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Top 10 Financial Reasons Blessings This Year
Nov 28th
provided by 
Yep, it’s been a tough year. There’s still much to lament, such as decades-high unemployment, rising budget deficits and shaky financial institutions, but considering the abyss we were staring squarely into at this time last year, we’ve also come a long way and made great strides toward a healthier economy. So, as we enter the traditional Thanksgiving period, let’s take a few moments to give thanks for the modest financial gifts we’ve received this year – and maybe more importantly, give thanks that in many cases, our worst financial fears failed to materialize.
1. Major Stock Indexes Rise
Good tidings! Major stock indexes are up 60% since their March lows. The rebound in our equity markets has been critical on several fronts. First, it has helped stem the losses seen in retirement accounts like 401(k)s and IRAs. These retirement accounts are increasingly the No.1 funding vehicle for retirees, so recouping any losses here is a big help, especially to the baby boomer demographic.
There’s also a confidence issue at play, and our stock markets – for better or worse – are a de facto barometer, an economic "feel-good" factor. Fortunately, stock markets look forward, not back. Right now, they’re telling us they anticipate better times down the road.
2. GDP Growth Returns
Gross domestic product growth is the engine that makes everything go in our economy. GDP growth leads to stock market growth contributes to job and wage growth, and increases tax revenues for state and local governments to help balance their budgets. We obviously need all of these things, and the GDP growth of 3.5% in the third quarter was a good start.
We still need consistent GDP growth over several quarters to claim economic victory, and we need it to be more organic, not artificially spurred by government stimulus and one-time fiscal measures. As we look forward to 2010, this will be the biggest catalyst to getting us out of this recession and bringing down our nosebleed unemployment level.
3. Banks Repay Their TARP Loans
Ten of the banks that received Troubled Asset Relief Program (TARP) funds were allowed to repay $68 billion to taxpayers in June, and most of the major recipients have committed to fully repaying their TARP loans over the next 24 months. Also, as the stock prices of major banks rise, the chances of the government earning a good return on its TARP loans and direct investments only increases.
Even the much-maligned auto makers are starting to make good on their promises to pay. General Motors even announced that it would start repaying its $15+ billion in federal loans.
4. Home Prices Are Stabilizing
While home prices are still down 30% from their peak, prices in many geographic areas ticked upward in August, September and October according to the benchmark Case-Shiller Index.
If home prices can stabilize and even (gasp!) begin to rise in 2010, the hundreds of billions in mortgage-backed securities (MBS) can begin to improve the balance sheets of our battered financial institutions rather than deteriorate them, as has happened for the past two years. There’s still much progress that needs to be made, however, as mortgage delinquencies are still on the rise, and the threat of higher interest rates looms on the horizon. But hey, it could be worse – a lot worse.
5. First-Time Homebuyer Tax Credit Is Extended
The $8,000 tax credit for first-time homebuyers was scheduled to end on December 1, but those who didn’t get on board in time have plenty of reason to be grateful. President Obama recently extended the credit until June 2010 in an effort to help to spur the housing market further. It was a smart move by Congress, as new housing starts remain at multi-decade lows, and inventory levels are still high across the housing market. The tax credit was also expanded to include income levels of up to $125,000 for individuals and $225,000 for joint filers.
6. Corporate Profitability Is Getting Stronger
Profit margins have been strong at corporations over the past few quarters as inventories have been depleted and costs wrung out of business models. We still need to see more demand in the form of revenue growth, but stabilization and earnings per share (EPS) growth is good and companies should come out of this whole mess stronger, smarter and looking to hire if conditions continue to improve. Higher EPS numbers also mean more tax revenues, which are sorely needed.
7. The Rest of the World Is Resilient and Growing
Another good sign: Many foreign markets are doing quite well. GDP growth in China and India is tracking above 7% for the year, Brazil is growing and will begin its mega infrastructure roll-out to prepare for the Olympics in 2016, and smaller emerging economies in South America and Asia are holding steady and/or growing.
The internal, domestic economic strength of these foreign markets will help U.S. exporters to sell more goods, which represent over half the earnings of S&P 500 companies.
