Deflation: why is it so dangerous?
With the economic news seemingly becoming worse by the day, there has been much talk about the possibility of deflation – a prolonged period of falling general prices.
By George Buckley
Last Updated: 11:35AM GMT 17 Mar 2009
But why would this be so bad? After all, surely deflation is good for households if it means that the cost of the goods and services is becoming cheaper?
There are a few reasons it's not that simple. First, prices tend to be influenced by the state of the economy. If demand is greater than the supply of goods and services then prices rise. If demand is weaker –as is the case at the moment – then prices can drop. So falling prices tell us something about the fragile shape of the economy.
A fall in prices is bad news for companies that make or sell the products we buy. Imagine a retailer having to cut prices to shift stock, but at the same time paying more for imported goods because of the fall in pound’s value. This causes profits to turn to losses, meaning some retailers will go to the wall, and many will cut staff.
Deflation, therefore, doesn’t just mean lower prices – it also means higher unemployment and lower wages. It will become much more difficult for those people who’ve lost their job or had to take a pay cut to continue repaying their debt.
Some might be forced to sell their house to pay off the mortgage – but the more people who do this, the more house prices may fall (causing negative equity). And if house prices fall that can be a blow to confidence leading to a weaker economy which in turn might perpetuate deflation. It is easy to see how a vicious cycle can develop.
Consider the situation in which we have deflation, and more importantly we think it is going to continue. There is, then, little incentive to spend money today – we may as well wait until tomorrow when prices will be lower. And tomorrow we might think the same again, deferring our purchase indefinitely.
This is what happened in Japan in the 1990s - deflation came, and shoppers disappeared. Economic growth turned to economic contraction, and we witnessed what became known as Japan's "lost decade". Following a brief interlude where growth returned, a second lost decade seems to be in the making.
Even worse was the Great Depression. In the 1930s share prices tumbled leading to an economic slump of epic proportions – and, of course, deflation and falling wages. The crash that led to that depression was caused by investors buying shares with borrowed money, pushing their prices up to ever unsustainable levels. This time round it was excesses in the housing market and the financial sector.
Governments are now trying to spend their way out of recession, attempting to fill in the gap left by households and firms. The Bank of England is helping too by bringing interest rates down to exceptionally low levels – making it less desirable to save and thereby encouraging spending.
It is still very uncertain as to how all of this stimulus will affect the economy. The pressing need is to avert a period of deflation, but the risk is that too much policy easing could cause exactly the opposite
George Buckley is chief UK economist at Deutsche Bank
http://www.telegraph.co.uk/finance/financetopics/recession/5005277/Deflation-why-is-it-so-dangerous.html
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Wednesday 18 March 2009
Monday 16 March 2009
Britain showing signs of heading towards 1930s-style depression, says Bank
Britain showing signs of heading towards 1930s-style depression, says Bank
Britain is showing signs of sliding towards a 1930s-style depression, the Bank of England says today for the first time.
By Edmund Conway, Economics Editor
Last Updated: 8:23AM GMT 16 Mar 2009
The country is displaying early symptoms of being trapped in a so-called “debt deflation trap” where families find themselves pushed further and further into the red every month, according to a Bank report published today.
The stark warning will cause serious concerns, since it was this combination of falling prices and soaring debt burdens that plagued the US in the 1930s.
The Bank is using its Quarterly Bulletin to highlight the threat posed to the economy by deflation – where prices fall each year rather than rise.
Although inflation is currently in positive territory, it is expected to become negative in the coming months.
The Bank is worried that this may combine with high levels of indebtedness to squeeze families further.
It says that families with high debts could fall prey to the debt deflation trap. This means that the cost of their debts, which are fixed, would rise compared to average prices throughout the economy. While inflation erodes debts, deflation makes them relatively higher.
The Bank’s paper suggests that Britain is particularly at risk because there is a high proportion of families with significant levels of debt, and many of them are on fixed mortgage rate, which means they will not benefit from rate cuts.
Britons’ total personal debt – the amount owed on mortgages, loans and credit cards – is, at £1.46 trillion, more than the value of what the country produces in a year.
Total personal debt has risen by 165 per cent since 1997 and each household now owes an average of about £60,000.
The Conservatives claim this is the highest personal debt level in the world.
The Bank’s paper also says that consumers were suffering as banks keep the cost of borrowing high, despite Government attempts to get them lending again.
Alistair Darling, the Chancellor, and fellow finance ministers used their pre-G20 meeting this weekend to warn that more drastic action was necessary to help bring the world economy back from the brink of a possible repeat of the 1930s.
The Bank’s report puts pressure on Gordon Brown, who this weekend faced further calls to apologise for the recession, to secure agreement on an effective international rescue strategy when he hosts the G20 leaders at a summit in London at the start of April.
It comes as figures this week are expected to show the number of people unemployed will reach the two million mark.
The Bank’s report says: “This configuration of falling asset prices and depressed economic conditions in the face of an adverse demand shock is consistent with recent and prospective macroeconomic developments in the United Kingdom and internationally”.
It helps explain why it took such dramatic action earlier this month to pump extra cash into the economy.
The bank slashed interest rates to just above zero and pledged to create £150 billion worth of cash with which to buy up government and corporate debt.
This so-called quantitative easing is regarded as a radical measure to help prevent a repeat of the conditions associated with the Great Depression.
Many experts believe that the US authorities’ initial reluctance in the 1930s even to cut interest rates was partly responsible for causing the worst economic slump in Western history.
The Chancellor acknowledged at the G20 meeting that the economic situation was “grave” but pledged not to allow a repeat of the Depression years. The ministers promised to pump more cash into their economies if necessary in the next few months.
However, some have expressed concern that the meeting failed in its aspiration to reach a specific agreement on the amount of cash countries need to spend in the coming year. Others have warned that it does not set a clear enough agenda for the much-anticipated full G20 summit on April 2.
Some speculate that the Prime Minister may use the G20 as a justification for a series of further tax cuts and spending increases in the Budget next month, though many economists have warned that despite the scale of the recession faced by the UK the Treasury has little capacity to borrow more.
Mr Darling has signalled that the meeting must not be allowed to mirror a 1933 summit in London which failed to halt the Great Depression. He said failure to agree co-ordinated action then meant that the Depression continued for years when it “need not have done so”.
Writing in The Sunday Telegraph George Osborne, the Shadow Chancellor, said Mr Brown must use the G20 as “the moment to send the clearest of signals that, unlike in the 1930s, this banking crisis will not send the world spinning into a protectionist spiral.”
He said that “ministerial promises” had failed to deliver any real benefits to struggling home owners or desperate businesses.
http://www.telegraph.co.uk/finance/financetopics/recession/4996994/Britain-showing-signs-of-heading-towards-1930s-style-depression-says-Bank.html
Britain is showing signs of sliding towards a 1930s-style depression, the Bank of England says today for the first time.
By Edmund Conway, Economics Editor
Last Updated: 8:23AM GMT 16 Mar 2009
The country is displaying early symptoms of being trapped in a so-called “debt deflation trap” where families find themselves pushed further and further into the red every month, according to a Bank report published today.
The stark warning will cause serious concerns, since it was this combination of falling prices and soaring debt burdens that plagued the US in the 1930s.
The Bank is using its Quarterly Bulletin to highlight the threat posed to the economy by deflation – where prices fall each year rather than rise.
Although inflation is currently in positive territory, it is expected to become negative in the coming months.
The Bank is worried that this may combine with high levels of indebtedness to squeeze families further.
It says that families with high debts could fall prey to the debt deflation trap. This means that the cost of their debts, which are fixed, would rise compared to average prices throughout the economy. While inflation erodes debts, deflation makes them relatively higher.
The Bank’s paper suggests that Britain is particularly at risk because there is a high proportion of families with significant levels of debt, and many of them are on fixed mortgage rate, which means they will not benefit from rate cuts.
Britons’ total personal debt – the amount owed on mortgages, loans and credit cards – is, at £1.46 trillion, more than the value of what the country produces in a year.
Total personal debt has risen by 165 per cent since 1997 and each household now owes an average of about £60,000.
The Conservatives claim this is the highest personal debt level in the world.
The Bank’s paper also says that consumers were suffering as banks keep the cost of borrowing high, despite Government attempts to get them lending again.
Alistair Darling, the Chancellor, and fellow finance ministers used their pre-G20 meeting this weekend to warn that more drastic action was necessary to help bring the world economy back from the brink of a possible repeat of the 1930s.
The Bank’s report puts pressure on Gordon Brown, who this weekend faced further calls to apologise for the recession, to secure agreement on an effective international rescue strategy when he hosts the G20 leaders at a summit in London at the start of April.
It comes as figures this week are expected to show the number of people unemployed will reach the two million mark.
The Bank’s report says: “This configuration of falling asset prices and depressed economic conditions in the face of an adverse demand shock is consistent with recent and prospective macroeconomic developments in the United Kingdom and internationally”.
It helps explain why it took such dramatic action earlier this month to pump extra cash into the economy.
The bank slashed interest rates to just above zero and pledged to create £150 billion worth of cash with which to buy up government and corporate debt.
This so-called quantitative easing is regarded as a radical measure to help prevent a repeat of the conditions associated with the Great Depression.
Many experts believe that the US authorities’ initial reluctance in the 1930s even to cut interest rates was partly responsible for causing the worst economic slump in Western history.
The Chancellor acknowledged at the G20 meeting that the economic situation was “grave” but pledged not to allow a repeat of the Depression years. The ministers promised to pump more cash into their economies if necessary in the next few months.
However, some have expressed concern that the meeting failed in its aspiration to reach a specific agreement on the amount of cash countries need to spend in the coming year. Others have warned that it does not set a clear enough agenda for the much-anticipated full G20 summit on April 2.
Some speculate that the Prime Minister may use the G20 as a justification for a series of further tax cuts and spending increases in the Budget next month, though many economists have warned that despite the scale of the recession faced by the UK the Treasury has little capacity to borrow more.
Mr Darling has signalled that the meeting must not be allowed to mirror a 1933 summit in London which failed to halt the Great Depression. He said failure to agree co-ordinated action then meant that the Depression continued for years when it “need not have done so”.
Writing in The Sunday Telegraph George Osborne, the Shadow Chancellor, said Mr Brown must use the G20 as “the moment to send the clearest of signals that, unlike in the 1930s, this banking crisis will not send the world spinning into a protectionist spiral.”
