Suggested Resolution

Source: Capital Pixel

Resolve to start or bolster your investment program.

If you are young:  congratulations!  One of the first principles of personal finance is to start investing early to take advantage of compounding.

Decision makers understand that taking no action is in fact a decision.  You can wait until you are 65 years old and then, after blowing out the birthday candles, figure out how you are going to produce an income to live on.  You can live on the financial edge. You can believe that things always work out.  You can procrastinate.  Know, though, that there are always things in the modern economy to sop up 100% of disposable income.  The best and the the brightest among us are working 24/7 to produce goods and services you'll want to spend your income on.  It is the way our economy works.  Too many procrastinate for 45 years.

There are plenty of seniors out there who would caution against this approach.  Many "have been there done that!"  Talk to them.  A wave of baby boomers are now retiring, and a goodly percentage will struggle financially.  They have definite thoughts on what they would have done differently both in terms of how much they saved and invested but also in how they invested.

As an aside, if feasible, ask your company human resources department to arrange a seminar featuring company retirees.  Ask the retirees to talk about retirement - how it was, what they expected, and some of the surprises, what they would do differently, and what they planned for correctly.  It can be an eyeopener and very helpful for all company employees.  Feed the retirees a nice lunch.  They will enjoy talking about their experience.

Many younger workers argue that they plan to work way past the accepted 65-year-old standard retirement age.  Good luck - the data shows that people don't work as long as they expect.  They get laid off/outsourced.  Medical problems come up.  And, yes, people burn out.  Then many  turn to Social Security and maybe take a part-time minimum wage gig.  The third leg of the stool - the so-called "nest egg" - has to take up the slack, and only 4% of that can safely be spent, according to a widely-used rule-of-thumb.

Another course is to take action now.  You can resolve to understand your company benefits.  You can resolve to read at least one good book on personal finance this year.  You can resolve to start thinking about what you need to do to have choices in the future and to support yourself and your family in the event you can't work.

HAVE A GREAT 2012!

Get Me Into the Market

Source: Capital Pixel

One of the questions I have potential clients answer is why they are seeking the services of RW investment Strategies.  This, of course, points me, as an advisor, in a particular direction and tells me a lot about whether I can help them.  A frequent answer is that they need help getting into the market.

This, in fact, is one of the best reasons to seek the help of an advisor. Often, I'll find that potential clients have poorly timed the market by buying in after the market has gone up.  They then wring their hands and stress out as they watch their portfolio drop, only to sell out at the wrong time.  After selling out, they have to watch from the sidelines as  the market rises.  This, of course, is the emotional roller coaster investors ( I use the term loosely) needlessly ride.  And - it is costly!

2011 has been a case in point.  I find investors have pulled their hair out as they've witnessed and reacted to 400-point swings in the market by capitulating at the wrong time and seeing now that market indices are  positive for the year.

This is the point where they show up on my doorstep.

Some appreciate the advice I give them by acting on it in timely fashion.  Others, despite my best attempt, don't.  They will walk away and, if the market moves 15% higher, jump in.  Basically they will continue the behavior that has been harmful in the past.  This, of course, is a phenomema that is not confined just to the financial arena.

Get Into The Market

I'm a proponent of indexing.  This makes getting into the market easy.  If you have a brokerage account and we meet at 9:30 a.m., I'll have you in the market by 10:30 a.m. at the latest.  We won't try to pick stocks or sectors.  We won't discuss macroeconomic developments.  We won't even try to guess what China and Europe have up their sleeves.  What we will do is buy the whole market.  If you are with Schwab, we'll buy SCHB.  If you are with Vanguard, we'll buy VTI.  With others, we may buy IWV. These are all low-cost, broad market exchange traded funds.

The bond portion is just as straight forward.  We use low-cost exchange traded funds that are indexed to broad portions of the fixed income market.

How much will we buy?  How much in stocks and bonds?  This takes a bit of time and collaboration.  It is why we might need until 10:30 to get you invested.  We'll talk about your goals and take into account answers to other questions on the questionnaire.  We'll determine an appropriate asset allocation model that targets a given percentage in stocks and fixed income.

If the appropriate model is 70% stocks but you are very leery of the market, we might start with 60% stocks.

A number of factors come into play, but the bottom line is you'll be in the market.

12-Months Experience

Some people are wondering what the big deal is.  Over the past 12 months ended 12/23, the "Moderately Conservative Benchmark" specified by Schwab returned 3.13%.  This benchmark is comprised of 60% bonds and cash and 40% stocks.

In comparison, your money fund probably returned on the order of 0.1%.  Even if you had money in a certificate of deposit, you likely earned only slightly above 1%.  Thus, the opportunity cost of not being in the market and riding out the craziness that has taken place over the past 12 months has been meaningful.  In fact, although the benchmark return at 3.13% is below the rate of consumer inflation over the past 12 months ,it is at least close to tracking it.  Money fund performance, in contrast, has been hammered by inflation.  This is a risk many fail to appreciate.

As a point of reference, markets over the past 12 months have bordered on the insane with a government that was totally inept, a Europe that has struggled all year with the possibility of a breakdown, China slowing, and a stubbornly high rate of unemployment in the U.S.  All of these scary factors and excuses have kept investors on the sidelines and have been costly.

2012 will very likely be just as wild.  Should you be in the market?

Disclosure:  This post is for educational purposes only.  Market returns are unpredictable.  Individuals should do their own research or consult a professional before making investment decisions.

Market Predictions

This is the season of predictions and forecasts.  Pundits are getting a lot of air time and magazine space trotting out all kinds of charts and esoteric facts to support highly specific predictions on where markets are headed.

If you are like a lot of investors, you will be impressed.  In fact, crystal ball seers in the market are usually introduced by citing a time in the past when they made accurate predictions. 

What should you make of them?  Sometimes potential clients reel off well-known pundits' names and their forecasts.  They say so-and-so says the market is headed higher/lower or gold is going to $ _____/oz. etc.  They want to know what I think.

I patiently explain that I can get super smart, very articulate people to give well-reasoned, highly-believable arguments on both sides.  Jeremy Siegal (author of Stocks For the Long Run), for example, will argue forcefully that stocks are headed higher while Bob Shiller (author of Irrational Exuberance) will take the opposite side and say that now is not a good time to buy. 