8. Inflation Is at Bay
Inflation has yet to appear, which is keeping interest rates low. This is helping the U.S., as it must borrow heavily to fund its growing budget deficits. Most economists do agree that inflation is inevitable down the road given all the money being sloshed around Washington and Wall Street, but there seems to be enough slack in the economy that we may have a few more quarters before inflation creeps up on us. By then, hopefully the economy is on better footing, which will allow the Federal Reserve to raise rates slowly, without stifling the recovery.
9. Regulatory Scrutiny Has Increased
The Securities and Exchange Commission (SEC) has been near the top of a long list of entities that deserve a good finger-wagging for errors of submission or omission leading up to the financial crisis. But new measures are being put into place to protect investors from fraud and negligence by their financial advisors and corporate CEOs.
Whether the SEC is up to the task remains to be seen, but you can bet that they are embarrassed and bruised, and will be on the warpath to find the next problem before it blows up in their face. Any increased diligence by the SEC, or by groups like the credit ratings agencies (who are also quite red in the face) can only help investors in 2010 and beyond.
10. We’re Still Standing!
Last year at this time, many wondered if our financial system would even survive at all. It did (thank goodness), and that may be the best blessing of all.
Happy 80th anniversary 1929 stock crash
Oct 29th
by Jay Hancock
The stock market crash of 1929 got cranked up on Black Thursday, Oct. 24. But it really took off the following Monday. Investors read about the Thursday drop in Friday’s papers, and they fretted about it over the weekend. On Monday they bailed. The Dow plunged 13 percent on Oct. 28 and another 12 percent the next day, says Wiki.
On dshort.com’s graph below of four bad bear markets, the trauma of October 1929 can be seen at the far left of the gray fever line. As you can see, the pain had only just begun. The blue line represents stocks’ performance in this particular crisis. We can be thankful that it has diverged from the pattern of 1929 and the 1930s.
Source: http://weblogs.baltimoresun.com/
What’s a P/E? (And 9 other ‘dumb’ questions)
Oct 25th
Stocks versus funds? Growth versus value? This confounding market has sent many of us back to the basics. Here are some answers to questions you might be asking.
MSN Money
It’s downright nasty out there. Jobs keep disappearing. Scared consumers have stuffed money under mattresses instead of spending or investing.
We’re all getting back to basics like friends, family and frugality. In the market, old hands have been forced to reconsider their basic assumptions, and newer investors wonder whether anything they’ve learned thus far still holds.
To help sort through the confusion, here are my answers to 10 simple (and not-so-dumb) questions we have to be able to answer before we can move ahead.
1. Should I own stocks?
This may seem like a candidate for Dumb Question of the Year in the midst of a precarious rally following an epic bear market that saw a fall of 50% from its high. But the answer is the same as it has always been: Yes, you should own stocks, assuming you are saving for a long-range goal like retirement or college tuition. Over the long run, stocks do better than other investments.
But here’s a good basic rule of thumb: Don’t put or keep money in stocks if you need it in less than five years. (Read "When’s the right time to invest?" for more on this.)
2. How do I know what a stock is really worth?
In the short term, what a stock is worth is exactly what someone will pay for it today. But that doesn’t help you invest for tomorrow.
The value gauge used most often by the pros is the price-earnings ratio. To calculate the ratio, take the current price of a stock and divide it by its earnings for a year. If a stock trades for $50 and is expected to earn $1 a share next year, it trades for a P/E ratio of 50.
Investing guru John Neff counted it as one of the key tools behind the 13.7% average annual returns he produced while he managed the Windsor Fund (VWNDX) from 1964 to 1995.
This ratio tells you whether a stock is cheap, meaning that it trades for a lower P/E than stocks of similar companies. But the biggest insight from the ratio, Neff says, is that it tells you what kind of growth other investors expect. If their expectations are too high, they’re willing to pay more, and the P/E ratio will be high.
For example: If one stock trades for a P/E of 50 and another trades for a P/E of 10, it means investors are willing to pay five times as much for a dollar of earnings at the first company. That’s usually because they expect earnings to grow much more rapidly at the first company. Neff reasoned that since investors have higher expectations for that stock, it runs a higher risk of crashing if it posts disappointing results, writes John Reese in his recent book "The Guru Investor."
Neff, as a value investor, favored cheap stocks of companies that were so disliked that people wouldn’t pay much for them. They had extremely low P/E ratios — often in the single digits. He knew that bad news wouldn’t drive them much lower and that any improvement would drive them much higher.