He said that “ministerial promises” had failed to deliver any real benefits to struggling home owners or desperate businesses.
http://www.telegraph.co.uk/finance/financetopics/recession/4996994/Britain-showing-signs-of-heading-towards-1930s-style-depression-says-Bank.html
Testing 3 Types Of Analysts
Testing 3 Types Of Analysts
by Rick Wayman
There are several types of analysts on Wall Street, and they produce different kinds of reports because they have different kinds of clients. Let's take a look at the different responsibilities required for each analyst, so that you can do your own litmus test to see which ones you need to pay attention to.
Sell-Side Analysts
These are the analysts that are dominating today's headlines. They are employed by brokerage houses to analyze companies and write in-depth research reports, conducting what is sometimes called primary research. These reports are used to "sell" an idea to individuals and institutional clients. Individual investors gain access to these reports mainly by having accounts with the brokerage firm. For example, to get free research from Merrill Lynch, you need to have an account with a Merrill Lynch broker. Sometimes the reports can be purchased through a third party such as Multex.com. Institutional clients (i.e. mutual fund managers) get research from the brokerage's institutional brokers. (Keep reading about fund managers in Should You Follow Your Fund Manager? and Choose A Fund With A Winning Manager.)
A good sell-side research report contains a detailed analysis of a company's competitive advantages and provides information on management's expertise and how the company's operating and stock valuation compares to a peer group and its industry. The typical report also contains an earnings model and clearly states the assumptions that are used to create the forecast. Writing this type of report is a time consuming process. Information is obtained by reading the company's filings for the Securities & Exchange Commission, meeting with its management and, if possible, talking with its suppliers and customers. It also entails analyzing (using the same process) the company's publicly-traded peers for the purpose of better understanding differences in operating results and stock valuations. This approach is called fundamental analysis because it focuses on the company's fundamentals. This is a rigorous and time-consuming process that limits a typical sell-side analyst specializing in two or three industries and covering about 10-15 companies, depending on the number of sectors he or she follows.The challenge facing the brokerages is that it's extremely expensive to create all this research. Brokerages must recover the costs of paying sell-side analysts from somewhere, but deregulation has significantly reduced the ability to make a profit at anything except investment banking deals. The main result of these "forces" is that research departments cannot research any companies that do not have a potential investment bank deal of about $50 million or more. This leaves thousands of great companies without research. Couple this with the fact that research departments drop coverage rather than issue "sell" reports, and you'll get the perception that analysts only issue "buy" recommendations. (To read more on this, see Why There Are Few Sell Ratings On Wall Street and Stock Ratings: The Good, The Bad And The Ugly.)
Buy-Side Analysts
Buy-side analysts are employed by fund managers like Fidelity and Janus, as well as pension funds. Like the sell-side analysis, the buy-side analyst specializes in a few sectors and analyzes stocks to make buy/sell recommendations; however, the buy-side differs from the sell-side in three main ways: they follow more stocks (30-40), they write very brief reports (generally one or two pages), and their research is only distributed to the fund's managers. Buy-side analysts can cover more stocks than sell-side analysts because they have access to all the sell-side research. They also have the opportunity to attend industry conferences, hosted by sell-side firms. During these conferences, the managements of several companies in a sector present why they are a better investment. After gathering this information, buy-side analysts summarize their case in a brief report that also contains an earnings forecast. These reports are only distributed to the fund's managers.
The sell-side provides research and conferences to the buy-side in the hopes that the buy-side will let them execute the large trades that the funds make when they act on the recommendation provided by the sell-side. Having access to the sell-side's primary research and the ability to attend industry conferences allows the buy-side analyst to follow many more stocks than a sell-side analyst. To compensate the firm for this information, the funds will buy and sell stocks with the brokerage firms that provide the best information.
Independent Analysts
Independent analysts are practitioners who are not employed by either brokerage firms or mutual/pension funds. "Indies", as they are sometimes called, are firms established to provide research that is "untainted" by investment banking deals. Some Indies focus on serving institutional clients and are paid a fee to follow certain stocks and/or to find new ideas that the sell-side is missing. In some cases, these institutional Indies have a relationship with a brokerage firm and are compensated by trades given to them by the funds. Sometimes it is a fee-only arrangement.Other Indies provide their research to both the institutional and individual investors. These firms may provide their research on a subscription basis or for free. In either case, it is important to understand the nature of the relationship between the research firm and the company that is being analyzed (generally called the "Subject Company"), even if the report is not free. Every research report is required to have a section called the disclaimer that discloses, among other things, the nature of the relationship between the research firm and the subject company. Every major brokerage firm and every Indie must provide this information. This disclaimer generally appears at the end of the report and is in small type. In it, the research firm must disclose if and how it is compensated for providing research. For example, major Wall Street firms will disclose that they provided investment-banking services to the subject company. Some indies will accept stock or other forms of equity as payment for their services. Other Indies will only accept a cash only fixed-fee.
Analyst Objectivity
The objectivity of research reports is a major question, one that is now asked of both the large Wall Street firms as well as the Indies. Is Wall Street research objective? Can an indie provide an objective research report if it is paid by the subject company? These are difficult questions to answer without reading the disclosure and the report and knowing something about the firm and the analyst. Just like on Wall Street, some indies strive to meet a higher standard of ethical conduct while others just try to manipulate stocks. But it is your responsibility to understand and evaluate this information.Indies play an important role in today's market by providing research on small/micro cap stocks that are ignored by traditional brokerage research departments. Wall Street has become myopic, focused on big cap stocks and pleasing big institutional investors. This has resulted in the majority of stocks becoming "orphans" despite their investment potential. Indies attempt to bridge this information gap by providing research on stocks Wall Street has orphaned. While the Internet revolution has increased the ability of individual investors to do their own trades and research, it takes time and experience to do a thorough job. Legitimate indies take the time to provide useful information. It is up to you to judge its worth.
by Rick Wayman, (Contact Author Biography)
http://investopedia.com/articles/analyst/052102.asp
by Rick Wayman
There are several types of analysts on Wall Street, and they produce different kinds of reports because they have different kinds of clients. Let's take a look at the different responsibilities required for each analyst, so that you can do your own litmus test to see which ones you need to pay attention to.
Sell-Side Analysts
These are the analysts that are dominating today's headlines. They are employed by brokerage houses to analyze companies and write in-depth research reports, conducting what is sometimes called primary research. These reports are used to "sell" an idea to individuals and institutional clients. Individual investors gain access to these reports mainly by having accounts with the brokerage firm. For example, to get free research from Merrill Lynch, you need to have an account with a Merrill Lynch broker. Sometimes the reports can be purchased through a third party such as Multex.com. Institutional clients (i.e. mutual fund managers) get research from the brokerage's institutional brokers. (Keep reading about fund managers in Should You Follow Your Fund Manager? and Choose A Fund With A Winning Manager.)
A good sell-side research report contains a detailed analysis of a company's competitive advantages and provides information on management's expertise and how the company's operating and stock valuation compares to a peer group and its industry. The typical report also contains an earnings model and clearly states the assumptions that are used to create the forecast. Writing this type of report is a time consuming process. Information is obtained by reading the company's filings for the Securities & Exchange Commission, meeting with its management and, if possible, talking with its suppliers and customers. It also entails analyzing (using the same process) the company's publicly-traded peers for the purpose of better understanding differences in operating results and stock valuations. This approach is called fundamental analysis because it focuses on the company's fundamentals. This is a rigorous and time-consuming process that limits a typical sell-side analyst specializing in two or three industries and covering about 10-15 companies, depending on the number of sectors he or she follows.The challenge facing the brokerages is that it's extremely expensive to create all this research. Brokerages must recover the costs of paying sell-side analysts from somewhere, but deregulation has significantly reduced the ability to make a profit at anything except investment banking deals. The main result of these "forces" is that research departments cannot research any companies that do not have a potential investment bank deal of about $50 million or more. This leaves thousands of great companies without research. Couple this with the fact that research departments drop coverage rather than issue "sell" reports, and you'll get the perception that analysts only issue "buy" recommendations. (To read more on this, see Why There Are Few Sell Ratings On Wall Street and Stock Ratings: The Good, The Bad And The Ugly.)
Buy-Side Analysts
Buy-side analysts are employed by fund managers like Fidelity and Janus, as well as pension funds. Like the sell-side analysis, the buy-side analyst specializes in a few sectors and analyzes stocks to make buy/sell recommendations; however, the buy-side differs from the sell-side in three main ways: they follow more stocks (30-40), they write very brief reports (generally one or two pages), and their research is only distributed to the fund's managers. Buy-side analysts can cover more stocks than sell-side analysts because they have access to all the sell-side research. They also have the opportunity to attend industry conferences, hosted by sell-side firms. During these conferences, the managements of several companies in a sector present why they are a better investment. After gathering this information, buy-side analysts summarize their case in a brief report that also contains an earnings forecast. These reports are only distributed to the fund's managers.
The sell-side provides research and conferences to the buy-side in the hopes that the buy-side will let them execute the large trades that the funds make when they act on the recommendation provided by the sell-side. Having access to the sell-side's primary research and the ability to attend industry conferences allows the buy-side analyst to follow many more stocks than a sell-side analyst. To compensate the firm for this information, the funds will buy and sell stocks with the brokerage firms that provide the best information.
Independent Analysts
Independent analysts are practitioners who are not employed by either brokerage firms or mutual/pension funds. "Indies", as they are sometimes called, are firms established to provide research that is "untainted" by investment banking deals. Some Indies focus on serving institutional clients and are paid a fee to follow certain stocks and/or to find new ideas that the sell-side is missing. In some cases, these institutional Indies have a relationship with a brokerage firm and are compensated by trades given to them by the funds. Sometimes it is a fee-only arrangement.Other Indies provide their research to both the institutional and individual investors. These firms may provide their research on a subscription basis or for free. In either case, it is important to understand the nature of the relationship between the research firm and the company that is being analyzed (generally called the "Subject Company"), even if the report is not free. Every research report is required to have a section called the disclaimer that discloses, among other things, the nature of the relationship between the research firm and the subject company. Every major brokerage firm and every Indie must provide this information. This disclaimer generally appears at the end of the report and is in small type. In it, the research firm must disclose if and how it is compensated for providing research. For example, major Wall Street firms will disclose that they provided investment-banking services to the subject company. Some indies will accept stock or other forms of equity as payment for their services. Other Indies will only accept a cash only fixed-fee.
