Notable Quote

We are what we repeatedly do. Excellence, therefore, is not an act but a habit. Aristotle

The Dow Crosses 13,000, now what?

For the first time since May of 2008 the Dow Jones Industrial Average closed above 13,000. Hopefully many readers held firm since the day of Dow 6547 in March of 2009 and have been able to enjoy the recovery in their investment accounts.

Those that have been waiting for the 2012 “pullback” to put their money to work have missed out on a nearly 8% run in the S&P 500 since the start of the year.  This investor may miss out on another two percentage point rise,  or catch a lucky break and get in when things drop a few percentage points. None of us can predict these,  or an infinite number of other possible scenarios.

So,  what’s a smart approach if you are either fully invested or if you have been sitting on the sidelines with a pile of cash?

If you are fully invested,  stay that way. You’ve heard it said countless times;  “don’t try to time the market”.  Instead,  look carefully at how your current assets are allocated. Thus far this year the market has been very kind to the stocks of large company domestic stocks. Chances are,  that part of your portfolio may have risen above its target range. You might be saying,  “but I don’t have a target range”. In that case, step back and create an asset allocation target. The end of Q1 is a great time to evaluate the asset allocation across all your investments,  in and outside of retirement accounts. It’s also a good time to rebalance if things have gotten too far out of target range.

For those with someone managing your money,  keep him on his toes by asking questions about your asset allocation during your Q1 portfolio review. If you don’t have an investment policy statement that outlines your allocation targets,  encourage your advisor to create one for your review and approval. You would never build a house without a set of plans;  similarly,  you should never invest without an investment policy statement.

What about the person who is sitting on cash waiting for the right time to get back into the market?  You should take a measured approach. Start coming back in but not all at once. Why,  because this run-up of the last eight weeks is not likely to continue for the rest of the year.

Sometimes,  when a market index crosses a big psychological barrier (like Dow 13,000) professionals start taking some profits. Institutional investors may want to lock in some profits and good performance figures for Q1. This could lead to downward pressure on stock prices due to institutional selling in the coming weeks. Not to mention the possibility of a negative effect on stocks from the newly looming concern (again) over gas prices.

Who knows which we’ll see first,  Dow 14,000 or Dow 12,000. In the long haul it won’t matter if your portfolio is created with care and managed with discipline.

A step in the right direction

As reported in the Wall Street Journal, the U.S. Senate overwhelmingly passed a bill today to ban lawmakers from profiting from inside information they learn while in the course of their duties in Congress. The bill goes to the House for a vote next week. There is so much heat and light on this issue that it seems inevitable the House will pass the bill.

It’s astounding that it has taken years of trying to get this far in the legislature with an insider trading ban. While it may seem a “no-brainer” there have been forces opposing such a ban for a long time. And the opposition has come from members on both sides of the aisle. Democrat, Ms. Pelosi and Republican, Mr. Bachus were two of the members in the news in recent months for engaging in this “legal” activity. If any of us in the investment profession, or even outside of it (remember Martha Stewart’s troubles in this area), engaged in similar activity we would be fined, risk losings a license, or in extreme cases even jailed.

It’s no wonder the members of Congress have poor ratings and such a credibility void in the eyes of the American people. Kudos to the Wall Street Journal for bringing this matter to the forefront in the last few months. The pressure became too much for Congress to sweep it under the rug. Watch for the outcome in the House next week.

 

Too “Even Bigger to Fail”

The banks were “too big to fail” before the 2008 crash. Do you know those same banks are even bigger today?

According to data compiled by Capital IQ,  JP Morgan had assets of $1.3 trillion before the crash, now it has $2.3 Trillion. BofA went from $1.4T to $2.2T,  Citi from $1.8T to $1.9T and Wells Fargo from $0.5T to $1.3T.

These four banks have the equivalent of more than half the entire output of the U.S. economy of $14.4 Trillion! That’s just too risky for the fiscal health of the country.