3. What’s a PEG ratio?
So-called growth investors prefer stocks in fast-moving sectors such as technology, which tend to have high P/E ratios because of higher growth expectations.
They compare a company’s P/E to its expected growth rate. Generally, a company is considered fairly valued if its P/E is the same as its growth rate. And it’s considered cheap if the P/E is below the growth rate. This ratio of P/E to expected growth is called the PEG ratio.
The PEG ratio helped one of the world’s most successful investors ever — Peter Lynch — produce 29.2% annual growth at Fidelity Investment’s Magellan Fund (FMAGX) when he managed it from 1977 to 1990.
4. How much do dividends matter?
Cautious investors love companies that send profits to shareholders. Companies that pay dividends tend to be in more-stable sectors, such as consumer staples or utilities, and they pay investors through good market times and bad. And with so many of us suspicious about Wall Street, dividends are real money you can trust more than forecasts or projections.
When shopping for dividend plays, though, avoid the trap. If dividend yields — dividend divided by stock price — are sky-high, it could be because the stock price has tanked or because of some serious problem not yet revealed. Troubled companies eventually cut their dividends. Be suspicious of a yield over 10%. (Read "Stocks that pay you to own them" for more.)
5. Should I buy individual stocks or mutual funds?
These days, some experts say single stocks are simply too risky for most investors. The real answer depends on how much time you have.
If you go with stocks, you’re going to need a portfolio of at least a dozen and probably more. A variety keeps you diversified, so that problems in one company or sector won’t wipe you out. You also need the time to understand and track those stocks; if you don’t, you’re speculating, not investing.
Mutual funds let investors pool their resources so that a professional money manager can invest for them. The problem here is that the returns posted by most mutual fund managers trail the market, partly because of their fees. (Read "Are fund managers worth their pay?" for more.)
You also get a tax bill as they buy and sell and, hopefully, collect capital gains.
A solution is to go with index funds that invest in a broad basket of stocks such as the S&P 500 Index ($INX). The fees are lower, and you get the diversification you need. Plus the stocks are traded less often, so the tax burden is usually lower.
6. What’s the difference between a mutual fund and an ETF?
With a mutual fund, you give your money to a fund company, which then invests it in such things as stocks or bonds. The fund’s value is calculated once a day, after the markets have closed. An ETF, or exchange-traded fund, is a basket of stocks, bonds or commodities that usually follows an index and that you can buy and sell throughout the day, just like a stock.
ETFs typically have lower expenses and fees, but, as with a stock, you have to pay a commission to buy them. Because you control sales, you have more control over when you’ll get a tax bill for taking profits.
7. Why can’t I time the market?
It looks easy because stocks go up and down so regularly. If you could consistently buy on the dips and sell into the rallies, you could retire in no time. Unfortunately, even most pros find it hard to time the market. Most hedge funds did horribly last year, for example.
There are two basic reasons it’s difficult. First, predicting what’s going to happen next at a company or in the economy is only half the problem. You also have to predict investor expectations, because they set market prices as much as anything else, points out Axel Merk of Merk Mutual Funds. Predicting what a large crowd is going to think next is virtually impossible.
It’s also tough not to get caught up in the emotion of the moment. When everyone is bullish and stocks are rising, you’re likely to do the same and stay in the market too long. Likewise, at market bottoms, things are typically so gloomy that you won’t want to put money into stocks. Because markets tend to move up over long periods, the best thing is to spend time in the market rather than try to time the market. (Read more in "The 5 biggest 401k mistakes.")
8. What is dollar-cost averaging?
A simple way to deal with the fact that you can’t time the market is to dollar-cost average. Put the same amount of money into the market at the same time every week, month or quarter.
True, you’ll rarely get the best prices. But you won’t always buy at the worst time either — at the top, when it is easiest to buy because you feel most confident. Instead, you’ll get an average of the prices of stocks over time, which is better than what would happen if you just followed your emotions. (Read "Wade into the market? Or plunge?")
9. What are bonds?
Bonds are loans — to companies or governments. They typically offer regular interest payments every quarter through what’s known as coupons. Then when the bonds expire, or reach maturity, you get your original loan back.
Bonds are generally safer than stocks. But returns tend to be lower, and they do carry risks. Bonds issued by companies carry credit risk. That means companies could do so badly that they go out of business and can’t pay you back.