What you don't see are all those in the gutter because their predictions turned out horribly wrong.  You won't see Miller, Paulson, Berkowitz, et al.  Sometimes this gets through; often times it doesn't.  After all, some people have their whole view of investing grounded in predicting which stocks and which sectors will do best.



If I thought forecasting was useful, I'd probably go with the most recent presenter given that they are so persuasive.  But I don't think it is useful.  In fact, it is harmful, IMHO, because many times investors use these forecasts as a  substitute for thinking; and when forecasts start to go awry, emotions come into play and the investor is set up for a stressful period that typically ends badly.


Larry Swedroe is the director of research of Buckingham Asset Management, LLC and a well-known proponent of index investing.  Here is his response when asked to make a forecast of macroeconomic events:
 
 From interview of  Larry Swedroe by "Seeking Alpha":


SA: Global Macro considerations dominated the headlines in 2011. Do you see 2012 unfolding differently? If so, how?
LS: Yes, it is always different, but my crystal ball is always cloudy. So I don’t make forecasts. Investors should learn what Warren Buffett knows: A market forecast tells you nothing about where the market is going but a lot about the person doing the forecast.
       There are good studies on the ability to forecast and the only thing that correlates with accuracy is fame, and the correlation is negative:  The more famous the forecaster, the less accurate the forecast.

Why Are Interest Rates So Low? (Part 8)

In this final, 4-minute Khan Academy video on currencies, "China Keeps Peg But Diversifies Holdings," Sal notes that China's holdings of U.S. Treasuries are decreasing as they diversify their holdings but other countries holdings of Treasuries are increasing.  In fact, globally the rest of the world has to do something with the excess of the amount we buy from them versus what they buy from us, i.e. our trade deficit.  They buy Treasury issues because they are liquid and safe and can be bought in very large amounts.

So, the end result is that China buys Treasuries to peg their currency below the market rate which results in a humongous demand for Treasuries, driving Treasury prices higher and rates lower.  This is a major factor holding U.S. rates low and expanding the U.S. trade deficit.  It holds Treasury rates lower than they would be otherwise as well as the rates on other issues. B y doing this, China is able to build their manufacturing base.  Eventually they should reach the point where they create a middle class to buy the goods they produce.

To me, the Khan Academy videos are a treasure.  For those interested in understanding how the economy works and financial markets, I suggest visiting the site on a regular basis and viewing the videos systematically.  To keep up-to-date on events, check out the new videos he is constantly producing.  Eventually your understanding of markets will become much more sophisticated.  I actually believe that many big-time money managers didn't fully appreciate the impact on rates described by Sal in the videos we have viewed this week.

Why Are Interest Rates So Low? (Part 7)

In today's Khan Academy video, "Debt Loops Rationale and Effects," Sal looks at the positives and negatives--for both China and the U.S.--of the on-going pegging of the Yuan on global markets.  He discusses the likely outcome once the process is halted and the result when it is reversed.  Very simply, it has held interest rates low and enabled the U.S. to finance its massive debt at historically low interest rates.  Understanding this whole dynamic is crucial, IMHO, for the DIY investor going forward because it will be a driving force.  In fact, it could be the driving force of the next big crisis - banks hold Treasuries!  Central banks around the world hold the dollar as a reserve currency in the form of Treasuries.

Why Are Interest Rates So Low? (Part 6)

In this Khan Academy video, "American - Chinese Debt Loop," Sal explains the effect of China pegging the Yuan, lending the U.S. funds via the buying of Treasury securities, and thereby contributing in a major way to low U.S. interest rates.  U.S. Treasury rates affect other U.S. rates as well, along with global interest rates.  Furthermore, low interest rates push global investors out on the risk spectrum - after all, individual investors, pension funds, insurance companies, et al. aren't satisfied with miniscule rates on the least risky assets being affected by this process.

Understanding the process leads naturally to the questions of how it gets unwound and what happens if and when the Chinese get tired of holding U.S. assets.  Not long ago, Fed Chairman Greenspan wondered why long-term Treasury note yields didn't rise as the Federal Reserve raised rates from the 1% level in the latter part of 2004.  His so-called "conundrum" is partially explained by the process explained here by Sal.

Enjoy the video:

Why Are Interest Rates So Low? (Part 5)

In this 16-minute video, Sal of Khan Academy takes us real close to understanding an important dynamic taking place in the global capital market that has held interest rates down and has been a bit underappreciated.  Here he shows how the Chinese Central Bank needs to constantly print Yuan and use that Yuan to buy U.S. dollars to maintain the peg between the Yuan and the U.S. dollar.  They do this to produce an ongoing trade surplus with the U.S. - i.e., to sell more goods to the U.S. than it buys from us to support its industries.

The key is what they do with the dollars bought with the Yuan they print.  As Sal points out, they need to put this massive accumulation in something that is safe and liquid, i.e. U.S. Treasuries.

Just this morning there is a report that Japan wants to increase the amount it can intervene with in currency markets to prevent the Yen from rising further.  So this whole process is not just unique to China.  Countries have an incentive to keep their currencies from appreciating versus the world's reserve currency!

Enjoy the video:

Why Are Interest Rates So Low? (Part 4)

The previous 3 posts presented short videos from the Khan Academy that covered some basics of international trade.  They showed a simple example of how a trade imbalance is resolved in a market of freely floating exchange rates.  They showed how currencies and prices adjusted.

Today's 7-minute video presentation, "Pegging the Yuan," takes us closer to the real world.  It begins to look at what happens if China wants to keep the currency at a level where demand for its goods stays high.  How does it do this?  What is the effect on U.S. interest rates?

This is especially interesting today because, as most market observers know, investment professionals expected Treasury yields to rise this year; and they actually fell.  It seems that, while everyone was focused on a Fed that was undertaking unprecedented monetary stimulus, less attention was directed to what the Chinese were doing in the currency markets.

Why Are Interest Rates So Low? (Part 3)

The last two posts have looked at how a trade imbalance gets worked out in a freely floating exchange rate environment as explained by Sal Khan.  Today's 10-minute video,  "Currency Effect on Trade Review" brings it all together and shows how the quantity demanded for dolls and cola adjust, along with prices, to result in balanced trade.

This sets the stage for what is happening in the real world with China controlling its currency and the role of U.S. Treasuries, which will be taken up next.