Analyst Objectivity
The objectivity of research reports is a major question, one that is now asked of both the large Wall Street firms as well as the Indies. Is Wall Street research objective? Can an indie provide an objective research report if it is paid by the subject company? These are difficult questions to answer without reading the disclosure and the report and knowing something about the firm and the analyst. Just like on Wall Street, some indies strive to meet a higher standard of ethical conduct while others just try to manipulate stocks. But it is your responsibility to understand and evaluate this information.Indies play an important role in today's market by providing research on small/micro cap stocks that are ignored by traditional brokerage research departments. Wall Street has become myopic, focused on big cap stocks and pleasing big institutional investors. This has resulted in the majority of stocks becoming "orphans" despite their investment potential. Indies attempt to bridge this information gap by providing research on stocks Wall Street has orphaned. While the Internet revolution has increased the ability of individual investors to do their own trades and research, it takes time and experience to do a thorough job. Legitimate indies take the time to provide useful information. It is up to you to judge its worth.
by Rick Wayman, (Contact Author Biography)
http://investopedia.com/articles/analyst/052102.asp
10 Financial Myths Busted
10 Financial Myths Busted
by Jeffrey R. Kosnett
Friday, March 13, 2009
Before the economic rout, you could rely on certain iron laws of personal finance. For example, it was a given that house values didn't fall. Money-market funds never lost a dime. And no matter how ugly the market, expert mutual fund managers could protect you from drastic losses.
Alas, in this Hydra-headed global financial crisis, another generally accepted principle of financial strategy or economic logic finds its way into the shredder almost every day. We gathered ten truisms that no longer pass the test.
MYTH 1: There's always a hot market somewhere. When U.S. markets began to blow up, you heard about "decoupling" and "the Chinese century." The idea is that Asia -- or Russia or Latin America -- can grow vigorously independent of the U.S. and Europe. Invest there and you'll offset losses at home. Instead, Chinese, Indian and Russian shares have crumbled. Net investment money flowing into emerging-market economies fell 50% in 2008, to $466 billion, and is forecast to sink to $165 billion in 2009.
Truth: In this age of globalization, economic downturns and bear markets observe no borders.
MYTH 2: Real estate behaves differently from other investments. Call it a bubble instead of a boom if you like, but it was supposed to be "proof" that real estate returns don't strongly correlate with the returns of stocks and other financial investments. The message: Rental properties or real estate investment trusts can make money despite drops in Standard & Poor's 500-stock index or the Nasdaq. Wrong. REITs lost 38% in 2008 because the credit crunch and overly aggressive expansion plans hammered profits and dividends. REIT returns used to have little correlation with the stock market. Now they closely track it.
Truth: Real estate won't overcome other risks when credit problems are harming all investments.
MYTH 3. Reliable dividend payers are safer than other stocks. Companies recognized as dividend "achievers" or "aristocrats" -- because they could be counted on to increase their payouts regularly -- used to perform more steadily than most stocks. That's because shareholders seeking income tended not to sell. But now shares of dividend achievers can be as volatile as the overall market. One reason: more mass trading of blue-chip stocks in baskets, a la exchange-traded and index funds. Another factor: Banks, insurance firms and real estate companies can no longer afford to pay high dividends.
Truth: Companies aren't too proud to stop increasing dividends. If you want stable dividends, ignore the past and look for companies with lots of cash flow.
MYTH 4. Foreign creditors can drain the U.S. Treasury overnight. Puny Treasury yields suggest that it's bad business for the rest of the world to lend so much money to the U.S. But think: What else would these investors do? And who has the power to impose this dramatic sell order? Nobody. Foreigners own $3.1 trillion of Treasury debt. Of that, $1.1 trillion is with private investors -- mainly pension funds, which cannot safely ignore a class of investment that is absolutely liquid and has never defaulted. Governments and institutional investors hold the rest. On occasion they have sold more U.S. debt than they have bought. But massive private buying has overwhelmed the modest pullbacks.
Truth: If what you want is super-safe bonds, the U.S. Treasury is the go-to place.
MYTH 5. Gold is the best place to hide in a lousy economy. In early February, an ounce of gold traded for $910. That's just where it sat a year ago, when world economies weren't so bad off. But foreign and domestic stocks, real estate, oil and riskier classes of bonds have all tanked since, and now gold looks -- ahem -- as good as gold. However, gold does not typically benefit from a recession. As inflation slows, people buy less jewelry, industry uses less gold, and strapped governments sell reserves to raise cash.
Truth: Gold tends to rally in prosperous times, when you have inflation, easy credit and flush buyers (kind of reminds you of real estate. . . ).
MYTH 6. Life insurance is not a good investment. This canard spread as 401(k)s and IRAs supplanted cash-value life insurance as Americans' most popular ways to build savings while deferring taxes. True, the investment side of an insurance policy has higher built-in expenses than mutual funds do. But two factors point to a revival of insurance as an investment. One is guaranteed-interest credits on cash values, which means that if you pay the premiums, you cannot lose money unless the insurance company fails (see "Savings Guarantees You Can Trust," on page 55). The other is the boom in life settlements. If you're older than 65, you can often sell the insurance contract to a third party for several times its cash value -- and pay taxes on the difference at low capital-gains rates.
Truth: A good investment is one in which you put money away now and have more later. Checked your 401(k) lately?
MYTH 7. The economic downturn dooms the dollar to irrelevance. No question, the U.S. is deep in debt and going deeper while the economy contracts. History teaches that when a country can't pay its bills, lags economically and cannot control inflation, its currency loses value. That's why currencies in Argentina, Iceland, Mexico and Russia have all crashed within recent memory. The dollar does swoon, and it's lost punch in places as unexpected as Brazil and India. But -- and here's the surprise -- as recession gripped the U.S., the dol-lar got stronger. For one thing, there aren't many alternatives. For another, some other currencies were temporarily inflated by oil and commodities speculation.
Truth: The dollar has survived a tough test and remains the world's "reserve" currency.
MYTH 8. Mass layoffs reward investors. In the 1990s, news of layoffs would boost a company's stock for several weeks. Stock traders lauded bosses for tightening their belts, so it was smart to buy or hold the shares. But mass firings no longer impress investors. Lately, firms as varied as Allstate, Boeing, Caterpillar, Dell, Macy's, Mattel and Starbucks have all announced enormous layoffs -- only to learn that, if anything, doing so spooks the market even more. For example, on the day in January when Allstate axed 1,000 of its 70,000 employees, its shares fell 21%.
Truth: Don't buy a stock thinking that a layoff will help profits. More likely, trouble's brewing.
MYTH 9. It's crucial to diversify a stock portfolio by investing style. Experts say a sound fund portfolio fills all "style boxes," starting with growth and value. Growth refers to companies with expanding sales and profits. Value describes stocks selling for less than the business is worth. In 1998 and 1999, growth stocks soared and value stocks stalled. Then, for a few years, value rose while growth got crushed. But since 2005, the differences have been melting away. In the current bear market, both styles have been disastrous, and it's hard even to classify stocks as growth or value anymore. Many former growth stocks, such as technology companies, are so cheap that they act like value shares. Banks and real estate, once lumped into value, are a mess.
Truth: Pick mutual funds that are free to search for good prices on stocks, whatever their labels.
MYTH 10. A near-perfect credit score will get you the best loan rate. Before the credit bust, if you could fog a mirror, you could get a mortgage. You know what happened next. But bankers still need to make a buck, so it sounds logical that if you can show a strong credit score, you'll win the best of deals on any kind of loan. Not so. Mortgage lenders prefer large down payments. Credit-card issuers are just as apt to reduce your credit line or raise your interest rate. And those 0% car loans? Often they last for only three years, which puts the payments so high you'll need to come up with more upfront cash anyway.
Truth: Credit is going to be tough to get for a while no matter what. So don't obsess over every few points of your FICO score.
http://finance.yahoo.com/banking-budgeting/article/106741/10-Financial-Myths-Busted
by Jeffrey R. Kosnett
Friday, March 13, 2009
Before the economic rout, you could rely on certain iron laws of personal finance. For example, it was a given that house values didn't fall. Money-market funds never lost a dime. And no matter how ugly the market, expert mutual fund managers could protect you from drastic losses.
Alas, in this Hydra-headed global financial crisis, another generally accepted principle of financial strategy or economic logic finds its way into the shredder almost every day. We gathered ten truisms that no longer pass the test.
MYTH 1: There's always a hot market somewhere. When U.S. markets began to blow up, you heard about "decoupling" and "the Chinese century." The idea is that Asia -- or Russia or Latin America -- can grow vigorously independent of the U.S. and Europe. Invest there and you'll offset losses at home. Instead, Chinese, Indian and Russian shares have crumbled. Net investment money flowing into emerging-market economies fell 50% in 2008, to $466 billion, and is forecast to sink to $165 billion in 2009.
Truth: In this age of globalization, economic downturns and bear markets observe no borders.
MYTH 2: Real estate behaves differently from other investments. Call it a bubble instead of a boom if you like, but it was supposed to be "proof" that real estate returns don't strongly correlate with the returns of stocks and other financial investments. The message: Rental properties or real estate investment trusts can make money despite drops in Standard & Poor's 500-stock index or the Nasdaq. Wrong. REITs lost 38% in 2008 because the credit crunch and overly aggressive expansion plans hammered profits and dividends. REIT returns used to have little correlation with the stock market. Now they closely track it.
Truth: Real estate won't overcome other risks when credit problems are harming all investments.
MYTH 3. Reliable dividend payers are safer than other stocks. Companies recognized as dividend "achievers" or "aristocrats" -- because they could be counted on to increase their payouts regularly -- used to perform more steadily than most stocks. That's because shareholders seeking income tended not to sell. But now shares of dividend achievers can be as volatile as the overall market. One reason: more mass trading of blue-chip stocks in baskets, a la exchange-traded and index funds. Another factor: Banks, insurance firms and real estate companies can no longer afford to pay high dividends.
Truth: Companies aren't too proud to stop increasing dividends. If you want stable dividends, ignore the past and look for companies with lots of cash flow.
