Kiplinger Quiz "Are You Saving Enough For Retirement ?"

Take this short quiz to see how you stack up against over 32,000 others who have taken the quiz.  This quiz is part of an article by Mary Beth Franklin, Don't Run Out of Money in Retirement.

A couple of points in the article worth mentioning.  First, recent research by Webb and Wei Sun of China's Remin University found that basing withdrawals on the required minimum distribution approach set forth by the IRS may be optimal.  RMDs are required at 70-1/2 and are based on an individual's life expectancy.

A second point, made at the very end, is that rules of thumb can be dangerous.  The withdrawal rate needs to be constantly reevaluated.  For instance, for much of the period over which studies are performed, bond prices rose as stocks declined.  In other words, bonds acted as a hedge.  Today markets face yields at historical lows, and the possibility exists that both fixed income and equity markets could decline at the same time over a protracted period.  This is just one significant way that the present environment differs compared to the past.  Others include medical costs and globalization.  The point is to reevaluate at least yearly.

Stocks Yield Higher Than Bonds and Other Stuff

According to Jeff Erdmann of Merrill Lynch, the average yield of Pepsi, Intel, Johnson & Johnson, Procter & Gamble, and McDonald's is 3.29%, 1.2% greater than the average yield on these companies' 10-year bonds at 2.09%.  After taking into account the favorable tax treatment of qualified dividends, the stocks yield 2.79% compared to 1.36% on the bonds which are taxed as ordinary income.  (Source:  Barron's, 7/23/2012, p. 28).

From the Pension Fund world:  According to Michael Aneiro, "Top Pension Fund Sends a Warning", Barron's, 7/23/2012. p. M9, CALPERS, the country's largest public pension fund at $233 billion, achieved a return of 1% for the 12-month period ended June 30, 2012.  Interestingly, 55% in SPY (S&P 500), 15% in VEU (global less U.S.), and 30% in AGG (U.S. investment grade bond market) would have returned 2.6% before fees.  That's an extra cool $3.7 billion--not to mention that big-time managers scraped off a hefty amount in fees and the huge staff maintained at the Fund.

Finally Europe:  Bloomberg Businessweek (7/23/2012, p.9) reports that the European Court of Justice ruled that workers in the European Union "are entitled" to another vacation if they get sick on vacation. Is this an incentive to, in fact, "drink the water"?

Hedge Funds' Performance

Source: Wikipedia

From 7/23 issue of Bloomberg Businessweek (p. 39):

The main Bloomberg hedge fund index, which tracks 2,697 funds, fell 2.2 percent a year in the five years ended June 30.  The Vanguard Balanced Index Fund, which has a 60/40 split of equities and bonds, gained 3.5 percent annually, and the S & P 500 gained 0.2% a year.

Many hedge funds can invest anywhere.  They can invest in gold, Finnish mortgage-backed securities, or even raw timber.  I believe most were formed by those with institutional investment backgrounds and impressive academic degrees who had achieved a track record capable of attracting assets.  For example, the largest hedge fund ever was Long Term Capital Management which had come from the risk arbitrage group at Salomon Brothers.  In addition to two Nobel prize winning economists who had developed the theory of risk, it was peopled by genius level quants and even a former central banker of Italy.

Its end game wasn't pretty.  Its value-at-risk model failed in the face of the liquidity freeze of 1998 as Russia defaulted.  The Federal Reserve had to engineer a bailout by bringing together the biggest investment bankers in the country and asking them to put up millions.  As an aside, Bear Stearns (may it RIP) was the only participant at the table who refused to put up money (classic "freeloader" case). Some say it is why the investment banking community turned its back when Bear reached the gallow steps in early 2008.

What is a Call Option?

Source: Capital Pixel

Suppose you want to "play" the stock market but (alas!) you have limited funds.  Or, suppose you are pretty fully invested but are getting the heebie jeebies reading the news coming out of Europe or prognostications on the "fiscal cliff."  Or assume you are seeking a way to increase income produced by your portfolio.  One area you might turn to is options.

Options are used in various ways to gamble/speculate, hedge, and produce extra income - not all at the same time.  In fact, the investor who is selling the options against securities in his or her portfolio is selling them to the gambler or hedger, as the case may be.