Why Are Interest Rates So Low (Part 2)

Yesterday we looked at the first short video of 7 that explains why interest rates are so low.  The effect comes from the global currency markets and, in my vie,  is an effect that hasn't been fully appreciated by investors - even very sophisticated investors.

Today's Khan Academy 14-minute video shows, in very basic terms, how freely varying exchange rates eliminate trade imbalances.  Notice especially, at the end, how prices in the countries change.

Again, this is leading to a fairly sophisticated understanding of the impact of controlling exchange rates and demonstrates that the economics investors need to understand can be presented without esoteric mathematics.

Why Are Interest Rates So Low?

I have previously touted the Khan Academy videos produced by Sal Khan. They are a revolution in education produced by a gifted teacher.  Bill Gates, in fact, has called Sal Khan his favorite teacher.
This is the first of 7 videos that takes the viewer into the world of currency exchange and shows how China's controlling its currency has an important influence on U.S. interest rates.  The videos are approximately 12 minutes in length.  Although most readers won't appreciate it, the typical way this information is presented is by using esoteric mind-numbing mathematics which, in the end, detracts from the fundamental principles presented.  Watching the 7 videos over the next several days will contribute to making DIY investors considerably more sophisticated.

In this first video, Sal takes us through the dynamics of an imbalance in the demand for U.S. $s versus the Chinese Yuan.

Socially Responsible Investing - Thoughts

Source: Capital Pixel

Last week I met with a client who held the Calvert Enhanced Equity Fund (CMICX).  This is a socially responsible fund.  It carefully screens stocks and selects only those that fit strict criteria in terms of their lines of business.  For example, many socially responsible funds would avoid tobacco stocks, military oriented stocks, etc.

My investment approach runs into a fundamental hurdle with these types of funds - they are typically very expensive.  For example, Morningstar reports that CMICX has expenses of 2.23%, a load of 1%, and turnover of 111%!  Yikes!

Not surprisingly, Mornningstar reports that CMICX achieved a return of 0.75% over the past 10 years versus 2.84% on the S&P 500 index.,- a huge give-up over this time frame.

In keeping with the "creative juices" theme of the past couple of posts, I suggested the client think of directly buying the stocks of the fund.  This client, by the way, has the time to do this--which is, obviously, an important consideration.  Partial duplication keeps the client in a values-investing mode and hopefully leads to better long-term performance by avoiding the high expenses.

To carry out this approach, the client was directed to Yahoo! Finance.  There they can put in the ticker symbol (CMICX) and on the right side click "more fund holdings." This would get them to:

Source: Yahoo Finance

CLICK IMAGE TO ENLARGE. The suggestion would be to create a 10-stock portfolio with 10% invested in each issue.  This represents 35%, approximately, of the total portfolio.  The client would have to check back quarterly to readjust on the basis of an updated listing.  These may be substantial, given the reported turnover!  In effect, this is a "poor man's index."

There obviously will be some difference between returns of the fund and the constructed portfolio  a type of basis risk), but it will satisfy the socially responsible criteria and avoid some heavy long-run expenses.

In fairness to Calvert, they do work hard to manage these funds, screen the stocks on the basis of strict criteria, and have some that perform well over the long term.  My perspective is to give my clients the best possible shot at a successful retirement.

As a final point, this approach can be used for any high-priced fund by those willing and able to take on the risks mentioned.

Disclosure:  I do not own the funds mentioned here but do own some of the stocks listed.  This post is for educational purposes only.

Trading Bonds (Part II)

Source: Capital Pixel

Yesterday we looked at the idea of bond trading on the basis of yield spreads.  Underlying this idea is that there is so-called "reversion to the mean" when it comes to yield spreads.

We looked at a set of data showing that, on average, selling IEF (a 7 - 10 Treasury ETF) and buying HYG ( a high yield ETF) resulted in a take out of $10.42.

Today HYG is $87.26 and IEF is $104.43 for a take out of $17.17! In other words, HYG is much cheaper relative to IEF than it has been on average.

This can also be expressed in terms of yield.  At $87.26, HYG is yielding 7.97%; and, at $104.43, IEF is yielding 2.69%.  The pickup in yield by moving IEF to HYG is, therefore, 5.28% (7.97 - 2.69).

Hopefully, this gives some insights into how bond traders shift among sectors of the bond market.  My plan is to revisit this trade in a couple of months to see how it works out!

Disclosure:  The information here is for educational purposes.  I hold HYG and IEF in client accounts.

Trading Bonds

Source: Capital Pixel

This post is for the active DIY investor who would like an approach  for  the fixed income portion of the portfolio.  It is presented solely as an idea to get the creative juices flowing.  In fact, in the end, the best approach for most DIY investors is to just buy the market, via AGG or BND which tracks the Barclay's Aggregate Index, i.e. the overall bond market, and forget it.

There are others who take investing as a challenge.  They like to try to "beat the  market" - at least for a portion of their assets.  They have a lot of time to study the market.  They spend considerable time researching stocks but are stymied when it comes to the bond portion of their assets.

Should I Try to Predict Interest Rates?
 
Serious investors understand that bond yields and bond prices move in opposite directions.  This, then, suggests that predicting interest rates is the natural way to outperform the bond market.

Sadly, as most professional bond managers will tell you, predicting interest rates is like predicting stock prices - it is a losers game.  2011 has been an excellent example of this.  When yields had been considerably higher than where they are today, most pros predicted yet higher rates.  Instead they dropped sharply; and, as a result, some of the most high-profile bond managers underperformed the bond market significantly.  So much for predicting rates.

Trade the Spread
 
Instead, many pros will tell you it is considerably easier dealing with spreads.  This is what I want to look at here.

A simple under-appreciated fact, IMHO, is that bonds are fundamentally different from stocks in that we know the future price of a bond.  For example, if we buy a 5-year Verizon bond, we know that at the maturity date the price of the bond will be $100 (for $100 in principal).  Obviously, if we buy Verizon stock, we have no idea where the price will be 5 years from now.

This gives special meaning to the much discussed "reversion to the mean" concept.  Think about it like this:  the price of a Verizon bond, for example, can wander all over the place depending on how investors feel about risk; but, in the end, it has to track closer to Treasury yields as it gets closer to maturity.  This is true in spades when a portfolio of bonds is considered.