MYTH 4. Foreign creditors can drain the U.S. Treasury overnight. Puny Treasury yields suggest that it's bad business for the rest of the world to lend so much money to the U.S. But think: What else would these investors do? And who has the power to impose this dramatic sell order? Nobody. Foreigners own $3.1 trillion of Treasury debt. Of that, $1.1 trillion is with private investors -- mainly pension funds, which cannot safely ignore a class of investment that is absolutely liquid and has never defaulted. Governments and institutional investors hold the rest. On occasion they have sold more U.S. debt than they have bought. But massive private buying has overwhelmed the modest pullbacks.
Truth: If what you want is super-safe bonds, the U.S. Treasury is the go-to place.
MYTH 5. Gold is the best place to hide in a lousy economy. In early February, an ounce of gold traded for $910. That's just where it sat a year ago, when world economies weren't so bad off. But foreign and domestic stocks, real estate, oil and riskier classes of bonds have all tanked since, and now gold looks -- ahem -- as good as gold. However, gold does not typically benefit from a recession. As inflation slows, people buy less jewelry, industry uses less gold, and strapped governments sell reserves to raise cash.
Truth: Gold tends to rally in prosperous times, when you have inflation, easy credit and flush buyers (kind of reminds you of real estate. . . ).
MYTH 6. Life insurance is not a good investment. This canard spread as 401(k)s and IRAs supplanted cash-value life insurance as Americans' most popular ways to build savings while deferring taxes. True, the investment side of an insurance policy has higher built-in expenses than mutual funds do. But two factors point to a revival of insurance as an investment. One is guaranteed-interest credits on cash values, which means that if you pay the premiums, you cannot lose money unless the insurance company fails (see "Savings Guarantees You Can Trust," on page 55). The other is the boom in life settlements. If you're older than 65, you can often sell the insurance contract to a third party for several times its cash value -- and pay taxes on the difference at low capital-gains rates.
Truth: A good investment is one in which you put money away now and have more later. Checked your 401(k) lately?
MYTH 7. The economic downturn dooms the dollar to irrelevance. No question, the U.S. is deep in debt and going deeper while the economy contracts. History teaches that when a country can't pay its bills, lags economically and cannot control inflation, its currency loses value. That's why currencies in Argentina, Iceland, Mexico and Russia have all crashed within recent memory. The dollar does swoon, and it's lost punch in places as unexpected as Brazil and India. But -- and here's the surprise -- as recession gripped the U.S., the dol-lar got stronger. For one thing, there aren't many alternatives. For another, some other currencies were temporarily inflated by oil and commodities speculation.
Truth: The dollar has survived a tough test and remains the world's "reserve" currency.
MYTH 8. Mass layoffs reward investors. In the 1990s, news of layoffs would boost a company's stock for several weeks. Stock traders lauded bosses for tightening their belts, so it was smart to buy or hold the shares. But mass firings no longer impress investors. Lately, firms as varied as Allstate, Boeing, Caterpillar, Dell, Macy's, Mattel and Starbucks have all announced enormous layoffs -- only to learn that, if anything, doing so spooks the market even more. For example, on the day in January when Allstate axed 1,000 of its 70,000 employees, its shares fell 21%.
Truth: Don't buy a stock thinking that a layoff will help profits. More likely, trouble's brewing.
MYTH 9. It's crucial to diversify a stock portfolio by investing style. Experts say a sound fund portfolio fills all "style boxes," starting with growth and value. Growth refers to companies with expanding sales and profits. Value describes stocks selling for less than the business is worth. In 1998 and 1999, growth stocks soared and value stocks stalled. Then, for a few years, value rose while growth got crushed. But since 2005, the differences have been melting away. In the current bear market, both styles have been disastrous, and it's hard even to classify stocks as growth or value anymore. Many former growth stocks, such as technology companies, are so cheap that they act like value shares. Banks and real estate, once lumped into value, are a mess.
Truth: Pick mutual funds that are free to search for good prices on stocks, whatever their labels.
MYTH 10. A near-perfect credit score will get you the best loan rate. Before the credit bust, if you could fog a mirror, you could get a mortgage. You know what happened next. But bankers still need to make a buck, so it sounds logical that if you can show a strong credit score, you'll win the best of deals on any kind of loan. Not so. Mortgage lenders prefer large down payments. Credit-card issuers are just as apt to reduce your credit line or raise your interest rate. And those 0% car loans? Often they last for only three years, which puts the payments so high you'll need to come up with more upfront cash anyway.
Truth: Credit is going to be tough to get for a while no matter what. So don't obsess over every few points of your FICO score.
http://finance.yahoo.com/banking-budgeting/article/106741/10-Financial-Myths-Busted
The Pros and Cons of Owning Company Stock
TheStreet.com
The Pros and Cons of Owning Company Stock
Tuesday March 10, 11:48 am ET
ByBob Feeman, Special to TheStreet.com
Like many employees, you might have the option of purchasing stock in your company through your 401(k).
Many employers, like health care company Gilead Sciences, sweeten the deal by offering their stock at discounted prices. Others, such as FirstEnergy and Sempra Energy, offer matching 401(k) contributions in the form of company stock.
Purchasing your company's stock can have benefits for both you and your employer, but investing too heavily can have negative consequences. That's why it's important to understand the pros and cons of investing in your company's stock -- and to find the right balance in your 401(k) assets.
The pros: One of the best reasons for investing in your company's stock is that it gives you some sense of control over your own financial future. When you feel you have a personal investment in a company, you'll work harder to ensure its success, and you'll feel a greater loyalty to it. If your efforts pay off and the stock rises, your financial stability rises with it, especially if you purchased the stock at a reduced rate.
There are benefits for employers as well. Offering stock options helps companies recruit better-qualified candidates, and motivates current employees to perform at the top of their game. Employers who offer stock options also find less turnover and better morale among their work forces, according to a 2000 report by the National Commission on Entrepreneurship.
The cons: On the flip side, owning too much company stock can have its drawbacks. Just ask the employees of Enron, WorldCom, Lehman Brothers and even General Motors. By investing heavily in company stock and depending on the same company for your salary and benefits, you're essentially staking your financial security on a single firm. Should the company hit a shaky spot, your financial future can start to tremble as well.
In addition, some companies place limitations on how much stock you can buy and sell, which limits your ability to freely manage your assets, especially if the stock should start to slide. (However, federal legislation passed in the wake of the Enron debacle mandates that companies that match employee contributions with company stock must allow employees with three or more years of service to transfer the company stock's value into other investments.) Other companies have placed a cap on how much company stock employees can hold through their 401(k)s.
Still, a December 2008 report by the Employee Benefit Research Institute found that about 8% of employees have more than 80% of their 401(k) assets tied up in company stock, and 19% of employees over 60 have more than half their assets in company stock.
Finding the balance: The key to managing risk is to diversify your portfolio. Generally, you should invest no more than 10% to 15% of your 401(k) assets in company stock. If you invest more than that, you're exposing yourself to risk.
When evaluating your asset allocation, revisit your original investment goals, specifically retirement savings goal, time horizon and risk tolerance. Then reconsider your investment options and make moves as necessary.
According to the Employee Benefit Research Institute report, new and recent hires, perhaps feeling less secure in their companies, are opting for balanced funds like lifecycle funds. These mutual funds start out weighted primarily in equities, and then shift to less-risky holdings as participants approach retirement. Depending on your goals, these funds might be a good option for you.
It's also important to understand the restrictions you face when buying and selling company stock. And keep on top of your company's financial health by reading its SEC filings, annual reports and quarterly reports, so you have a better idea of the level of risk in carrying its stock. By diversifying your portfolio and staying informed, you'll be doing your best to protect your retirement nest egg.
http://biz.yahoo.com/ts/090310/10469833.html?.v=1
The Pros and Cons of Owning Company Stock
Tuesday March 10, 11:48 am ET
ByBob Feeman, Special to TheStreet.com
Like many employees, you might have the option of purchasing stock in your company through your 401(k).
Many employers, like health care company Gilead Sciences, sweeten the deal by offering their stock at discounted prices. Others, such as FirstEnergy and Sempra Energy, offer matching 401(k) contributions in the form of company stock.
Purchasing your company's stock can have benefits for both you and your employer, but investing too heavily can have negative consequences. That's why it's important to understand the pros and cons of investing in your company's stock -- and to find the right balance in your 401(k) assets.
The pros: One of the best reasons for investing in your company's stock is that it gives you some sense of control over your own financial future. When you feel you have a personal investment in a company, you'll work harder to ensure its success, and you'll feel a greater loyalty to it. If your efforts pay off and the stock rises, your financial stability rises with it, especially if you purchased the stock at a reduced rate.
There are benefits for employers as well. Offering stock options helps companies recruit better-qualified candidates, and motivates current employees to perform at the top of their game. Employers who offer stock options also find less turnover and better morale among their work forces, according to a 2000 report by the National Commission on Entrepreneurship.
The cons: On the flip side, owning too much company stock can have its drawbacks. Just ask the employees of Enron, WorldCom, Lehman Brothers and even General Motors. By investing heavily in company stock and depending on the same company for your salary and benefits, you're essentially staking your financial security on a single firm. Should the company hit a shaky spot, your financial future can start to tremble as well.
In addition, some companies place limitations on how much stock you can buy and sell, which limits your ability to freely manage your assets, especially if the stock should start to slide. (However, federal legislation passed in the wake of the Enron debacle mandates that companies that match employee contributions with company stock must allow employees with three or more years of service to transfer the company stock's value into other investments.) Other companies have placed a cap on how much company stock employees can hold through their 401(k)s.
Still, a December 2008 report by the Employee Benefit Research Institute found that about 8% of employees have more than 80% of their 401(k) assets tied up in company stock, and 19% of employees over 60 have more than half their assets in company stock.
Finding the balance: The key to managing risk is to diversify your portfolio. Generally, you should invest no more than 10% to 15% of your 401(k) assets in company stock. If you invest more than that, you're exposing yourself to risk.
When evaluating your asset allocation, revisit your original investment goals, specifically retirement savings goal, time horizon and risk tolerance. Then reconsider your investment options and make moves as necessary.
According to the Employee Benefit Research Institute report, new and recent hires, perhaps feeling less secure in their companies, are opting for balanced funds like lifecycle funds. These mutual funds start out weighted primarily in equities, and then shift to less-risky holdings as participants approach retirement. Depending on your goals, these funds might be a good option for you.