The U.S. government had no choice but to bail out the banks. Had they not done so the economic catastrophe in this country would probably have been at least as bad as that of the Great Depression. Sometimes you can learn from  history. Why aren’t we learning from this piece of recent and painful history by still allowing these banks to get bigger than they were before the crash of ’08?

JP Morgan consumed Bear Stearns and Washington Mutual. Bank of America gobbled up Merrill Lynch and Countrywide. Wells Fargo picked up Wachovia. Citibank was in such tough shape back in 2008 they were not in a position to  acquire any of the troubled financial firms.

So what will happen when one of these financial mega outfits gets in trouble the next time? Most likely, the same exact thing as the last time, a government bailout. In fairness, these institutions are much better capitalized  then they were in the period leading up to the crash. One might argue the oversight is better now, though after what recently happened to MF Global that hope seems overly optimistic.

The fact remains, these banks are at the core of the financial lives of millions of Americans and they are once again “too big to fail”. Why? Because the repercussions of failure would be devastating to our way of life.

By all accounts the probability of failure of any of these institutions is extremely low but should we even allow a low probability scenario to remain in play? When the financial engine of the world’s biggest economy is at stake it  seems the answer should be a resounding, ‘no’. While we may agree that the prospect of a mega bank failure is highly unlikely there is another and much more likely outcome. Let’s call it “too big to serve”. That is, too big to serve its customer base effectively. It’s a daunting task to merge big corporations. The different corporate cultures, information technology, politics, compensation systems and so on make these mergers almost doomed from the start.

We’ve recently seen one example of how the hubris of a mega bank can impact the customer experience. Just a few months ago Bank of America was about to roll out a monthly fee for customers using their debit cards. The backlash was  fast and furious which led to the bank retracting its position.

Customers will decide for themselves if their Merrill Lynch experience is better now that it’s a Bank of America experience. or if their Wachovia relationship is better coming from Wells Fargo, or their Washington Mutual  interactions are better now that they are JP Morgan Chase.

Too big to fail…too big to serve. Either way, “too big” in this instance is not good for the country or the customer.

Note: You are encouraged to leave your comments to this editorial and/or forward the link to others.

Volatility can be bad for traders and good for investors

Stock market volatility sounds like a dirty word but it can be a friend to the individual investor. Let me explain.

If you are trader,  market volatility can lead to your doom. Professional traders like to make big bets. A trader that bets the wrong way before the market takes a precipitous fall can suffer losses from which he can’t recover.  It’s true that the trader can make a huge score too but if he gets it wrong then his next move is to attempt to control the damage and often results in an even bigger trade in the opposite direction.

For the non-professional trader the likelihood of making the right call, at the right moment during a day with lots of volatility is really a fool’s game. The non-professional doesn’t have the pricing power, technology, or market knowledge to achieve consistent success during volatile market movements. Eventually he will get burned badly.

On the other hand the investor who applies three key principles can benefit from short term volatility. The principles call for having:

1)      A long term investing horizon (i.e. 10 or more years)

2)      A defined asset allocation policy

3)      A scheduled asset rebalancing plan (i.e. quarterly)

If the value of an asset drops noticeably below its target allocation during the quarter, money can be re-allocated to buy that asset at a lower (and favorable) price. This works especially well when there is cash in the portfolio that can be put to work buying the asset that declined in value.

Successful investing is about planning, discipline and patience.

What are your thoughts? Please feel free to comment below.

“Who cares what S&P says, anyway”

The news about the Standard and Poor’s downgrade of the U.S. credit rating has circled the globe with damaging effects to the markets. The Asian market began its decline Sunday night that cascaded through Europe and continued right through the U.S. Monday trading day as the Dow closed down more than 600 points.

Most of the objective analysts think the U.S. market decline has more to do with the economic troubles in Europe (i.e. they are facing what we went through in 2008) and the lack of real progress on the talks to curtail the U.S. debt. Still, this S&P downgrade is the equivalent of kicking someone while he is down.