Bonds also present interest-rate risk. Once a bond has been issued, its price in the market will move in the opposite direction of interest rates. When rates go up, the prices of existing bonds have to fall so that they offer a higher return to anyone who wants to buy them at that point.
None of this matters if you buy a bond outright and plan to hold it until the loan is repaid. Your gain is the interest — or coupon — that you signed up for at the start.
But if you buy bond mutual funds, it’s a different matter. The value of the fund is affected by the prices of bonds in the fund. If interest rates go up, the price of the bonds in your fund will sink, and so will the value of your fund. The fund value could then stay down for a long time, depending on how your fund manager reacts.
10. Should I own gold?
At its best, gold serves as a store of value for the times when things get so bad that all other assets, such as stocks, bonds and home values, are falling apart. Look at it as a kind of insurance.
But unless you are a gold bug or a survivalist who also keeps a year’s supply of food and water on hand at all times, it doesn’t make sense to have more than about 5% of your wealth in gold. The reason: Gold prices are extremely volatile, and it’s tough to predict where they are going next.
Historically, gold prices go up when the dollar sinks, when oil prices rise and sometimes when inflation heats up. But since predicting any of those trends is tough, it doesn’t make sense for most average investors to hold gold as a play on those themes.
How should you own gold? The survivalists like bullion buried in the backyard. But for most people, gold is costly to store, and commissions are high. The gold ETFs make more sense for a portfolio. ( Read "Why gold prices will keep rising" for more.)
And there you have it: 10 basic answers and some rules to hold on to at a time when nothing seems particularly simple. They won’t bring your portfolio back overnight, but they might help you get back on track.
Looking for other answers or have your own rules to offer? Post your questions or comments on the Your Money message board, and I’ll consider them for a future column.
At the time of publication, Michael Brush did not own or control shares of any fund mentioned in this column.
Updated Sept, 25, 2009
8 costly mistakes investors make
Oct 25th
How investors think often gets in the way of their results. Be sure to get these common missteps and misconceptions out of the way.
What was I thinking?
If there’s one question that investors have asked themselves over the past year and a half, it’s that one. If only I had acted differently, they say. If only, if only, if only.
Yet here’s the problem: While we know we made investment mistakes, and vow not to repeat them, most people have only the vaguest sense of what those mistakes were, or, more importantly, why they made them. Why did we think and feel and behave as we did? Why did we act in a way that today, in hindsight, seems so obviously stupid? Only by understanding the answers to these questions can we begin to improve our financial future.
This is where behavioral finance comes in. Most investors are intelligent people, neither irrational nor insane. But behavioral finance tells us we are also normal, with brains that are often full and emotions that are often overflowing. And that means we are normally smart at times and normally stupid at others.
The trick, therefore, is to learn to increase our ratio of smart behavior to stupid. And since we cannot (thank goodness) turn ourselves into computer-like people, we need to find tools to help us act smart even when our thinking and feelings tempt us to be stupid.
Let me give you one example. Investors tend to think about each stock we purchase in a vacuum, distinct from other stocks in our portfolio. We are happy to realize "paper" gains in each stock quickly, but procrastinate when it comes to realizing losses. Why? Because while regret over a paper loss stings, we can console ourselves in the hope that, in time, the stock will roar back into a gain.
By contrast, all hope would be extinguished if we sold the stock and realized our loss. We would feel the searing pain of regret. So we do pretty much anything to avoid that pain — including holding on to the stock long after we should have sold it. Indeed, I’ve recently encountered an investor who procrastinated in realizing his losses on WorldCom stock until a letter from his broker informed him that the stock was worthless.
Successful professional traders are subject to the same emotions as the rest of us. But they counter it in two ways. First, they know their weakness, placing them on guard against it. Second, they establish "sell disciplines" that force them to realize losses even when they know that the pain of regret is sure to follow.
So in what other ways do our misguided thoughts and feelings get in the way of successful investing — not to mention increasing our stress levels? And what are the lessons we should learn, once we recognize those cognitive and emotional errors? Here are eight of them.