To buy and sell options you should know that, even though you may have a brokerage account, it is likely that you aren't approved for options trading.  You'll have to fill out an application that seeks to ascertain you have the means and sophistication to trade options. Furthermore, we'll just look at Yahoo! here, but brokerages have options platforms that you'll need to get familiar with if you trade options.  For example, Schwab has "Options Express" that provides all kinds of tools for the options trader.

Joe Gets Going

So how do call options work?  Let's take the case of Joe, who has $500, and sees himself as a budding stock market guru.  He's done his research and has determined that Intel is ready to pop 5 points.  Joe does the math and calculates that his $500 can buy 20 shares and a 5 point pop would get him $100.

Although a great return, Joe is disappointed.  $100 is hardly sufficient compensation for the brainpower that has gone into the trade.  He looks around and somehow is able to open an options account.  He looks into call options.

So, Joe goes to Yahoo! Finance and clicks "Investing" and then "options," as shown.

Source: Yahoo

 CLICK TO ENLARGE   This takes Joe to the quote box below (Joe notices there are 2 quote boxes and is careful to put the ticker symbol in the appropriate box!):

Source: Yahoo

Joe takes note of the various resources  available below the quote box to check out later.













He clicks "Get Options" and this brings him to:

Source: Yahoo

CLICK TO ENLARGE Now Joe is getting into the nitty-gritty. He notices a price column headed by "Strike."  This is the strike price.  If the price of the security is above this price, it is "in the money."  For the strike price of $17, Intel at $26.06 is way in the money, to the tune of $9.06.

Here's the point that Joe needs to get:  if he owned a call option on one share of Intel at a strike price of $17, he could buy a share for that price and sell it immediately for $26.06.

In fact, what is done is the option itself is sold.  As shown, selling the option would get a bit more at $9.95.  This is because of another critical concept - expiration date.  Options in the U.S. can be exercised (i.e., sold) anytime at the discretion of the holder up until the expiration date.  Here the expiration date (actually at the close of trading today) is shown in the ticker symbol "INTC120721...".

Looking back at the last graphic, Joe notices the other expiration months.  He decides to check out "Jan 14."

Source: Yahoo

Here's where it gets interesting for Joe, aka "Da' Gambler" (hey... I'm just poking fun at Joe here - he's got better odds trading options than going to Vegas!).

He is interested in the Jan 30 calls at $1.38. With his $500, he can buy 3 call options (they come in 100 share units) to have the right to buy 300 shares of Intel anytime between now and the expiration date 1/18/2014, at $30/share.  Recall from above that, if he bought shares outright, he could only buy 20 shares!

If Joe is right, and Intel pops 5 points, Joe could make a decent return, especially if it happens soon.  If he holds on to the end and Intel is 5 points higher, his call option will actually be worth slightly less. One of the concepts every options trader needs to understand is how the premium due to the time value of money works.

Fred Writes Calls

What about the other side of the trade?  After all, someone is writing these options.  Let's check in on Fred.  Fred happens to own 300 shares of Intel.  He is happily collecting 3.2% dividend on his Intel shares and augments this return by selling call options.  This greatly enhances his return in a sideways or even down market.  Fred will lose out, however, if Intel does, in fact, "take off."  Suppose Intel spurts 10 points.  Fred will miss that because he will have to sell his shares at $30 to Joe.

Fred and Joe, of course, don't know each other - all of this takes place on a centralized exchange.

Sally Hedges

The final player in all of this is the hedger.  This is Sally (FYI:  academic studies prove women are better investors than men).  Sally bought Intel at $15/share (Sally gets a smiley face) and wants to protect her profit.  One way for Sally to do this is to buy a put on Intel with a strike price of $22/share, say.  Puts are the opposite of calls.  The put would give Sally the right to sell at the strike price any time prior to expiration.  She can use the put to lock in her profit.  This hedging obviously has a cost.

Other Stuff

I set up Joe as a stock picker.  Instead he may feel he can forecast the market.  Instead of call options on a stock like Intel, he would probably be more interested in a call or put option on  SPY, the exchange traded fund that tracks the S&P 500.