I find it interesting that professionals spend a lot of time studying and trading on the basis of yield spreads and yet, despite all of the investment information on line, yield graphs are not easy to find!  In fact, I had to create my own data for this simple exercise to illustrate this idea of investing on the basis of yield spreads.

In thinking about what we are trying to do, first consider two bonds:  a corporate bond and a government bond.  Assume the Treasury bond yields 5% and the corporate bond yields 7%, i.e. the spread is 2%. Then, if the spread goes to 1.5%, it means that the price of the corporate bond has risen (or decreased less) relative to the price of the government bond - remember:  bond prices rise when bond yields drop. The idea then boils down to this:  buy corporate bonds when yield spreads are wide and you are getting paid to take on risk, and sell and go into Treasuries when the reward-to-risk is not so appealing. Professional bond traders spend a lot of time doing exactly this - studying yield spread graphs in their search for value.

Data Analysis
 
So, to begin I first found some historical yields.

I collected monthly yields on Moody's Baa rated bonds (Baa is actually the bottom of the investment grade category) and the 5-year constant maturity Treasury note going back to November 2005.  I then took the difference in the monthly yields and calculated the average.  At the end of November, the Baa yield was 5.14%, the Treasury note yield was 0.91%, and so the spread was 4.23%.  The average over the whole period for this spread was 3.58%.  So, as a first cut, a bond trader would say the Baa corporate "has value."

On the other hand, if the spread was less than the average of 3.58%, bond traders would typically prefer the Treasury.  In other words, they would say an investor is not getting paid enough to take on the risk of the corporate issue.

2011-04	6.02	2.17	3.85
2011-05	5.78	1.84	3.94
2011-06	5.75	1.58	4.17
2011-07	5.76	1.54	4.22
2011-08	5.36	1.02	4.34
2011-09	5.27	0.9	4.37
2011-10	5.37	1.06	4.31
2011-11	5.14	0.91	4.23
		AVG.	3.58

 Again, the above is a partial listing of the data.  The column headed by 6.02 is the Baa yield, the next column is the Treasury note yield, and the final column is the "spread," i.e. the difference.  The average is for the whole period going back to the of 2005.

Hopefully you get the idea at this point - the adept trader who sold corporates on 4/2011 at a spread of 3.95% could buy them back considerably cheaper on 11/2011 at a spread of 4.23%.

Let's go a step further and think about the best way for a DIY investor to exploit spreads.  For this purpose, I collected price data, back to 4/2007,  on HYG (high yield bond ETF) and IEF (7 - 10-year Treasury note ETF).  A significant positive here is that these are low-cost, highly-diversified investment instruments appropriate for the DIY investor.  HYG is a good choice for up to 5% of a portfolio for the fixed income portion of most DIY portfolios.  The question is when is a good time to buy?

Below is a partial listing of my data.  The difference here is that we are looking at prices.  The prices of the funds go up when bond prices rise, i.e. yields fall.  If yields on high yield corporates fall more than yields on Treasury notes, then HYG will rise more than IEF will and vice versa.  The spread reflects confidence in the economic recovery, etc.  When the spread is large (on an absolute basis), it means you have to pay a lot (example:  10/2010 at -12.52) for the safety of Treasuries - this is the time to buy HYG! As you can see, by early 2011, HYG had appreciated in price (from 83.04 to 86.93) and IEF had actually declined!  If you go to the earlier chart and collect the yield data, you'll find that the spread over the same period dropped from 4.59% to 3.92%! 

Hopefully this gives you a bit of an idea how spread information can help position the fixed portion of the portfolio.  There are, of course, other areas of the market, including mortgage-backeds, single-A corporates, etc., where this approach can be used profitably.  Keep in mind that the yield advantage of sectors relative to Treasuries brings time into the process.  This post is intended for educational purposes. Individuals should consult with a professional and do their own research.  I hold ETFs mentioned above.

	HYG	IEF	SPREAD
2010-10	83.04	95.56	-12.52
2010-11	81.99	94.7	-12.71
2010-12	84.26	91.45	-7.19
2011-01	85.67	91.43	-5.76
2011-02	86.9	91.24	-4.34
2011-03	86.93	91.1	-4.17
2011-04	88.32	92.78	-4.46
2011-05	88.44	95.1	-6.66
2011-06	87.93	94.62	-6.69
2011-07	88.25	97.62	-9.37
2011-08	85.84	102.16	-16.32
2011-09	81.29	104.45	-23.16
2011-10	88.19	103.1	-14.91
2011-11	86.05	103.7	-17.65
		AVERAGE	-10.42

2012 Dividend Aristocrats

Source:

melmelsmith.com

Dividend aristocrats are S&P 500 companies that have increased dividends for 25 years in a row.  There are 50 companies on the list.  A listing, including number of years dividends have increased for each company, has been produced by Dividend Growth Investor.  Note that near the bottom of the post is a listing for so-called "Dividend Champions."  This is a broader listing with less stringent capitalization requirements.

These lists are excellent starting points for those building a portfolio to create a specific income stream as well as those just looking to pick up a little yield.

Heroes Breakfast Speech

 Worth watching and reflecting on. Found on Biz of Life site.


Paul Tudor Jones II- 2011 Heroes Breakfast from Robin Hood on Vimeo.

Great Holiday Gifts!

The joy of the holidays brings the stress of choosing gifts.  Some of us will participate in that sanity-testing tradition of "Secret Santa" and draw the name of the least liked or least known person in the office or even (yikes!) the boss. Others stress over getting something for someone in a different age bracket with tastes they can't relate to.  Still others dread meandering in crowds of rude shoppers trying to get a feel for what's out there.

Here's a couple of suggestions.  Just about everyone at a certain stage in life can profitably read the following two books.  They are especially well suited for the person or couple who are in their first few years following college . This is a period where people are making financial decisions that will significantly impact their lifetime well-being.

Book #1 is Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School by Andrew Hallam.  A very quick read, even for the financial novice, this book yields insights that provide value over a lifetime.  I would suggest that a couple read it together and discuss it.  To get an idea of Andrew Hallam's writings, visit his blog.

Book #2 is I Will Teach You To Be Rich by Ramit Sethi.  Again, this is a book that young people will find invaluable.  To get an idea of Ramit Sethi's writing,s visit his blog.

Both books are available as paperbacks and are life-changing and inspirational.

Can You Manage Your Own Assets?

