good deal with stocks.

Like LSBRX, Vanguard High Yield (VWEHX) has only had a negative full year in one out of the last 10 (in 2008). We believe that a somewhat "conservative" junk bond fund such as VWEHX can still make sense as compared to many other such funds which would heighten one's risk.

PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX) is another PIMCO bond fund we can highly recommend and think it should be a "core" holding for those who are willing to invest in funds that invest abroad. Better opportunities for bond appreciation lie abroad than in the US, and currency hedging at a time the dollar may well continue to rise, should be a net advantage over non-hedged international bond funds.

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Page 7

July 2015

(Grow Rich Slowly, continued from page 1)

Recent results seem so clearly stacked in favor of the current above-mentioned types of funds as to make appear "a dinosaur" anyone who hasn't ridden such winners. In fact, the mouth-watering gains might seem so "natural" right now that they could easily be regarded as a no-brainer. And for those who remain in what once appeared to be promising market segments that have recently underperformed, it may be increasingly hard to "stay the course."

Over the last year alone, Vanguard Health Care (VGHCX) has returned nearly 30% (through 6-26); Fidelity Select IT Services Portfolio (FBSOX), (technology sector) has returned over 23%. (And over five years, owning both could have nearly tripled your investment.) These funds are largely made up of Growth stocks. By contrast, some of the bigger funds investing primarily in Value stocks, such as Vanguard Value ETF (VTV) and American Funds American Mutual A (AMRMX), are returning on the order of 7% over the last 12 months. Can it be that investors in the former funds are that much smarter than those who invested in the latter funds? It certainly might appear that way.

Of course, many investors who invested in a similarly aggressive fashion eventually learned the negative side of always gunning for high returns year after year. The bear markets of 2000-2002 and late 2007 through early 2009 showed just how much one can suffer when continuing to stick with the best performing types of funds when their reign finally topples. Yet still, now over 6 years into the current bull market, some may be tempted to assume that, yes indeed, you should be able to get rich perhaps easily and somewhat quickly by aiming for constant high returns regardless of the build-up of risk that comes after years of outsized returns.

Here's my main point which not everyone will agree with, since it is more of an opinion than a provable fact: Believing overtly, or even on a subconscious level, that investing should be about aiming for uninterrupted wealth-producing gains is a strategy that can lead to "feast or famine."

Stories abounded over the last decade and a half about people who amassed large amounts of investment gains only to lose much or all of it when the markets changed direction. If you want to almost guarantee that nothing like that will ever happen to you, especially the older you get since you will have less time to recover from severe losses, consider the alternative: Be willing to accept and actually work toward a somewhat slower and safer build-up of wealth.

For most investors, especially those reading a funds investing newsletter such as this one, you can obtain wealth far more reliably by seeking out and settling for more modest gains, while at the same time, avoiding risky choices that can easily wipe out most or all your overall yearly or even multi-year gains.

Back in 2003 and in early 2009, when stock prices were relatively low, it might have made sense to have had high expectations for stocks, although of course, the risks were still there. While the future, as always, remains unclear, it appears that it may not be that long before many of the most money-producing investments of recent years will certainly have more downside risk and less upside potential. Therefore, while adopting an investing strategy that nearly always features the same aggressive assumptions year after year may work, but, likely, only provided that today's winning choices will remain so continuously.

So, let me succinctly re-state the alternate strategy to attempting to get rich quickly: Get rich slowly!

The history of successful investing has shown that your chances of acquiring considerable wealth are actually quite good, if

a) you "settle" for a well-diversified portfolio that permits you to neutralize occasional loses with either offsetting gains, or at least less severe losses, and

b) you allow enough time for moderate gains to grow down through the years into much larger sums that you can expect to enjoy later in life or at least leave to your heirs.

Most investors have some difficulty in following each of these above conditions, a) and b). Let's see why.

Most people have various forms of biases that disincline them from putting together a well-diversified portfolio consisting of various types of both stocks and bonds. I define a bias here as a belief that while it may have some element of truth, prevents a person from fully utilizing the money-generating capacities, as well as wealth-protecting features, of an asset class. Here are just a few examples:

Page 8

July 2015

  • "Stocks are far better investments than bonds so why should I invest in bonds?"
  • "Stocks are much too risky; look at how they performed in 2000-2002 and during the financial crisis. I can't expose my savings to these kinds of risks."
  • "Bonds are always safer than stocks."
  • "Bull markets or not, stocks haven't performed very well over the last 15 years. Remember some of the best performing stock funds back in 2000? Some of them haven't even returned 3% a year since then. I don't think the average person should bother with stocks."
  • "I don't understand bonds; I've heard you always lose money when interest rates go up."
  • "Experts really have no agreement which stock or bond funds are best so I'll just invest in a basic index fund such as one investing in the S&P 500 or a bond market index fund."

As a result of such biases, and many more, vast numbers of investors tend to heavily focus their investments on only certain types of investments. Many often omit important categories of stocks, such as international, value, or small cap funds, or stocks or bonds altogether.

When things are going as expected for the sometimes limited number of categories of funds they have chosen, investors can relax and enjoy their profits. But when things inevitably start to go bad, these investors, often caught by surprise, tend to sell these funds after some (or even a great deal) of the profits made in these investments are lost.

As stated above, investors in more diversified portfolios often find that such losses are offset by either smaller losses or even gains in other parts of their portfolio. And such stutter-step patterns of gains and losses make it easier for them to occasionally refocus their portfolios, or alternatively, to "rebalance," in the hopes of earning better returns going forward.

In short, better diversification, while perhaps somewhat limiting your gains in up markets, usually enables you to potentially do better in down markets. And why shouldn't you trade some loss of potential gains when, over time, the markets rewards are sufficient that you don't need to always go for the highest returns? Just earning, say, 9 to 10% on average on your stock returns, and 4 to 4.5% on your bonds over the years, should actually enable you to become quite wealthy in as few as 20 years or so, assuming of course you do not manage to spend all of your gains along the way.

And what about condition b), that is, continuing to invest over a long enough period to allow your gains to grow? While some people do this, in my estimation, many, many people do not. Rather, many succumb to either the fear of losses or to temptation to pull out after achieving only a fraction of potential gains.

So if you are under 55 years old, you should have still have plenty of time to steadily and reliably accumulate wealth ahead of you without resorting to high-risk investing. But what if you are over 55? By settling for moderate gains, instead of always aiming for the biggest ones, your investments should still grow nicely, with a much reduced chance of one or two really bad investment years cutting into the amounts you will almost surely need to comfortably prosper in your advanced years.

As I have frequently pointed out, both the stock and bond markets and the pundits who expound on them, almost regularly seem to send out dire signals suggesting that the bottom is about to fall out. Experience suggests to me that in well over the majority of instances, these warnings are off-base. In fact, often, when the economic news looks particularly awful for an asset category (take, for example, the troubles in the eurozone or bonds right now), the subsequent outcome turns out far less dire than expected.

During such numerous instances, investors should carefully weigh the risks and rewards involved in staying invested in an asset category, or alternatively, switching to a less "threatened" category, when necessary, rather than pulling out of their investments altogether. The majority of such moves, if made at all, should be small and gradual to protect against these predictions of scary scenarios that never wind up happening, or our own often incorrect interpretations of the economic and investment tea leaves, that also never happen, or even if they do, often have consequences that are all but eradicated within days or perhaps weeks.

Tom Madell, Publisher

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