by Archie M. Richards, Jr., CFP^®
August 13, 2001

Barton Biggs, senior strategist at Morgan Stanley, estimates that there are about 6,000 hedge funds around the world, averaging just under $100 million each. Hedge funds are like mutual funds, but they can sell short as well as buy long, and many of them are highly leveraged, which increases risk enormously. Unregulated, they make convenient abodes for con artists. Hedge funds generally charge 1-2% operating fees plus 20% of profits. Sorry, they don't share in losses.

Assume an account of $100,000 in a Wilshire 5000 index fund, which gains 10% for the year. This makes $110,000. Reduce the $10,000 gain by 20-percent long term capital gains tax ($2,000), and you're left with $108,000.

Alternatively, you place $100,000 in a hedge fund that gains half again as much: 15 percent. The yearend value is $115,000. Deduct the 2-percent operating fee ($2,300), leaving $112,700. Deduct the 20-percent share of the net profits (20% of $12,700 is $2,540), leaving $110,160. Finally, deduct the 20-percent capital gains tax on the $10,160 net gain ($2,032), leaving $108,128.

Despite the hedge fund gaining 15 percent instead of 10 percent, you cleared, after tax, only $128 more ($108,128 less $108,000). You don't suppose this is worth the risk, do you?

The occasional hedge fund that performs well makes sure the press knows all about it. But most hedge funds hope that no one notices their crummy records. If you want your friends to know what a hotshot you are, be my guest; invest in a hedge fund. But to make money consistently, avoid them.

In a computer, most of the electronic impulses, as you probably know, are either on or off. Our brains work the same way, but brains have so many billions of synapses that we can walk, talk, see where we're going, listen for cars, smell french fries, chew gum, and feel sexy at the same time.

Our eyes and ears are analog, and so is most of nature. When you walk in a park, the green isn't just there or not there. Instead, there's an infinite variety of green.

Let's say that an analog sensor is installed at the front of your car. It detects a moose crossing the road ahead. Running into one of those big guys can ruin your whole day. The tall legs break, the body slides up the hood, smashes through the windshield, and forces 800 pounds of moosemeat down your gullet.

But the sensor detects danger. Its analog signal is converted into a digital signal, which is processed by the on-board computer. The digital output, converted back to analog, instructs the brakes to slow the car as gently as possible. The signals are constant in both directions, fast and accurate.

To sense and control the real world, we need ever more sensors and devices that convert analog signals to digital and digital signals to analog. The largest, pure-play manufacturer is Analog Devices, Inc. (ADI), which plows back a huge 15- percent of revenues into R&D. If you have a foundation of index funds, buy Analog Devices, now $47.45.

The requests for pork-barrel projects in the U.S. House have reached nearly 19,000, at a potential cost of $279 billion - almost as much as the defense budget.

Stephen Moore, President of The Club for Growth, observes that the current recession is driven by a lack of investment. Venture capital funding is down more than half this year, and few IPOs are being sold. Here's what Moore thinks is needed:

• An immediate reduction in the capital gains tax.

• Immediate repeal of the death tax. This tax brings in small revenues but creates big distortions.

• Bring the tax cuts forward, so that they take effect in 2002, not 2005 and beyond.

• We need more liquidity from the Federal Reserve.

• The President should veto appropriations bills that exceed a 4-percent spending target. With inflation running at less than 2 percent, growth of government spending by 7-to-8 percent is absurd.

Things Aren't What They Seem Department: Commercial jets use lots of fuel, right? Nevertheless, they've become about as fuel-efficient as cars, because they fly fully loaded, while cars drive nearly empty.