Source: Capital Pixel

Here's an excellent article for those considering the DIYer route which I highly recommend:  "Should I Hire a Financial Advisor or Go it Alone?" by Walter Updegrave.

Thinking about becoming a DIYer is something I promote.  IMHO ( as well as Warren Buffet's and many other respected market practitioners) many people are throwing money away by paying professionals to time the market or pick stocks.

Yesterday I had coffee with a lady who explained that her portfolio consisted of three issues:  a total stock ETF, an international stock ETF, and a total bond market ETF.  Here's the thing:  there is voluminous evidence supporting the thesis that a three issue, low expense ratio, low trading cost, broadly diversified portfolio has historically outperformed most professionals over the longer-term (10 years and longer) after all fees are accounted for.

There are some things to know going in, though.  First you need to understand that controlling emotions is important.  The article points out that those who do not use an advisor actually underperform by 3%/annually on average due partially to emotions - see the study by Financial Engines cited in the article. Secondly, asset allocation is important.  Most people get some experience in this by making decisions for their 401(k).  The scary part for some is when they get assets outside their 401(k) by rolling over assets when they change jobs or retire.  Having more choices and less structure can get some to throw up their hands and pay big management fees to advisors.  They assume that investing is complicated and consumes a lot of time.  I believe, with a bit of help in the beginning along with some instruction, many can become DIYers as the article suggests.

As an aside - when it comes time to roll over assets, etc., I think just about everyone should at a minimum get some hourly professional advice.  It is trickier than most people know.  I've written before about trying to wire the dryer in my house and almost burning the house down.  You have the same kind of situation here.  There are nuances about not taking the rollover as a check to be deposited, rolling assets in kind, the type of account to roll company stock into, etc. that can have a big tax impact.

The article also lists numerous tools to help the DIYer.  I find that most major discount brokers offer these tools to analyze funds, allocate assets, track investments (and in the case of Charles Schwab, which I use, track performance relative to a well-defined benchmark) for free.  Understanding how to use these tools is the key for the DIYer.  One of the services I offer is to set up potential DIYers by doing the initial investing after the assets are rolled over, accounts combined, etc., then explain the investing process, and, when the client feels they are ready,  hand it over to them - at which point they are a true DIYer.

In fact, I would encourage those with larger portfolios to consider peeling off a part of their portfolio and give the DIY approach a shot.  They will be surprised how little time it takes to manage a portfolio of low-cost index funds.  As an added benefit, they will have a means of really assessing their high priced advisor!

Disclosure: the information here is for educational purposes only. No investment returns are implied or guaranteed.

An Interview With An Investment Guru

Seth Klarman is a legend in a league with Warren Buffett. In this interview with Charlie Rose I found on The Biz of Life site, he first talks about his non-profit organization and then gets into his investment approach.

No matter what style an investor chooses, it is always valuable, I think, to listen to those who have mastered the game. He notes that it takes a certain, rare gene to invest in line with the Benjamin Graham style. He talks about his book Margin of Safety. He lists the 3 stages of investing followed by Buffett. Interestingly, he humbly claims that he is only good at the first: "buying cigar butts at good prices."



You can follow Seth Klarman and his holdings as derived from 13f filings at guru focus.

As shown,CLICK IMAGE TO ENLARGE, he takes some big positions.

As readers of this blog know, I believe investors should index at least 80% of their retirement assets and invest at most 20% in individual stocks. I would also argue that one should be careful following the top hedge fund managers. You may find you don't have that "special gene" at exactly the wrong time ;)

Disclosure: This post is for educational purposes only. Investors should do their own research before investing. I may hold stocks mentioned in this post.

Long-Term Care Insurance

As one who concentrates on investments and portfolio management, I am very much aware that the process is carried out within the context of an overall plan. Plainly put, the investment program can be the exact fit for a client in terms of overall assets, risk tolerance, retirement goals, etc. but something else can be totally out of kilter - sort of like a well-fitted suit with a long loose thread hanging from the jacket sleeve. Such a thread for the DIY investor can be that taboo of subjects - Long-Term Care.

The issue here is very simple. It has to do with "...The best laid plans of ...." Again, everything can be in place; but then a need for long-term medical assistance can throw everything out of whack. The problem is that long-term care is expensive, as will be detailed in the following video. Think about it like this: suppose you move into the house of your dreams but you don't have homeowners insurance. Then, the house burns down. That could be the situation if you work hard to build the nest egg to the appropriate size and then need long-term care.

Long-term care is expensive. One thing some creative families have done is to have  children or other potential beneficiaries pitch in to pay the annual premium.  After all, in many cases, it is potentially an insurance on their likely inheritance.

I recommend watching the following excellent video by Christine Benz, Morningstar's Director of Personal Finance. Ms. Benz has a talent for explaining complex topics.



If you need specific info (and live in the Baltimore area) on choices available for you and their costs or even whether LTC is appropriate in your specific case, I would recommend meeting with Sharon Kreiger. sharon.kreiger@ltcfp.net  (223-275-1764). Ms. Kreiger's philosophy is to start with a meeting to basically educate a potential client on LTC.

Movie Recommendation

For those who get overdosed on cheer this holiday season, I recommend the DVD Inside Job . It will quickly bring you back to reality.  It proves what most people know - there is no upper bound for greed.  Still, to see how it has played out to bring us to where we are today is sobering.

We have paid a heavy price for assuming that those in charge know what they are doing and that they are operating in the nation's best interest.

Many want the bad actors in the film put in jail--which is easily understandable. The problem is that a lot of bad things can be done without it being criminal.  It is easy to not do one's job in the pursuit of greater riches, which will be seen over and over in the film.  This isn't a crime under the criminal code.  Most viewers will get that.

What is unfathomable is that the leading institutions of the country continue to employ many of these people at the highest level.  The Federal Reserve, Columbia Business School, the various think tanks should be ashamed.

I, for one, am deeply ashamed for the economics profession.  Watch the film and see why.

How to Find Release Dates of Earnings Reports

Source: Capital Pixel

The most important firm specific date is usually when earnings are released.  If you invest in individual stocks, you are interested in when the report is coming out and the expectations of the market.  A disappointing report or a surprisingly good report typically will move the price significantly.  Those who follow Apple stock closely know exactly what I mean.  When Apple reports, its stock moves sharply in after-hours trading.