No. 1: Caring that Goldman Sachs is faster than you
There is an old story about two hikers who encounter a tiger. One says: There is no point in running because the tiger is faster than either of us. The other says: It is not about whether the tiger is faster than either of us. It is about whether I’m faster than you. And with that he runs away. The speed of the Goldman Sachses of the world has been boosted most recently by computerized high-frequency trading. Can you really outrun them?
It is normal for us, the individual investors, to frame the market race as a race against the market. We hope to win by buying and selling investments at the right time. That doesn’t seem so hard. But we are much too slow in our race with the Goldman Sachses.
So what does this mean in practical terms? The most obvious lesson is that individual investors should never enter a race against faster runners by trading frequently on every little bit of news (or rumors).
Instead, simply buy and hold a diversified portfolio. Banal? Yes. Obvious? Yes. Typically followed? Sadly, no. Too often cognitive errors and emotions get in our way.
No. 2: Thinking foresight can be as clear as hindsight
Wasn’t it obvious in 2007 that financial institutions and financial markets were about to collapse? Well, it was not obvious to me, and it was probably not obvious to you, either. Hindsight error leads us to think that we could have seen in foresight what we see only in hindsight. And it makes us overconfident in our certainty about what’s going to happen.
Want to check the quality of your foresight? Write down in permanent ink your forecast of tomorrow’s stock prices. Do that each day for a year and check the accuracy of your predictions. You are likely to find that your foresight is not nearly as good as your hindsight.
As the market tanked, investors wondered where to put their money. Many are turning to advisers, but don’t know how to choose the right one.
Some prognosticators say we are in a new bull market and others say this is only a bull bounce in a bear market. We will know in hindsight which prognostication was right, but we don’t know it in foresight.
When I hear in my mind’s ear a voice that says the stock market is sure to zoom or plunge, I activate my "noise-canceling" device rather than go online and trade. You might wish to install this device in your mind as well.
No. 3: Being led by the pain of regret
Emotions are useful, even when they sting. The pain of regret over stupid comments teaches presidents and the rest of us to calibrate our words more carefully. But sometimes emotions mislead us into stupid behavior.
We feel the pain of regret when we find, in hindsight, that our portfolios would have been overflowing if only we had sold all the stocks in 2007. The pain of regret is especially searing when we bear responsibility for the decision not to sell our stocks in 2007. We are tempted to alleviate our pain by shifting responsibility to our financial advisers. "I am not stupid," we say. "My financial adviser is stupid." Financial advisers are sorely tempted to reciprocate, as the adviser in the cartoon who says: "If we’re being honest, it was your decision to follow my recommendation that cost you money."
In truth, responsibility belongs to bad luck. Follow your mother’s good advice: "Don’t cry over spilled milk."
Where am I leading you? Stop focusing on blame and regret and yesterday and start thinking about today and tomorrow. Don’t let regret lead you to hold on to stocks you should be selling. Instead, consider getting rid of your 2007 losing stocks and using the money immediately to buy similar stocks. You’ll feel the pain of regret today. But you’ll feel the joy of pride next April when the realized losses turn into tax deductions.
No. 4: Letting investment success stories blind you
Have you ever seen a lottery commercial showing a man muttering "lost again" as he tears his ticket in disgust? Of course not. What you see instead are smiling winners holding giant checks.
Lottery promoters tilt the scales by making the handful of winners available to our memory while obscuring the many millions of losers. Then, once we have settled on a belief, such as "I’m going to win the lottery," we tend to look for evidence that confirms our belief rather than evidence that might refute it. So we figure our favorite lottery number is due for a win because it has not won in years. Or we try to divine — through dreams, horoscopes, fortune cookies — the next winning numbers. But we neglect to note evidence that hardly anybody ever wins the lottery, and that lottery numbers can go for decades without winning. This is the work of the "confirmation" error.
What is true for lottery tickets is true for investments as well. Investment companies tilt the scales by touting how well they have done over a pre-selected period. Then, confirmation error misleads us into focusing on investments that did well in 2008.
Lottery players who overcome the confirmation error conclude that winning lottery numbers are random. Investors who overcome the confirmation error conclude that winning investments are almost as random. Don’t chase last year’s investment winners. Your ability to predict next year’s investment winner is no better than your ability to predict next week’s lottery winner. A diversified portfolio of many investments might make you a loser during a year or even a decade, but a concentrated portfolio of few investments might ruin you forever.