It's also important to understand the restrictions you face when buying and selling company stock. And keep on top of your company's financial health by reading its SEC filings, annual reports and quarterly reports, so you have a better idea of the level of risk in carrying its stock. By diversifying your portfolio and staying informed, you'll be doing your best to protect your retirement nest egg.
http://biz.yahoo.com/ts/090310/10469833.html?.v=1
You've Sold Your Stocks. Now What?
You've Sold Your Stocks. Now What?
Friday, March 13, 2009
Back in the summer of 2007, Ben Mickus, a New York architect, had a bad feeling. He and his wife, Taryn, had invested in the stock market and had done well, but now that they had reached their goal of about $200,000 for a down payment on a house, Mr. Mickus was unsettled. “Things had been very erratic, and there had been a lot of press about the market becoming more chaotic,” he said.
In October of that year they sat down for a serious talk. Ms. Mickus had once lost a lot of money in the tech bubble, and the prospect of losing their down payment made Mr. Mickus nervous. “I wanted to pull everything out then; Taryn wanted to keep it all in,” he said. They compromised, cashing in 60 percent of their stocks that fall — just before the Dow began its slide.
A couple of months later, with the market still falling, Ms. Mickus was convinced that her husband was right, and they sold the remainder of their stocks. Their down payment was almost completely preserved. Ms. Mickus said that in private they had “been feeling pretty smug about it.”
“Now our quandary is, what do we do going forward?” Ms. Mickus said.
Having $200,000 in cash is a problem many people would like to have. But there is yet another worry: it’s no use taking money out of the market at the right time unless it is put back in at the right time. So to get the most from their move, the Mickuses will have to be right twice.
“Market timing requires two smart moves,” said Bruce R. Barton, a financial planner in San Jose, Calif. “Getting out ahead of a drop. And getting back in before the recovery.”
It’s a challenge many investors face, judging from the amount of cash on the sidelines. According to Fidelity Investments, in September 2007 money market accounts made up 15 percent of stock market capitalization in the United States. By December 2008, it was 40 percent.
“In 2008 people took money out of equities and took money out of bond funds,” said Steven Kaplan, a professor at the Booth School of Business at the University of Chicago.
He cited figures showing that in 2007 investors put $93 billion into equity funds. By contrast, in 2008 they took out $230 billion.
Michael Roden, a consultant to the Department of Defense from the Leesburg, Va., area, joined the ranks of the cash rich after a sense of déjà vu washed over him in August 2007, as the markets continued their steep climb. “I had taken quite a bath when the tech bubble burst,” he said. “I would never let that happen again.”
With his 2002 drubbing in mind, he started with some profit taking in the summer of 2007, but as the market turned he kept liquidating his investments in an orderly retreat. But he was not quite fast enough.
“When Bear Stearns went under I realized something was seriously wrong,” he said. The market was still in the 12,000 range at that time. When the Federal Reserve announced it would back Bear Stearns in March 2008, there was a brief market rebound. “I used that rally to get everything else out,” he said.
Mr. Roden said he had taken a 6 percent loss by not liquidating sooner, which still put him ahead of the current total market loss. Now he has about $130,000, with about 10 percent in gold mutual funds, 25 percent in foreign cash funds and the rest in a money market account.
“I am looking for parts of the economy where business is not impaired by the credit crunch or changes in consumer behavior,” he said. He is cautiously watching the energy markets, he said, but his chief strategy is “just trying not to lose money.”
As chief financial officer of Dewberry Capital in Atlanta, a real estate firm managing two million square feet of offices, stores and apartments, Steve Cesinger witnessed the financial collapse up close. Yet it was just a gut feeling that led him to cash out not only 95 percent of his personal equities, but also those of his firm in April 2007.
“I spent a lot of time trying to figure out what was happening in the financial industry, and I came to the conclusion that people weren’t fessing up,” he said. “In fact, they were going the other way.”
Now, he said, “We have cash on our statement, and it’s hard to know what to do with it.”
Having suffered through a real estate market crash in Los Angeles in the early 1990s, Mr. Cesinger is cautious to the point of re-examining the banks where he deposits his cash. “Basically, I’m making sure it’s somewhere it won’t disappear,” he said.
The F.D.I.C. assurance doesn’t give him “a lot of warm and fuzzy,” Mr. Cesinger said. “My recollection is, if the institution goes down, it can take you a while to get your money out. It doesn’t help to know you’ll get it one day if you have to pay your mortgage today.”
His plan is to re-enter the market when it looks safe. Very safe. “I would rather miss the brief rally, be late to the party and be happy with not a 30 percent return, but a bankable 10 percent return,” he said.
Not everyone is satisfied just to stem losses. John Branch, a business consultant in Los Angeles, said his accounts were up 100 percent from short-selling — essentially betting against recovery. “The real killer was, I missed the last leg down on this thing,” Mr. Branch said. “If I hadn’t missed it, I would be up 240 percent.”
Mr. Branch said he had seen signs of a bubble in the summer of 2007 and liquidated his stocks, leaving him with cash well into six figures. Then he waited for his chance to begin shorting. The Dow was overvalued, he said, and ripe for a fall.
Shorting is a risky strategy, which Mr. Branch readily admits. He said he had tried to limit risk by trading rather than investing. He rises at 4:30 a.m., puts his money in the market and sets up his electronic trading so a stock will automatically sell if it falls by one-half of 1 percent. “If it turns against me, I am out quickly,” he said. By 8, he is off to his regular job.
Because Mr. Branch switches his trades daily based on which stocks are changing the fastest, he cannot say in advance where he will put his money.
And if he did know, he’d rather not tell. “I hate giving people financial advice,” he said. “If they make money they might say thank you; if they miss the next run-up, they hate you.”
http://finance.yahoo.com/focus-retirement/article/106735/You've-Sold-Your-Stocks-Now-What;_ylt=AoiI.2en_9S5neo.3TcUqbiVBa1_?mod=fidelity-buildingwealth
Friday, March 13, 2009
Back in the summer of 2007, Ben Mickus, a New York architect, had a bad feeling. He and his wife, Taryn, had invested in the stock market and had done well, but now that they had reached their goal of about $200,000 for a down payment on a house, Mr. Mickus was unsettled. “Things had been very erratic, and there had been a lot of press about the market becoming more chaotic,” he said.
In October of that year they sat down for a serious talk. Ms. Mickus had once lost a lot of money in the tech bubble, and the prospect of losing their down payment made Mr. Mickus nervous. “I wanted to pull everything out then; Taryn wanted to keep it all in,” he said. They compromised, cashing in 60 percent of their stocks that fall — just before the Dow began its slide.
A couple of months later, with the market still falling, Ms. Mickus was convinced that her husband was right, and they sold the remainder of their stocks. Their down payment was almost completely preserved. Ms. Mickus said that in private they had “been feeling pretty smug about it.”
“Now our quandary is, what do we do going forward?” Ms. Mickus said.
Having $200,000 in cash is a problem many people would like to have. But there is yet another worry: it’s no use taking money out of the market at the right time unless it is put back in at the right time. So to get the most from their move, the Mickuses will have to be right twice.
“Market timing requires two smart moves,” said Bruce R. Barton, a financial planner in San Jose, Calif. “Getting out ahead of a drop. And getting back in before the recovery.”
It’s a challenge many investors face, judging from the amount of cash on the sidelines. According to Fidelity Investments, in September 2007 money market accounts made up 15 percent of stock market capitalization in the United States. By December 2008, it was 40 percent.
“In 2008 people took money out of equities and took money out of bond funds,” said Steven Kaplan, a professor at the Booth School of Business at the University of Chicago.
He cited figures showing that in 2007 investors put $93 billion into equity funds. By contrast, in 2008 they took out $230 billion.
Michael Roden, a consultant to the Department of Defense from the Leesburg, Va., area, joined the ranks of the cash rich after a sense of déjà vu washed over him in August 2007, as the markets continued their steep climb. “I had taken quite a bath when the tech bubble burst,” he said. “I would never let that happen again.”
With his 2002 drubbing in mind, he started with some profit taking in the summer of 2007, but as the market turned he kept liquidating his investments in an orderly retreat. But he was not quite fast enough.
“When Bear Stearns went under I realized something was seriously wrong,” he said. The market was still in the 12,000 range at that time. When the Federal Reserve announced it would back Bear Stearns in March 2008, there was a brief market rebound. “I used that rally to get everything else out,” he said.
Mr. Roden said he had taken a 6 percent loss by not liquidating sooner, which still put him ahead of the current total market loss. Now he has about $130,000, with about 10 percent in gold mutual funds, 25 percent in foreign cash funds and the rest in a money market account.
“I am looking for parts of the economy where business is not impaired by the credit crunch or changes in consumer behavior,” he said. He is cautiously watching the energy markets, he said, but his chief strategy is “just trying not to lose money.”
As chief financial officer of Dewberry Capital in Atlanta, a real estate firm managing two million square feet of offices, stores and apartments, Steve Cesinger witnessed the financial collapse up close. Yet it was just a gut feeling that led him to cash out not only 95 percent of his personal equities, but also those of his firm in April 2007.
“I spent a lot of time trying to figure out what was happening in the financial industry, and I came to the conclusion that people weren’t fessing up,” he said. “In fact, they were going the other way.”
Now, he said, “We have cash on our statement, and it’s hard to know what to do with it.”
Having suffered through a real estate market crash in Los Angeles in the early 1990s, Mr. Cesinger is cautious to the point of re-examining the banks where he deposits his cash. “Basically, I’m making sure it’s somewhere it won’t disappear,” he said.
The F.D.I.C. assurance doesn’t give him “a lot of warm and fuzzy,” Mr. Cesinger said. “My recollection is, if the institution goes down, it can take you a while to get your money out. It doesn’t help to know you’ll get it one day if you have to pay your mortgage today.”
His plan is to re-enter the market when it looks safe. Very safe. “I would rather miss the brief rally, be late to the party and be happy with not a 30 percent return, but a bankable 10 percent return,” he said.
Not everyone is satisfied just to stem losses. John Branch, a business consultant in Los Angeles, said his accounts were up 100 percent from short-selling — essentially betting against recovery. “The real killer was, I missed the last leg down on this thing,” Mr. Branch said. “If I hadn’t missed it, I would be up 240 percent.”
Mr. Branch said he had seen signs of a bubble in the summer of 2007 and liquidated his stocks, leaving him with cash well into six figures. Then he waited for his chance to begin shorting. The Dow was overvalued, he said, and ripe for a fall.