So suppose we are interested in finding, for example, Pepsi's release date and analyst expectations.

For this, we turn to the "Earnings Calendar" available at most major financial sites.  We'll use the Yahoo! site.  At the site, just type in the ticker, PEP, to find the release date of February 6, as shown:

Source: Thompson Financial Network

 CLICK IMAGE TO ENLARGE  Note the other useful items available, especially the conference call link.  At this link, you can listen to the last conference call.  If you stay on until the end, you usually can hear questions from analysts and the company's response.  To me, this is one of the best ways to identify issues with a company.  For example, analysts will want to know why sales in South America are down slightly or, if it's the Apple conference call, why phone sales were below expectations.  Questions will come up about the all-important revenue projections, etc.

Scrolling down the list for earnings releases for February 6 brings you to:

Source: Thompson Financial Network

 CLICK IMAGE TO ENLARGE  As you can see, analysts expect Pepsi to earn $1.14/share for the quarter.  Also note that you can add the event to a Yahoo! calendar, so it is easy to track a portfolio of stocks.  Clicking on the PEP link and then on "analyst estimates" (on the left-hand side after scrolling down) will give you even more info on earnings history and expectations--including the all-important number of analyst who are providing estimates.

Disclosure:  I agree with Warren Buffett et al. that most investors will be better off by buying well-diversified low-cost index funds tailored to an asset allocation model.  This information is for those who find buying a few stocks an enjoyable and challenging undertaking.
 

Average Joe's Retirement Fund

• Assume: Joe has worked for 20 years at a company that matched  the company 401(k) by 50% up to 6% of salary. 
• Joe contributed 6% of salary and being risk averse allocated his contribution and the company match to 50% bonds (aggregate exchange traded fund, AGG) and 50% stocks (S&P 500,SPY).

He was 45 years old when he started and today he is 65 years old. How much was his portfolio  worth at year end 2010?

Data sources: Average Joe made the average wage during his career. This data was obtained at http://www.ssa.gov/oact/cola/awiseries.html . The market return data was taken from the "20 Year Periodic Table of Returns" produced by BlackRock. Here's the data and results:

CLICK TABLE TO ENLARGE The table shows that an average person, continually making the average wage over his peak earning years, at a company that offered  basic retirement benefits, accumulated $113,000 using an extremely conservative investment approach. This despite waiting until he was 45 years old before he saved a dime.

It is not easy to understand sometimes why people constantly complain.  Suffice it to say that the human race has not always had it so easy and that billions would trade places today with Joe in the blink of an eye. And they wouldn't be stuck at an average wage for 20 years.

A Good Source of Investment Information

Source: Capital Pixel

One of the challenges today for DIY investors, who actively manage their own assets, is handling the vast amount of information at their finger tips.  A key is to find good sources.  One worth checking out is "Market Currents" at Seeking Alpha.

Scanning recent lists you'll find many reports on the troubled Europe region.  This, of course, is where investors are presently focused.

Other reports will grab your attention as well.  For example, from yesterday's items, we find this tidbit worth thinking about if you are contemplating buying or selling banks' stocks.

6:50 PM Fitch has it wrong, U.S. banks could actually wind up benefiting from Europe's debt crisis, says Rochdale's Dick Bove.  He cites two reasons:   first, U.S. banks have a relatively low level of exposure to European banks.  Second, the problems facing European banks could actually drive business to seek healthier institutions in the U.S.  His top picks: PNC Financial (PNC) and Fifth Third Bancorp (FITB).  Both get hit when Europe erupts, but neither are heavily exposed to European banks.  [Quick Ideas, Global & FX, Financials]

The reports, as you can see, have numerous links making it easy to further research the information presented, if necessary. 

You'll also notice the search box in the upper right of the page.  Here is where you can type in a ticker symbol and get recent stock specific reports.  Do this today for Intel (INTC) and you'll find reports ranging from Buffett's 13F filing showing he bought chip companies (which is news because he previously has famously avoided tech altogether) to industry projections on the inventory and profit outlook.

If you buy individual stocks or make general market bets, this kind of information can be invaluable.  Not that long ago it would have taken days to garner the information now available at the click of a button.

Full Disclosure:  I recommend that at least 80% of retirement assets be invested in index funds aligned with a carefully selected asset allocation model reflective of risk tolerance.

America's #1 Personal Finance Book

Source: Amazon

Andrew Hallam's book Millionaire Teacher has deservedly reached #1 on Amazon's best seller list of personal finance books.  It's not hard to figure out why - it is readable, witty, and provides a desperately needed message to individuals on how to become financially literate.  If it was up to me, it would be required reading in all high schools and colleges; and Human Resources departments would do well passing it out to employees.  At least then we would know that students and workers had one real-life case put in front of them of someone who has figured out how to build wealth on a modest salary.  Millionaire Teacher spells out this valuable information.  It gives people a road map with the lessons it teaches.

But for most readers, this won't be all.  There is an added bonus... Andrew produces one of the top financial blogs in the world.  Readers will be impressed with the trips he takes and adventures he has.  It is clear that getting one's finances in order provides the means to live an interesting life.  Readers of his blog will also be inspired by the head-on battle he has fought with serious medical issues.  Not only has he fought back but he has continued as a world class distance runner.

I was honored in being asked to endorse the book.  Seeing my name in print next to the heavy hitters in the world of finance has been a thrill.  I hope that this book finds its way into the hands of the financially challenged this holiday season.  It truly has life-changing potential.

Observations on "Conventional Wisdom"

Kim Clark offers some interesting points on so-called "conventional wisdom" in "Investing: Throw Out Conventional Wisdom."  Many have to do with the all-important subject of asset allocation.  IMHO, this is where investors should focus their efforts rather than spending the bulk of their time picking stocks and trying to figure out which "guru du jour" to follow.

From this perspective, Clark's overview of "broad framing" is worth thinking hard about.  It really isn't as simplistic as she presents it, though.  For example, people have to view their own housing situation and whether they would be willing to downsize, take a reverse mortgage, etc.  This will determine if it definitely is part of their portfolio and should be taken into account as a negatively correlated asset with equities.

Her thoughts on individuals reaching peak financial capability in their mid-50s is worth thinking about, as well.  It definitely emphasizes the importance of working through and setting up the retirement process early on.  It is interesting that many become responsible for their rolled over 401(k)s, etc. just as their financial acumen is decreasing - a phenomena little discussed.