No. 5: Putting fear or exuberance in control
A Gallup Poll asked: "Do you think that now is a good time to invest in the financial markets?" February 2000 was a time of exuberance, and 78% of investors agreed that "now is a good time to invest." It turned out to be a bad time to invest. March 2003 was a time of fear, and only 41% agreed that "now is a good time to invest." It turned out to be a good time to invest.
I would guess that few investors thought that March 2009, another time of great fear, was a good time to invest. So far, so wrong. It is good to learn the lesson of fear and exuberance, and use reason to resist their pull.
As the market tanked, investors wondered where to put their money. Many are turning to advisers, but don’t know how to choose the right one.
No. 6: Basing happiness on wealth ups and downs
John found out today that his wealth fell from $5 million to $3 million. Jane found out that her wealth increased from $1 million to $2 million. John has more wealth than Jane, but Jane is likely to be happier. This simple insight underlies Prospect Theory, developed by Daniel Kahneman and Amos Tversky. Happiness from wealth comes from gains of wealth more than it comes from levels of wealth. While gains of wealth bring happiness, losses of wealth bring misery. This is misery we feel today, whether our wealth declined from $5 million to $3 million or from $50,000 to $30,000.
We’ll have to wait a while before we recoup our recent investment losses, but we can recoup our loss of happiness much faster, simply by framing things differently. John thinks he’s a loser now that he has only $3 million of his original $5 million. But John is likely a winner if he compares his $3 million to the mountain of debt he had when he left college. And he is a winner if he compares himself to his poor neighbor, the one with only $2 million.
In other words, it’s all relative, and it doesn’t hurt to keep that in mind, for the sake of your mental well-being. Standing next to people who have lost more than you and counting your blessings would not add a penny to your portfolio, but it would remind you that you are not a loser.
No. 7: Losing sight of your goals
Another lesson here in happiness. Mental accounting — the adding and subtracting you do in your head about your gains and losses — is a cognitive operation that can regularly mislead you. But you can also use your mental accounting in a way that steers you right.
Say your portfolio is down 30% from its 2007 high, even after the recent stock market bounce. You feel like a loser. But money is worth nothing when it is not attached to a goal, whether buying a new TV, funding retirement or leaving an inheritance to your children or favorite charity.
A stock market crash is akin to an automobile crash. We check ourselves. Is anyone bleeding? Can we drive the car to a garage, or do we need a tow truck? We must check ourselves after a market crash as well.
Suppose you divide your portfolio into mental accounts: one for your retirement income, one for college education for your grandchildren and one for bequests to your children. Now you can see that the terrible market has wrecked your bequest mental account and dented your education mental account, but left your retirement mental account without a scratch. You still have all the money you need for food and shelter, and you even have the money for a trip around the country in a new RV. You might want to affix to it a new version of the old bumper sticker: "I’ve only lost my children’s inheritance."
So here’s my advice: Ask yourself whether the market damaged your retirement prospects or only deflated your ego. If the market has damaged your retirement prospects, then you’ll have to save more, spend less or retire later. But don’t worry about your ego. In time it will inflate to its former size.
No. 8: Ignoring the benefits of dollar-cost averaging
Suppose you were wise or lucky enough to sell all your stocks at the top of the market in October 2007. Now what? Today it seems so clear that you should not have missed the opportunity to get back into the market in mid-March, but you missed that opportunity. Hindsight messes with your mind and regret adds its sting. Perhaps you should get back in. But what if the market falls below its March lows as soon as you get back in? Won’t the sting of regret be even more painful?
Dollar-cost averaging is a good way to reduce regret — and make your head clearer for smart investing. Say you have $100,000 that you want to put back into stocks. Divide it into 10 pieces of $10,000 each and invest each on the first Monday of each of the next 10 months. You’ll minimize regret. If the stock market declined as soon as you invested the first $10,000, you’ll take comfort in the $90,000 you have not invested yet. If the market increases, you’ll take comfort in the $10,000 you have invested. Moreover, the strict "first Monday" rule removes responsibility, further mitigating the pain of regret. You did not make the decision to invest $10,000 in the sixth month, just before the big crash. You only followed a rule. The money is lost, but your mind is almost intact.
Things could be a lot worse.
Meir Statman, a professor of finance at Santa Clara University in Santa Clara, Calif., wrote this piece for The Wall Street Journal.
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