Shorting is a risky strategy, which Mr. Branch readily admits. He said he had tried to limit risk by trading rather than investing. He rises at 4:30 a.m., puts his money in the market and sets up his electronic trading so a stock will automatically sell if it falls by one-half of 1 percent. “If it turns against me, I am out quickly,” he said. By 8, he is off to his regular job.
Because Mr. Branch switches his trades daily based on which stocks are changing the fastest, he cannot say in advance where he will put his money.
And if he did know, he’d rather not tell. “I hate giving people financial advice,” he said. “If they make money they might say thank you; if they miss the next run-up, they hate you.”
http://finance.yahoo.com/focus-retirement/article/106735/You've-Sold-Your-Stocks-Now-What;_ylt=AoiI.2en_9S5neo.3TcUqbiVBa1_?mod=fidelity-buildingwealth
When Stock Prices Drop, Where's the Money?
When Stock Prices Drop, Where's the Money?
by Investopedia Staff
Monday, March 16, 2009
Have you ever wondered what happened to your socks when you put them into the dryer and then never saw them again? It's an unexplained mystery that may never have an answer. Many people feel the same way when they suddenly find that their brokerage account balance has taken a nosedive. So, where did that money go? Fortunately, money that is gained or lost on a stock doesn't just disappear. Read to find out what happens to it and what causes it.
Disappearing Money
Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.
So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you. The company that issued the stock doesn't get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?
Implicit and Explicit Value
The most straightforward answer to this question is that it actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors' favorable perception of it.
But this capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Yes, money is a teaser - at once intangible, flirting with our dreams and fantasies, and concrete, the thing with which we obtain our daily bread. More precisely, this duplicity of money represents the two parts that make up a stock's market value: the implicit and explicit value.
On the one hand, money can be created or dissolved with the change in a stock's implicit value, which is determined by the personal perceptions and research of investors and analysts. For example, a pharmaceutical company with the rights to the patent for the cure for cancer may have a much higher implicit value than that of a corner store.
Depending on investors' perceptions and expectations for the stock, implicit value is based on revenues and earnings forecasts. If the implicit value undergoes a change - which, really, is generated by abstract things like faith and emotion - the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss because their asset is now worth less than its original price. Again, no one else necessarily received the money; it has been lost to investors' perceptions.
Now that we've covered the somewhat "unreal" characteristic of money, we cannot ignore how money also represents explicit value, which is the concrete worth of a company. Referred to as the accounting value (or sometimes book value), the explicit value is calculated by adding up all assets and subtracting liabilities. So, this represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all of liabilities.
But you see, without explicit value, implicit value would not exist: investors' interpretation of how well a company will make use of its explicit value is the force behind implicit value.
Disappearing Trick Revealed
For instance, in February 2009, Cisco Systems Inc. had 5.81 billion shares outstanding, which means that if the value of the shares dropped by $1, it would be the equivalent to losing more than $5.81 billion in (implicit) value. Because CSCO has many billions of dollars in concrete assets, we know that the change occurs not in explicit value, so the idea of money disappearing into thin air ironically becomes much more tangible. In essence, what's happening is that investors, analysts and market professionals are declaring that their projections for the company have narrowed. Investors are therefore not willing to pay as much for the stock as they were before.
So, faith and expectations can translate into cold hard cash, but only because of something very real: the capacity of a company to create something, whether it is a product people can use or a service people need. The better a company is at creating something, the higher the company's earnings will be and the more faith investors will have in the company.
In a bull market, there is an overall positive perception of the market's ability to keep producing and creating. Because this perception would not exist were it not for some evidence that something is being or will be created, everyone in a bull market can be making money. Of course, the exact opposite can happen in a bear market.
To sum it all up, you can think of the stock market as a huge vehicle for wealth creation and destruction.
Disappearing Socks
No one really knows why socks go into the dryer and never come out, but next time you're wondering where that stock price came from or went to, at least you can chalk it up to market perception.
http://finance.yahoo.com/focus-retirement/article/106739/When-Stock-Prices-Drop-Where's-the-Money;_ylt=AtKDegLJbLsM_eXKgk0P2zu7YWsA?mod=fidelity-buildingwealth
More from Investopedia.com: •
In Pictures: 8 Ways to Survive a Market Downturn •
In Pictures: Biggest Stock Scams •
In Pictures: 7 Stock Blunders to Avoid
by Investopedia Staff
Monday, March 16, 2009
Have you ever wondered what happened to your socks when you put them into the dryer and then never saw them again? It's an unexplained mystery that may never have an answer. Many people feel the same way when they suddenly find that their brokerage account balance has taken a nosedive. So, where did that money go? Fortunately, money that is gained or lost on a stock doesn't just disappear. Read to find out what happens to it and what causes it.
Disappearing Money
Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.
So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you. The company that issued the stock doesn't get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?
Implicit and Explicit Value
The most straightforward answer to this question is that it actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors' favorable perception of it.
But this capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Yes, money is a teaser - at once intangible, flirting with our dreams and fantasies, and concrete, the thing with which we obtain our daily bread. More precisely, this duplicity of money represents the two parts that make up a stock's market value: the implicit and explicit value.
On the one hand, money can be created or dissolved with the change in a stock's implicit value, which is determined by the personal perceptions and research of investors and analysts. For example, a pharmaceutical company with the rights to the patent for the cure for cancer may have a much higher implicit value than that of a corner store.
Depending on investors' perceptions and expectations for the stock, implicit value is based on revenues and earnings forecasts. If the implicit value undergoes a change - which, really, is generated by abstract things like faith and emotion - the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss because their asset is now worth less than its original price. Again, no one else necessarily received the money; it has been lost to investors' perceptions.
Now that we've covered the somewhat "unreal" characteristic of money, we cannot ignore how money also represents explicit value, which is the concrete worth of a company. Referred to as the accounting value (or sometimes book value), the explicit value is calculated by adding up all assets and subtracting liabilities. So, this represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all of liabilities.
But you see, without explicit value, implicit value would not exist: investors' interpretation of how well a company will make use of its explicit value is the force behind implicit value.
Disappearing Trick Revealed
For instance, in February 2009, Cisco Systems Inc. had 5.81 billion shares outstanding, which means that if the value of the shares dropped by $1, it would be the equivalent to losing more than $5.81 billion in (implicit) value. Because CSCO has many billions of dollars in concrete assets, we know that the change occurs not in explicit value, so the idea of money disappearing into thin air ironically becomes much more tangible. In essence, what's happening is that investors, analysts and market professionals are declaring that their projections for the company have narrowed. Investors are therefore not willing to pay as much for the stock as they were before.
So, faith and expectations can translate into cold hard cash, but only because of something very real: the capacity of a company to create something, whether it is a product people can use or a service people need. The better a company is at creating something, the higher the company's earnings will be and the more faith investors will have in the company.
In a bull market, there is an overall positive perception of the market's ability to keep producing and creating. Because this perception would not exist were it not for some evidence that something is being or will be created, everyone in a bull market can be making money. Of course, the exact opposite can happen in a bear market.
To sum it all up, you can think of the stock market as a huge vehicle for wealth creation and destruction.
Disappearing Socks
No one really knows why socks go into the dryer and never come out, but next time you're wondering where that stock price came from or went to, at least you can chalk it up to market perception.
http://finance.yahoo.com/focus-retirement/article/106739/When-Stock-Prices-Drop-Where's-the-Money;_ylt=AtKDegLJbLsM_eXKgk0P2zu7YWsA?mod=fidelity-buildingwealth
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Saturday 14 March 2009
Preventing the Next Crisis
Preventing the Next Crisis
by Jack M. Guttentag
Posted on Wednesday, March 11, 2009, 12:00AM
While policymakers and their kibitzers, among which I count myself, debate what is needed to cure the current crisis and associated recession, another debate brews in the background: how to fix the system so that it doesn't happen again.
Any coherent proposal for fixing the system is necessarily based on judgments about the causes of the current crisis. While there are many differences in emphasis, I believe that most observers would agree on the essentials: the crisis originated with a bubble in the residential real estate market, followed by its inevitable aftermath of declining home prices, and a subsequent explosion of home mortgage defaults and foreclosures.
The resulting losses were worldwide because foreign investors held enormous amounts of U.S. mortgage-related assets. Global financial institutions did not have the capital to absorb these losses, resulting in the collapse of many, and enormous infusions of capital by governments, plus loans and guarantees, to prevent the collapse of many more.
Shoring Up the Financial Systems
This sequence of events could be prevented by blocking the bubble, or by shoring up the capacity of the financial system to absorb the losses resulting from a bubble's collapse. In my opinion, the second should have priority. We don't know where the next bubble will come from, but if the system has enough capital, a crisis can be averted regardless of its source.
Private financial institutions will never voluntarily carry enough capital to cover the losses that would occur under a disaster scenario. For one thing, such disasters occur very infrequently, and as the period since the last occurrence gets longer, the natural tendency is to disregard it -- to treat it as having a zero probability. In a study of international banking crises, Richard Herring and I called this "disaster myopia."
Disaster myopia is reinforced by "herding." Any one firm that elects to play it safe will be less profitable than its peers, making its shareholders unhappy and even opening itself to a possible takeover.
Playing It Safe Not the Best Option
Furthermore, even if those controlling financial firms knew the probability of a severe shock, and the very large losses that would result from it, it is not in their interest to hold the capital needed to meet those losses. Because they don't know when the shock will occur, playing it safe would mean reduced earnings for the firm and reduced personal income for them for what could be a very long period. Better to realize the higher income for as long as possible, because if they stay within the law, it won't be taken away from them when the firm becomes insolvent.
Indeed, insolvency may not mean the demise of the firm if many firms are affected at the same time. The government can't allow them all to fail without allowing the crisis to become a catastrophe. This is clearly borne out by the government's actions in the current crisis. Government bailouts further validate the premise that it is foolhardy for a financial firm to hold the capital needed to meet the losses associated with a very severe shock.
This appears to lead logically to the conclusion that the government ought to impose capital requirements on financial firms. Capital requirements stipulate the amount of capital firms must have, based largely on the amounts and types of assets and liabilities they have.
Capital Requirements: An Inherent Flaw
Unfortunately, capital requirements won't prevent financial crises. An inherent flaw in capital requirements is that required capital varies by broad asset categories, which allows the regulated firms to replace less risky assets with more risky assets within any given asset class. The shift to subprime mortgages during the last bubble, for example, did not increase their required capital.