Jury Duty, Investing, and Warren Buffett

At some point in a jury trial, you get to credentials.  In the jury trial I was on, a "first responder" was getting equipment off a firetruck in a cordoned-off area when he was sideswiped by an elderly lady whose car had somehow made it into the area.  He rolled down an embankment and damaged his knee.

I was hoping the trial would go into analyzing how the lady got her car into the area, but instead it veered off into discussing the problem knee.

With a damaged knee, the defendant couldn't do his second job - roofing.  After some background in what roofers go through, we took a much-needed break.  Next, they brought the credentialed experts in - in this case, the knee specialists.  As Warner Wolf used to say, "Let's go to the tape!"

Both sides took 20 minutes to present the credentials of their experts.  They have gone to prestigious schools, written the most widely-used text books on knee surgeries and reconstruction, invented a knee brace or two, and performed one zillion surgeries.  They have been on Presidential Commissions and one even performed knee surgery on the moon, if I remember correctly.  After a while, it all started to blend together.

All of this, and time to be a professional expert witness!  You can't help but be impressed.

The testimony on each side took 20 seconds.  "I examined the x-rays and with this knee injury the defendant can do/can't do roofing."  

When you think about it, though, expert witness is many times the best.  Especially when it comes uncompensated.  Many people understand that this isn't the case in the world of financial services.

In this world, it is easy to impress with colored graphs and fancy promotional materials.  It is not uncommon to find prospective clients overwhelmed by bulky analysis and jargon.

This is exactly where  the best approach is to put all of that aside and ask the uncompensated expert witness.  We go to the tape and see what Warren Buffett has to say about the best way to invest:



Better yet, I like to go to a direct quote from  his 1996 annual report:

Most investors, both institutional and individual, will find that the best way to own common stocks  is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.  

This sentence is worth parsing.  He mentions both "...institutional and individual...."  Institutional includes the large pension funds and others whom hire the best and the brightest from the nation's best business schools.  If anyone could beat the market by stock picking, timing or voodoo even, it would certainly be this group.  Yet Buffett says they, too, should use low-cost index funds.  And, they do to a surprising extent; but that is the subject of a future post. 

Hedge Your Portfolio

Source: http: Capital Pixel

Sometimes when I talk with potential clients about the fixed income portion of their portfolio, I find that they are thinking "cash" à la money markets, etc.  They see cash as their defense against a falling market.

Me:  "Maybe you should consider the asset allocation model that has 50% in fixed income."
Them:  "I'm pretty much there.  I have 3 certificates of deposit (CDs) and 20% in money markets."

Ooops!  CDs and money markets are not what asset allocators mean when they say "fixed income."  Fixed income means bonds.  The huge difference is that, when yields fall, bond prices rise and money markets and CDs, etc. don't.

To see this clearly, take a look at  the "Callan Periodic Table of Investment Returns."  This table shows 20 years of returns, on an annual basis, for 9 asset classes, including the 2 we want to focus on - the S&P 500 and Barclay's Aggregate Bond Index.

The table shows there were 4 years where the S&P 500 (the light blue box in the table) dropped. The following table shows these returns along with the returns on the Barclay's Aggregate Bond Index (shown as the gray box in the table).

Year          S&P 500         BC Agg
2000             -9.11%          +11.63%
2001           -11.98%            +8.63%
2002           -22.10%          +10.26%
2008           -37.00%            +5.24%

Given the anemic yields of CDs and money markets today, the hedging property of bonds is obvious.  It's worth noting that an even more effective hedge in down markets would be U.S. Treasury notes and bonds, but they could be costly in a rising rate environment - there's no free lunch here!

To bring bonds into a portfolio on a cost effective basis has never been easier.  The AGG is the most widely-traded bond exchange traded fund, and it has a management fee of .22%.  It pays to also check with your broker.  For example, Schwab offers SCHZ which tracks the same index, has a management fee of .1%, and is commission free.

If more hedging is desired, long-term put options (LEAPS) could be considered.  These were discussed previously.

Disclosure:  This post is intended for educational purposes.  Investors should do their own research or consult with an advisor before making investment decisions.  I own the exchange traded funds mentioned.

Shameless Promotion

Source: Amazon

Yesterday I gave a pitch to the Howard County Public Schools Academy of Finance board, of which I am a member, for Andrew Hallam's book Millionaire Teacher.  The book is highly recommended for anyone interested in learning the appropriate way to invest for the longer term and how a person of modest salary can attain a sizeable nest egg.  Andrew's humor and talent for explaining complex topics make the book extremely readable and, a rarity for this genre, highly entertaining.

The basic message in the book, for young people to start investing early, diversifying, and paying attention to costs, is lost on many as evidenced by the report described by Shawn at Watson Inc in his post "Young People Avoiding Investing in Record Numbers."

The Wells Fargo report Shawn reported on found that those in their 20s prefer CDs rather than investing in stocks.

The customer reviews of Millionaire Teacher speak for themselves.  Andrew's book is a giant step in the right direction for attaining financial literacy.

Full disclosure:  RW Investment Strategies is mentioned in the book.

Trying to Understand Greece

It's hard to understand why someone would try to pull a foot off the brakes of a car careening towards a cliff.  That's the puzzle facing investors as they get the latest news out of the European Union on Greece's call for a referendum on last week's agreement.  Some people and nations make agreements and then live up to the agreements.  Some don't.  A useful source for understanding Greece, as well as the overall European crisis better, is Michael Lewis' readable and entertaining book Boomerang.   I quote from page 47:

"...in October 2009, the Greek government had estimated its 2009 budget deficit at 3.7 percent.  Two weeks later that number was revised upward, to 12.5 percent, and actually turned out to be nearly 14 percent.  He (talking about Papaconstaninou - the new finance minister) was the man whose job it had been to figure out and explain to the world why, "The second day on the job I had to call a meeting to look at the budget," he says. "I gathered everyone from the general accounting office, and we started, like, this discovery process."  Each day they discovered some incredible omission. A pension debit of a billion dollars every year somehow remained off the government's books, where everyone pretended it did not exist, even though the government paid it; the hole in the pension plan for the self employed was not the 300 million euros they had assumed but 1.1 billion euros, and so on, "At the end of each day I would say, "Okay guys, is this all?"  And they would say, "Yeah". The next morning there would be this little hand rising in the back of the room: "Actually, Minister, there's this other one-hundred-to-two hundred-million-euro gap."