A couple of points about options for the beginner.  Fred is going to find that time goes by very fast when he speculates in options.  In other words, January will get here fast as he waits for Intel to take off.  Secondly, Fred should understand going in that there will be times when he is right (or at least guesses right) but his timing is wrong, i.e., Intel does go up big but only after the options expire (aargh!).  Also, options tend to confuse people because of the terminology.  Like other parts of the investment markets, they become clearer once you take a position.  If you do so, I suggest starting small and going slow.  It will appear that "out of the money" options are cheap.  They aren't.  It typically costs beginning options traders a few thousand in tuition to learn this.

I would also recommend reading at least one good book on options, especially if you are interested in going beyond the basics.  Options trading can get exotic fairly quickly with straddles, butterflys, strangles, etc.

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

"Sheriff of Wall Street"

This is an interview by Jim Cramer of U.S. attorney Preet Bharara, the so-called "sheriff of Wall Street" at the recent "Delivering Alpha" conference.

Preet is smart and has a great sense of humor and is dead serious about nailing the bad guys.  Hopefully his audience took to heart his warnings on what suspected  insider trading could do to a firm.  In the interview, he points out that hedge funds et al. look at the law as a line and try to get as close to the line as possible without going over.  He points out that this is an unhealthy way to look at it.  Instead, create an ethical culture.

I do have to admit that hedge fund managers remind me a bit of many teenagers.  Lay down the law to them by telling them not to do something (don't take drugs, for example), and they hear it as a challenge on whether they can get away with whatever it is.

Anyways...every investor will enjoy and learn from this video:

What is the "Death Cross"?

Stock analysis falls into two distinct buckets:  fundamental analysis and technical analysis.  Fundamental analysis involves studying financial reports, industry trends, etc.  Technical analysis, on the other hand, studies charts and looks for patterns.  A big deal in technical analysis is when moving averages break key levels.

What is a Moving Average?

A moving average is constructed by dropping a term in the past and adding the most recent term and then taking the average.  As a simple example, consider a 5-day moving average of the temperature.  Today we would add the daily temperatures of the past 5 days and take the average.  Tomorrow we would drop the oldest day and add in the new temperature and again calculate the average temperature.  Continue for a period of time and you get a numerical sense of whether it is getting cooler or warmer.


If you want a challenge, see if you can find a bored teenager (easy part) who can calculate and graph a 5-day moving average of the temperature over the next 10 days without a calculator.  Good luck!

The Death Cross

Short-term trends relative to long-term trends are significant in technical analysis.  These are captured by various moving averages derived from laborious studies of past data.  One that stands out is the 50-day moving average relative to the 200-day moving average.  When the 50-day average moves above or below the longer term 200-day average, it gives the technician an important signal of a buy or sell, respectively.  It is an important tool in the kit of those who follow this approach.

Well, the "Ultimate Death Cross" to which Albert Edwards, of Societe Generale, has alerted the investment community is the impending fall of the 50-month moving average of the S&P 500 through the 200-month moving average.  In the past, including Japan in 1988, this has been followed by a long-term bear market.

Edwards adds in that declining analyst optimism data also implies a pending bear market.

Stay tuned!

The Weasel and the Fox

Suppose we sent the fox to investigate the weasel digging a hole under the fence to the chicken coop.  It's probably pretty clear to most people that the fox would be hard put to understand the problem and condemn the action.

Substitute the NY Fed (including former NY Fed president Geithner) for the fox, Barclays et al. for the weasel, and the Libor rate for the hen house, and you've got the gist of the Libor rate-fixing scandal and the failure of many to grasp the need to respond to the manipulation.

Here's the news:  the Federal Reserve manipulates the rate at which banks lend reserves in the U.S.  The target rate is determined by the Federal Open Market Committee, chaired by Bernanke, and detailed instructions are forwarded to the trading desk at the New York Fed. The New York Fed then buys and sells securities in the open market to manipulate the rate at the target level.  Push this rate to 1%, like they did in 2003, and you get a parabolic rise in house prices and all kinds of exotic mortgages offering low adjustable rate teaser rates, no doc loans, etc., coming out of the wood work.

The only difference here is that private banks have encroached on what central banks do on an ongoing basis.

This, of course, is likely to keep the Wall Street lawyer community pretty busy- as if they needed further work.  Hopefully it will also focus more attention on how central bank rate manipulation distorts resource allocation as well.

Bernanke starts his two-day Congressional testimony today.  Hopefully some senator will inquire as to when the Fed will start doing its job.