In principle, regulators can offset this by making discretionary adjustments in the requirements in response to changing economic conditions. For this to work, however, regulators must have better foresight than those they regulate, which they don't. Neither should we expect regulators to have the political courage to "remove the punchbowl from the party."
An increase in capital requirements large enough to burst a bubble would be extremely disruptive, forcing many firms to sell stock at the same time, and/or to substantially reduce their lending. Concerns about such disruptions reinforce disaster myopia and political timidity among regulators.
The proof is in the pudding. Banks and other depositories have been subject to capital requirements since the 1980s, but no adjustments in the requirements were made in response to the recent housing bubble.
http://finance.yahoo.com/expert/article/mortgage/147279
by Jack M. Guttentag
Posted on Wednesday, March 11, 2009, 12:00AM
While policymakers and their kibitzers, among which I count myself, debate what is needed to cure the current crisis and associated recession, another debate brews in the background: how to fix the system so that it doesn't happen again.
Any coherent proposal for fixing the system is necessarily based on judgments about the causes of the current crisis. While there are many differences in emphasis, I believe that most observers would agree on the essentials: the crisis originated with a bubble in the residential real estate market, followed by its inevitable aftermath of declining home prices, and a subsequent explosion of home mortgage defaults and foreclosures.
The resulting losses were worldwide because foreign investors held enormous amounts of U.S. mortgage-related assets. Global financial institutions did not have the capital to absorb these losses, resulting in the collapse of many, and enormous infusions of capital by governments, plus loans and guarantees, to prevent the collapse of many more.
Shoring Up the Financial Systems
This sequence of events could be prevented by blocking the bubble, or by shoring up the capacity of the financial system to absorb the losses resulting from a bubble's collapse. In my opinion, the second should have priority. We don't know where the next bubble will come from, but if the system has enough capital, a crisis can be averted regardless of its source.
Private financial institutions will never voluntarily carry enough capital to cover the losses that would occur under a disaster scenario. For one thing, such disasters occur very infrequently, and as the period since the last occurrence gets longer, the natural tendency is to disregard it -- to treat it as having a zero probability. In a study of international banking crises, Richard Herring and I called this "disaster myopia."
Disaster myopia is reinforced by "herding." Any one firm that elects to play it safe will be less profitable than its peers, making its shareholders unhappy and even opening itself to a possible takeover.
Playing It Safe Not the Best Option
Furthermore, even if those controlling financial firms knew the probability of a severe shock, and the very large losses that would result from it, it is not in their interest to hold the capital needed to meet those losses. Because they don't know when the shock will occur, playing it safe would mean reduced earnings for the firm and reduced personal income for them for what could be a very long period. Better to realize the higher income for as long as possible, because if they stay within the law, it won't be taken away from them when the firm becomes insolvent.
Indeed, insolvency may not mean the demise of the firm if many firms are affected at the same time. The government can't allow them all to fail without allowing the crisis to become a catastrophe. This is clearly borne out by the government's actions in the current crisis. Government bailouts further validate the premise that it is foolhardy for a financial firm to hold the capital needed to meet the losses associated with a very severe shock.
This appears to lead logically to the conclusion that the government ought to impose capital requirements on financial firms. Capital requirements stipulate the amount of capital firms must have, based largely on the amounts and types of assets and liabilities they have.
Capital Requirements: An Inherent Flaw
Unfortunately, capital requirements won't prevent financial crises. An inherent flaw in capital requirements is that required capital varies by broad asset categories, which allows the regulated firms to replace less risky assets with more risky assets within any given asset class. The shift to subprime mortgages during the last bubble, for example, did not increase their required capital.
In principle, regulators can offset this by making discretionary adjustments in the requirements in response to changing economic conditions. For this to work, however, regulators must have better foresight than those they regulate, which they don't. Neither should we expect regulators to have the political courage to "remove the punchbowl from the party."
An increase in capital requirements large enough to burst a bubble would be extremely disruptive, forcing many firms to sell stock at the same time, and/or to substantially reduce their lending. Concerns about such disruptions reinforce disaster myopia and political timidity among regulators.
The proof is in the pudding. Banks and other depositories have been subject to capital requirements since the 1980s, but no adjustments in the requirements were made in response to the recent housing bubble.
http://finance.yahoo.com/expert/article/mortgage/147279
U.S. Household Wealth Falls by Trillions
Household Wealth Falls by Trillions
By VIKAS BAJAJ
Published: March 12, 2009
In the last few months, most Americans have felt poorer. Now they have the numbers to prove it.
The Federal Reserve reported Thursday that households lost $5.1 trillion, or 9 percent, of their wealth in the last three months of 2008, the most ever in a single quarter in the 57-year history of recordkeeping by the central bank.
For the full year, household wealth dropped $11.1 trillion, or about 18 percent. Though the numbers do not yet reflect it, the decline in the stock market so far this year has probably erased trillions more in the country’s collective net worth.
The next biggest annual decline in wealth came in 2002, when household net worth fell 3 percent after the collapse of the technology bubble. The most recent loss of wealth is staggering and will probably put further pressure on the economy because many people will have to spend less and save more.
Most of the wealth was lost in financial assets like stocks, which tumbled at the end of last year. The Standard & Poor’s 500-stock index, for instance, fell 23 percent in the fourth quarter. The value of residential real estate, the biggest asset for most families, fell much less — $870 billion, or about 4 percent.
Even the richest among us have become a lot poorer. This week, Forbes magazine published its list of the richest people in the world. At No. 1, Bill Gates, the founder of Microsoft, still had $40 billion to his name, but that was down $18 billion. The wealth of Warren E. Buffett, the investor whose company Berkshire Hathaway had a rare bad year, tumbled $25 billion, to $37 billion.
The loss of wealth is concentrated among the most affluent Americans, in large part because they own more stocks and bonds than the rest of the country. Only about 50 percent of households own stock, and many of them own relatively small sums in retirement accounts.
As a result of their greater wealth and higher incomes, the affluent tend to spend a lot more than their share of the population would imply. The top 20 percent of income earners spend more than the bottom 60 percent of income earners, according to calculations by Tobias Levkovich, the chief United States equity strategist at Citigroup.
“When their wealth is mauled, they are not particularly interested in spending,” Mr. Levkovich said.
The Fed report released on Thursday also showed that total borrowing and lending increased at an annual rate of 6.3 percent in the fourth quarter, mostly as a result of increased borrowing by the federal government to finance its operations and various bailouts of the financial system. The government’s borrowing increased at an annual rate of 37 percent.
But borrowing by households dropped 2 percent. Lending to businesses was up 1.7 percent. Recent surveys of loan officers by the Fed have shown that companies have been drawing down lines of credit that were established in the past, and that only a small fraction of the lending to the private sector is through new loans, which are much harder to obtain than in recent years.
http://www.nytimes.com/2009/03/13/business/economy/13wealth.html?partner=yahoo
By VIKAS BAJAJ
Published: March 12, 2009
In the last few months, most Americans have felt poorer. Now they have the numbers to prove it.
The Federal Reserve reported Thursday that households lost $5.1 trillion, or 9 percent, of their wealth in the last three months of 2008, the most ever in a single quarter in the 57-year history of recordkeeping by the central bank.
For the full year, household wealth dropped $11.1 trillion, or about 18 percent. Though the numbers do not yet reflect it, the decline in the stock market so far this year has probably erased trillions more in the country’s collective net worth.
The next biggest annual decline in wealth came in 2002, when household net worth fell 3 percent after the collapse of the technology bubble. The most recent loss of wealth is staggering and will probably put further pressure on the economy because many people will have to spend less and save more.
Most of the wealth was lost in financial assets like stocks, which tumbled at the end of last year. The Standard & Poor’s 500-stock index, for instance, fell 23 percent in the fourth quarter. The value of residential real estate, the biggest asset for most families, fell much less — $870 billion, or about 4 percent.
Even the richest among us have become a lot poorer. This week, Forbes magazine published its list of the richest people in the world. At No. 1, Bill Gates, the founder of Microsoft, still had $40 billion to his name, but that was down $18 billion. The wealth of Warren E. Buffett, the investor whose company Berkshire Hathaway had a rare bad year, tumbled $25 billion, to $37 billion.
The loss of wealth is concentrated among the most affluent Americans, in large part because they own more stocks and bonds than the rest of the country. Only about 50 percent of households own stock, and many of them own relatively small sums in retirement accounts.
As a result of their greater wealth and higher incomes, the affluent tend to spend a lot more than their share of the population would imply. The top 20 percent of income earners spend more than the bottom 60 percent of income earners, according to calculations by Tobias Levkovich, the chief United States equity strategist at Citigroup.
“When their wealth is mauled, they are not particularly interested in spending,” Mr. Levkovich said.
The Fed report released on Thursday also showed that total borrowing and lending increased at an annual rate of 6.3 percent in the fourth quarter, mostly as a result of increased borrowing by the federal government to finance its operations and various bailouts of the financial system. The government’s borrowing increased at an annual rate of 37 percent.
But borrowing by households dropped 2 percent. Lending to businesses was up 1.7 percent. Recent surveys of loan officers by the Fed have shown that companies have been drawing down lines of credit that were established in the past, and that only a small fraction of the lending to the private sector is through new loans, which are much harder to obtain than in recent years.
http://www.nytimes.com/2009/03/13/business/economy/13wealth.html?partner=yahoo
Bankers Say Mark to Market Rules Are the Problem
Bankers Say Rules Are the Problem
by Floyd Norris
Friday, March 13, 2009
If mark-to-market accounting is to blame for the current financial crisis, then the National Weather Service is to blame for Hurricane Katrina; if it hadn't told us the hurricane hit New Orleans, the city would never have flooded.
This is the logic the bankers are using, and they are getting sympathetic ears in Congress. The bankers have gotten two members of Congress to introduce a bill to establish a new body that could suspend accounting rules for financial institutions.
Edward L. Yingling, the president of the American Bankers Association, says the proposal addresses "systemic risks that accounting standards can have on the economy."
Steve Forbes, the publisher and erstwhile presidential candidate, goes even further. "Mark-to-market accounting is the principal reason why our financial system is in a meltdown," he wrote in a Wall Street Journal op-ed piece.
They say the problem, in short, is not that the banks acted irresponsibly in creating financial instruments that blew up, or in making loans that could never be repaid. It is that someone is forcing them to fess up. If only the banks could pretend the assets were valuable, then the system would be safe.