So how much weight should we put on the S&P opinion? Maybe the answer depends on how much credibility you think S&P has after its role in the economic crisis of 2008. This is the same rating agency that was pumping up most of the garbage assets being sold around the world as collateralized debt obligations (CDOs) during the height of what became the 2008 financial crisis.  They awarded a AAA rating to truly “junk” assets. They probably did as much to cause the financial crisis as any of the large brokerage houses and thousands of mortgage companies that “looked the other way”. There were municipalities in Europe that suffered financial ruin because they bought CDOs on the basis of the nearly risk-free implication of a triple A rated investment.

S&P is getting all the attention now because they stuck their neck out on the U.S. downgrade but make no mistake the other ratings agencies, Moody’s and Fitch had just as big a hand in assigning top ratings to poison CDOs. So far, those other two agencies have quietly held a AAA designation on the U.S. credit rating.

How these three companies have stayed in business (and largely unscathed) is a fascinating matter. Michael Lewis in his terrific book, “The Big Short” offers an excellent analysis of the rating agency role in the financial crisis.

So what should an investor do amidst this market turmoil and economic malaise? First, ignore the opinion of Standard & Poor’s. Next, heed the advice of John Bogle, founder of Vanguard. He says, “Don’t just do something, stand there”. The worst “something” you can do is try to time the market by pulling out your money, going into all cash, or heaven forbid, going all “gold”. Riding out the storm is the best thing you can do for yourself. It worked in 2008 and 2009 (as it has many times over the decades). To help you feel better, the situation plaguing the U.S. markets today is nowhere near as dire as it was in 2008 when the banking system was on the verge of collapse. We got through it in 2008 and we will get through it today.

 

 

“The Best Investment Advice I Ever Got”

I posed the following question to a group of clients, friends and colleagues; “What’s
the best investment advice you ever got”?  This advice comes from people of different ages, life stages, and
varying degrees of net worth.

After reviewing the responses it became clear that there were distinct categories to
which most of the responses could be assigned. Here are the
responses by category (some edited for brevity while keeping the central
theme):

Asset Allocation & Diversification:

“…taking a conservative approach rather than a risky approach…having 20-40% of your
investment portfolio in fixed income really does protect on the downside when
you go through a year like 2008”

“…layer the investment risks (within your portfolio), stable, growth and aggressive
elements with varying portions (based upon circumstances)”

“The vast majority of investment returns are determined by how your assets are allocated”

Market Timing:

“Don’t try to time the market or go ‘all cash’…be ‘in the market’ all of the time”

“Quiz your advisor when they significantly under or overweight (a portion of your
portfolio) compared to the S&P”

“…if you try to make money by trading you will likely be fleeced by the brokerages and
investment banks who run the casino”

Investment Performance:

“Look at the portfolio returns over long periods of time rather than how you did last year”

Investment Decision Making:

“…when (a company’s) bad news contradicts the expectations set by management…don’t wait
around for more bad news”

“…sell immediately when (a company) announces a cut to the dividend”

“Hope is not a strategy…be honest with your investments and make decisions on facts”

“Don’t listen to analyst buy or sell recommendations…do your own research”

“Don’t invest in something you don’t understand!”

“Buy a duplex as your starter home…you can live in one side and rent out the other”

“Start investing in the stock market early…high school or even grade school is not too
early”

“If you buy a business also buy the land and buildings…if the business fails you still have
the real estate”

Patience:

“Slow and steady wins the race”

“To be happy, live beneath your means”

Savings:

“If you can’t live on 100% of your salary, you can’t live on 95%, live on 95% and start
saving 5% of your income every year…it will add up…”

“…the earlier you get started the power of compounding returns over time makes a huge
difference”

“Pay yourself first!”

“Every time you get a raise in pay, increase the amount you save.”

“Open a college savings account when your child is an infant, you’ll be glad you did”

A final thought…

This story has implications beyond sound investment advice. It seems
especially appropriate as we approach Father’s day 2011.