That's the cost side.  Then there's revenue.  Tax collection in Greece would probably make even Grover Norquist take pause.  Lewis talks to a tax collector "...an estimated two-thirds of Greek doctors reported incomes under 12,000 euros a year - which meant, because incomes below that amount weren't taxable, that even plastic surgeons making millions a year paid no tax at all."
"If the law was enforced ," the tax collector said, "every doctor in Greece would be in jail."

We Know What to Do - Let's Do It!

Isn't it striking how every politician in Washington DC can eloquently riff on what is wrong with the U.S. political system and yet the system continues in a highly dysfunctional state?  This points up the well-known and frustrating fact that people know what to do to take steps to regain functionality but the will is lacking.  Sort of like dealing with an accident-prone teenager walking around with a cell phone glued to his ear.

Thomas Friedman (of whom I'm not especially a big fan) bluntly makes some recommendations on banking in "Did You Hear the One About the Bankers?":

1) If a bank is too big to fail, it is too big and needs to be broken up. We can’t risk another trillion-dollar bailout. 2) If your bank’s deposits are federally insured by U.S. taxpayers, you can’t do any proprietary trading with those deposits — period. 3) Derivatives have to be traded on transparent exchanges where we can see if another A.I.G. is building up enormous risk. 4) Finally, an idea from the blogosphere: U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they’re taking money from.

These are basic recommendations.  OK, maybe #4 is a bit extreme - but that's the blogosphere:).  Still, you don't need a PhD to grasp the thrust of Friedman's recommendations, but that's the case for most sensible policy.  For example, it doesn't take an Einstein to understand that there should be a law that you can't buy a house without at least a 15% down payment - period.  But nobody stood up and said the crazy mortgages leading up to the housing crisis were the stuff of a global meltdown.  In fact, one theory says that those outside of politics who recognize the ramifications exploit them by their trading prowess. This was evidenced by the fortunes made by those who analyzed mortgage data and shorted securities bogusly rated AAA when they were comprised of obvious (except I guess to the rating agencies) toxic debt.

But it is also the case that sensible policy many times pulls the gravy bowl away from special interests who profit at the expense of the public.  I believe the "Occupy Wall Street" movement and the Herman Cain ascendency are telling politicians they better get this if they want to get elected.  In fact, we may have reached the point where those in power need to step on some "third rails".

Italian Bond Yields

Source: Capital Pixel

So Europe pulled it off!  They agreed on haircut for Greek debt, percent of debt to GDP, bolstering Tier 1 capital position for banks, and funding for EFSF.  I echo those who wonder if the U.S. government can learn something here.

Now it's about execution, and a key indicator will be Italian bond yields - in particular the 10-year Italian bond yield.  To the extent that its level (5.91%) comes down and especially its spread ( +3.50%) to the 10-year German Bund narrows, it is an indication that pressures are easing.  In particular, it indicates a lessening in the probability of contagion - the spreading of the crisis throughout the region.  Another way to say this is:  it indicates the EFSF is sufficient.  A spreading of the crisis to Italy, etc. could not be handled by a $1 trillion EFSF.

The German Bund is, of course, a benchmark throughout Europe given the strict monetary policy the German central bank followed after the country's episode with hyperinflation during the 1930s. 

Following European Bond Yields

One of the really good sources for following the yield on the Italian 10-year bond, along with other European yields, is the Financial Times financial data site:

Source:  Financial Times

 CLICK IMAGE TO ENLARGE 








This chart from The Economist provides a longer term perspective and shows what happened to Greek debt as the crisis unfolded:

Source:  The Economist 10/27/2011

CLICK IMAGE TO ENLARGE As an aside, I highly recommend picking up from time to time both of the publications mentioned here.  You'll come to understand how U.S. centric the views are that are reported and editorialized on by the U.S. press - the rest of the world sees many events from a completely different perspective.

The Best Investment - Revisited

Source: durtcom

In August, I wrote a post about rear view mirror investing. At the time, investors were piling into bonds and precious metals and didn't like stocks.  I cited the following year-to-date returns at the time:

TLT (longer term U.S. Treasury exchange traded fund): +20.79%
GLD (gold exchange traded fund): +29.02%
INTC (intel common stock):  -6.03%

Back then, the 10-year Treasury note yield was 2.07%, the S&P 500 stood at  1123.53, and gold was $1,848/oz..

Today the yield on the 10-year Treasury note is 2.26%, the S&P 500 stands at 1254.19, and gold is priced at $1661.50/oz.

The returns on the aforementioned ETFs and Intel common stock since the August post have been:

TLT = 3.05% (helped by a drop in the yield on the 30-year bond from 3.39% to 3.27%)
GLD = -10.5% ( no dividends - ouch!!!!!)
INTC = +28.1% (this is without the dividend to be paid in November).

These particular investments are obviously very different with their associated risks and returns.  The return on most precious metals is driven by the fear factor.  Investing in precious metals when fear is running very high introduces the possibility of buying close to a peak.  The investor needs, in this instance, for fear to be maintained at a high level or even to ramp up.  As is well known, there is no dividend here - the investor is relying on a future buyer denanding the metal at a higher price.  There's no guard rail on the trampoline.

Also driven by fear, especially in today's markets, is the U.S. Treasury market - still considered the safest in the world despite downgrades and potential downgrades.  Investors continue piling into an issue that pays roughly 2% for the next 10 years.  At today's inflation rate, this is a negative real return.  With the global investment community on its knees begging Germany to print money, it is scary to contemplate where inflation could go several years down the road. 

Intel, on the other hand, pays a dividend yield of 3.50% which has the potential to increase over the next 10 years and has had exceptional earnings fueled by the apparently insatiable global demand for electronics products.  Investing in any single stock is risky, of course, and Intel is used here only as an example.

The bottom line is that rear view mirror investing, i.e. chasing the hot sector, can be costly.  Sometimes valuations get out of whack.  Perhaps a useful question is how wide would the spread have to be between the 10-year Treasury note and a particular dividend yielding stock to make the swap?

Disclosure:  I own Intel stock.  The purpose of this post is for educational purposes.  Investors should do their own research and consult with an advisor before investing.