“When I was much younger and making my first investments, I was visiting with my father (a
product of the great depression), and was very proud when I told him, “Dad, I
made 400% on a tech stock that I purchased”. He calmly replied,”‘maybe you
should sell it”. I replied, “Oh not now, it is still going up!” He replied,
“maybe you should sell half of it”. Of course I knew better than my father and
ignored this advice. Within six months the stock was worth just a little over
what I had paid for it. I can still hear his words so clearly”

 

Please comment below on this post or other topics of personal financial interest.

 

A lesson from the Oracle of Omaha: Don’t get attached to your investments

In a regulatory filing on February 15th, Warren Buffet’s Berkshire Hathaway announced it had sold its entire stake in Bank of America.

The firm held five million (of its original 8.7 million) shares of  B of A stock as recently as September, 2010. The result was a staggering loss of two thirds of the value Buffet paid a little over three years ago.

Even the great ones (Buffet, Lynch, Miller, and Gross, to name a few) have suffered colossal losses in their investing lifetimes. The rest of us should feel in good company with the blunders we’ve made along our investing journey. More importantly though, let’s take a valuable lesson away from Berkshire’s recent disclosure.  Never get so emotionally tied to your investments that you can’t divest from them, regardless of how scarred you may feel by the financial loss.

To quote a famous line from movie lore…”it’s not personal, it’s business”.  Warren Buffet clearly views investing as business.  We should too.

The Power of Asset Allocation: A Four Step Process

I often hear the question, “Where do you think the market is going”? Unfortunately, my crystal ball is no more accurate than anyone else’s. I will say, lately, there seems to be more debate fodder to suggest that a downward move has a higher probability than an upward one. Still, there is a case for both.

The case for a downward move hinges upon things like double digit unemployment, unprecedented national debt, a war on two fronts, aftershock from the worst financial crisis in America since the Depression, a feared commercial real estate disaster, and more. However, the case for upward moves in the market is not without merit. Some suggest there is reason for market optimism given the U.S. (and other countries) navigating away from economic Armageddon, a strong 2009 for the market, stabilizing unemployment, terribly low interest rates on risk-free investments, and more.

Like all investors, I want a market that rises, albeit in a rational way. If it goes up, great. If it goes down I’ll buy more shares at a lower price.

Predicting market moves makes for great debate and stimulating conversation, but taking action based on predictions (e.g. timing the market) rarely pays off.

So, what is an investor to do? Like so many things, the answer is…develop a plan and stick to it.

In navigating with map and compass a hiker identifies her destination and starting points on the map. She uses the compass to stay “true” to the heading. Inevitably she encounters obstacles that force a temporary departure from the intended course. While bypassing the obstacle the hiker uses the compass to “re-orient” herself on the true path.

And, so it is with investing. Asset allocation is the means by which you can wind up in the right place  while navigating around the inevitable obstacles.  Here’s a four step process:

1)      Define the financial objective (identify your destination)

2)      Draw the map (define the right asset allocation model for your situation)

3)      Travel the path  (implement the asset allocation model)

4)      Course-correct using the compass (rebalance the portfolio to the target asset allocation)

Using the principles of  asset allocation is a rational way to manage the balance between risk and reward.

Retirement asset rollovers; what you need to know.

The situation:

With a record number of employees leaving their jobs, some by choice, many by force, there are a myriad of questions they find themselves needing to answer.

After a few of the most fundamental ones such as:

Are my assets sufficient to pay the mortgage?
What are my options for health insurance and how much will it cost?
What standard of living can I sustain?

There is another important question we’ll start to answer here…What should I do with the assets in my retirement account?

Leaving a job in the commercial sector might mean you have 401(k) assets, or if you were a public sector employee you may be lucky enough to have a pension and a 403(b). Perhaps you hold a retirement profit sharing account from employement in a medical practice.

Some key questions:

Regardless of the type of retirement account, one thing is certain; your assets need a home. They may need a new home, or they may be just fine remaining in the current one. Still, here are some questions you need to answer:

1) Can I remain in my current plan even though I may no longer be able to contribute to it?
2) If I can stay in my current plan, should I?
3) If I decide to, or are required to move the assets to a new plan, how do I do it?
4) Where should I move the assets, and into what type of investments?

Question 1 is easily answered by a review of the plan literature. This can usually be found on the employer or plan administrator’s website. If that doesn’t work contact your benefits representative or HR department.

Question 2 starts to be a bit more complicated. It involves a review of how your investments have performed over time, especially as compared to the benchmark averages (e.g. S&P 500, Dow Jones Industrial, etc) of similar investment options. Some plans offer a multitide of investment choices while others can be as restrictive as only having a company stock investment option. If you are in a restrictive plan chances are you should not walk to the exit; you should run to it. I’m not saying every company is an
Enron-esque timebomb but this is your future and you just don’t mess with that.

Now, regarding Question 3…You are faced with a decision to “transfer” your assets or do a “roll-over”. These may sound like one and the same though in the world of retirement asset treatment they hold very specific meaning.

In a roll-over you take receipt of the assets for up to 60 days before reinvesting them in another retirement plan. In a transfer the assets are transferred directly from one custodian (read: investment company) to another one.

Examples:

Sara has left a Fortune 500 company and decides to move her $260,000 of 401(k) assets from her former employer’s plan to a Traditional IRA (Individual Retirement Account). Sara will direct her 401(k) administer to move the funds directly to her new investment company. Sara is doing this via a “custodian-to-custodian” transfer.

Jack leaves his employer where he had $40,000 of traditional IRA assets. He takes possession of those funds via check made out to him. Within 60 days he sets up and deposits the funds into his new IRA and all is well. By taking receipt of the funds and then depositing them, Jack has done an IRA “roll-over” transaction. Ah, a pretty sweet deal you say. Jack can put the money in the bank and earn some interest before rolling over the proceeds to his new account. True, but he might also miss a run-up in the market if his assets are not invested in time. Of course the opposite could be true as well. Jack has to be careful though. If he forgets to get this done within the 60 day window he’ll be very unhappy with the tax bill he gets from Uncle Sam (who defintely will not forget to send it). Oh yeah, one other thing…Jack can’t do this same type of transaction again for another 12 months. The IRS is picky about this stuff.

Summary:

Generally speaking, if the person takes possession of the assets prior to reinvesting them (within 60 days of course) it is considered a roll-over. If the assets are moved directly from one custodian to another, never passing through the account owner’s hands, it is considered a transfer.

As with all things IRS, there are exceptions to these rules and definitions. For example, a transfer from a “qualified plan” (e.g. 401(k), 403(b), Profit Sharing plan) directly to a new custodian is indeed a transfer, however, for accounting purposes the IRS calls it a “roll-over”. Nothing changes about the tax treatment though you will get a 1099 form from your former employer that needs to be filed with your tax return. Tax rules…don’t ask.

Next steps:

Asset allocation is the key to starting to answer question 4. The need for diversification among your investments is essental. Some stocks, some bonds, international and domestic equities are some of the elements of a well diversified portfolio. With whom you invest should be determined after a careful analysis of the manager’s style, fee structure and ability to match your risk tolerance with an appropriately structured portfolio.

If you are a do-it-yourself investor, the web has a wealth of resources you can study and learn. Do your homework, understand the rules, and execute your plan. If you need help, find a reputable investment advisor, accountant, tax attorney (if you are affluent enough to need one) or one of the big firms such as Vanguard, T. Rowe or others.

Do yourself a favor though; Be sure you understand how the person or firm helping you is compensated. Many put their interest ahead of yours and are not legally bound to act as your Fiduciary. Understand how much they will make from the immediate transaction and from all follow-on fees. Make your decision in the quiet of your own home and take action knowing you’ve done the proper due diligence.