On Thursday, members of a House subcommittee joined in demanding that the rules be suspended. It was a bipartisan lynching of the accounting rule writers.
The panel's chairman, Representative Paul E. Kanjorski, Democrat of Pennsylvania, said the accounting rule "does provide transparency for investors," but that "strict application" of the rule had "exacerbated the ongoing economic crisis."
Then he issued the threat. "If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself."
Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets -- and that is, at best, debatable -- changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?
It is true, as the bankers argue, that valuing illiquid instruments is tricky. And it is true that markets can overshoot. Some of these securities may well be undervalued now. But the solution is not to go to what Robert H. Herz, the chairman of the Financial Accounting Standards Board, calls "mark-to-management" accounting.
I call it "Alice in Wonderland" accounting, after Humpty Dumpty's claim in that book that "When I use a word, it means just what I choose it to mean, neither more nor less." After Alice protests, he replies, "The question is, which is to be master -- that's all."
Although you would not know it from the angry complaints, the accounting board's Statement 157 did not require mark-to-market accounting. That was already required under earlier rules. What it did do was clarify how such values should be determined. That stopped banks from defining "market value" as meaning whatever they chose it to mean.
Conrad Hewitt, who was chief accountant at the Securities and Exchange Commission when it conducted a Congressionally mandated review of the issue late last year, said at a recent Pace University accounting forum that he asked all the complainers if they had a better way to determine market value than the one prescribed by Statement 157. None did.
That statement set out procedures for dealing with illiquid markets and distress sales, and the board is now at work on setting out more guidelines on how to do that. You can bet that its efforts will not satisfy the banks.
But there are three steps that could improve the situation.
First, the regulators could make it clear they are committed to what is now called countercyclical regulating. They could ease capital rules when things are bad, and require more capital as the economy improves. As Ben S. Bernanke, the Federal Reserve chairman, said this week, regulations should allow capital "to serve its intended role as a buffer -- one built up during good times and drawn down during bad times in a manner consistent with safety and soundness."
In other words, accept that market values are low and report the facts to investors. But give the banks a break by not acting as if that will last forever.
Of course, many will doubt that the regulators will really get tough when things improve. They stood by mutely while the banks went on the binge that created this crisis. But we can hope.
The second step would be to force banks to disclose -- to the public and to the other banks that trade with them -- just which toxic assets they own.
The bankers assert that those assets are now trading for less than they will be worth at maturity. In fact that is unknowable, which is one reason we have markets. If the current deep recession turns into Great Depression II, then even today's market values may prove to be too high.
But if we knew which securities each bank owned, and where it was valuing them, we could go over each security and reach our own conclusions as to values. We could also see which banks seemed to be more or less optimistic in their estimates of market value.
When I suggested that to a top official of one big bank, he dismissed the idea, saying it would damage his bank's trading position to advertise what it had. Of course, he also complained that there was virtually no trading going on, so I'm not sure what the damage would be. But if the banks want to disclose the information with a three-month delay, so that there is no way to know if they still own the securities, that would be fine with me.
The final step would be to get the market for such securities functioning. Right now, it is largely blocked by the Obama administration's slow efforts to design a program to stimulate such sales by offering generous financing and partial guarantees to buyers. No one wants to buy now if a much better deal might be available next week. The Treasury Department needs to get the details out, and then see who is willing to buy, and at what price.
Of course, any such government-subsidized market would need to make widely available what was on offer, to assure that the price received was the best one possible. It's not a market price if market participants cannot bid.
It is possible that there will be few trades even then. Edward J. Kane, a finance professor at Boston College, suggests that banks, particularly those that know they need a miracle to regain solvency, will be unwilling to sell. "Cheap volatile assets with a huge upside are precisely the kinds of optionlike investments that clever zombie managers are energetically looking for," he said. If they soar, the banks' stock may be worth something. If not, the taxpayers will take the loss.
Next time you hear a banker denounce mark-to-market rules, ask if he runs his business that way. Will he offer you a mortgage loan based on what you think your home should be worth, which you can repay only if you make a lot more money than anyone will pay you? If so, then perhaps the bank should be able to use "Alice in Wonderland" accounting on its own books.
Or maybe that is not such a good idea. The banks already tried that, with liars' loans. Those loans did not work out so well.
Floyd Norris's blog on finance and economics is at nytimes.com/norris.
http://finance.yahoo.com/banking-budgeting/article/106746/Bankers-Say-Rules-Are-the-Problem;_ylt=Aqc620M0nd9ZfdYWQBwa529O7sMF
by Floyd Norris
Friday, March 13, 2009
If mark-to-market accounting is to blame for the current financial crisis, then the National Weather Service is to blame for Hurricane Katrina; if it hadn't told us the hurricane hit New Orleans, the city would never have flooded.
This is the logic the bankers are using, and they are getting sympathetic ears in Congress. The bankers have gotten two members of Congress to introduce a bill to establish a new body that could suspend accounting rules for financial institutions.
Edward L. Yingling, the president of the American Bankers Association, says the proposal addresses "systemic risks that accounting standards can have on the economy."
Steve Forbes, the publisher and erstwhile presidential candidate, goes even further. "Mark-to-market accounting is the principal reason why our financial system is in a meltdown," he wrote in a Wall Street Journal op-ed piece.
They say the problem, in short, is not that the banks acted irresponsibly in creating financial instruments that blew up, or in making loans that could never be repaid. It is that someone is forcing them to fess up. If only the banks could pretend the assets were valuable, then the system would be safe.
On Thursday, members of a House subcommittee joined in demanding that the rules be suspended. It was a bipartisan lynching of the accounting rule writers.
The panel's chairman, Representative Paul E. Kanjorski, Democrat of Pennsylvania, said the accounting rule "does provide transparency for investors," but that "strict application" of the rule had "exacerbated the ongoing economic crisis."
Then he issued the threat. "If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself."
Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets -- and that is, at best, debatable -- changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?
It is true, as the bankers argue, that valuing illiquid instruments is tricky. And it is true that markets can overshoot. Some of these securities may well be undervalued now. But the solution is not to go to what Robert H. Herz, the chairman of the Financial Accounting Standards Board, calls "mark-to-management" accounting.
I call it "Alice in Wonderland" accounting, after Humpty Dumpty's claim in that book that "When I use a word, it means just what I choose it to mean, neither more nor less." After Alice protests, he replies, "The question is, which is to be master -- that's all."
Although you would not know it from the angry complaints, the accounting board's Statement 157 did not require mark-to-market accounting. That was already required under earlier rules. What it did do was clarify how such values should be determined. That stopped banks from defining "market value" as meaning whatever they chose it to mean.
Conrad Hewitt, who was chief accountant at the Securities and Exchange Commission when it conducted a Congressionally mandated review of the issue late last year, said at a recent Pace University accounting forum that he asked all the complainers if they had a better way to determine market value than the one prescribed by Statement 157. None did.
That statement set out procedures for dealing with illiquid markets and distress sales, and the board is now at work on setting out more guidelines on how to do that. You can bet that its efforts will not satisfy the banks.
But there are three steps that could improve the situation.
First, the regulators could make it clear they are committed to what is now called countercyclical regulating. They could ease capital rules when things are bad, and require more capital as the economy improves. As Ben S. Bernanke, the Federal Reserve chairman, said this week, regulations should allow capital "to serve its intended role as a buffer -- one built up during good times and drawn down during bad times in a manner consistent with safety and soundness."
In other words, accept that market values are low and report the facts to investors. But give the banks a break by not acting as if that will last forever.
Of course, many will doubt that the regulators will really get tough when things improve. They stood by mutely while the banks went on the binge that created this crisis. But we can hope.
The second step would be to force banks to disclose -- to the public and to the other banks that trade with them -- just which toxic assets they own.
The bankers assert that those assets are now trading for less than they will be worth at maturity. In fact that is unknowable, which is one reason we have markets. If the current deep recession turns into Great Depression II, then even today's market values may prove to be too high.
But if we knew which securities each bank owned, and where it was valuing them, we could go over each security and reach our own conclusions as to values. We could also see which banks seemed to be more or less optimistic in their estimates of market value.
When I suggested that to a top official of one big bank, he dismissed the idea, saying it would damage his bank's trading position to advertise what it had. Of course, he also complained that there was virtually no trading going on, so I'm not sure what the damage would be. But if the banks want to disclose the information with a three-month delay, so that there is no way to know if they still own the securities, that would be fine with me.
The final step would be to get the market for such securities functioning. Right now, it is largely blocked by the Obama administration's slow efforts to design a program to stimulate such sales by offering generous financing and partial guarantees to buyers. No one wants to buy now if a much better deal might be available next week. The Treasury Department needs to get the details out, and then see who is willing to buy, and at what price.
Of course, any such government-subsidized market would need to make widely available what was on offer, to assure that the price received was the best one possible. It's not a market price if market participants cannot bid.
It is possible that there will be few trades even then. Edward J. Kane, a finance professor at Boston College, suggests that banks, particularly those that know they need a miracle to regain solvency, will be unwilling to sell. "Cheap volatile assets with a huge upside are precisely the kinds of optionlike investments that clever zombie managers are energetically looking for," he said. If they soar, the banks' stock may be worth something. If not, the taxpayers will take the loss.
Next time you hear a banker denounce mark-to-market rules, ask if he runs his business that way. Will he offer you a mortgage loan based on what you think your home should be worth, which you can repay only if you make a lot more money than anyone will pay you? If so, then perhaps the bank should be able to use "Alice in Wonderland" accounting on its own books.
Or maybe that is not such a good idea. The banks already tried that, with liars' loans. Those loans did not work out so well.
Floyd Norris's blog on finance and economics is at nytimes.com/norris.
http://finance.yahoo.com/banking-budgeting/article/106746/Bankers-Say-Rules-Are-the-Problem;_ylt=Aqc620M0nd9ZfdYWQBwa529O7sMF
Do Bear-Market Veterans Manage Better in a Downturn?
Do Bear-Market Veterans Manage Better in a Downturn?
Bridget B. Hughes, CFA
Thursday March 12, 2009, 7:00 am EDT
As the markets continue to crumble, many mutual fund managers are scratching their heads. They say the markets aren't recognizing some companies' good fundamentals, including resilient earnings figures, strong balance sheets, and stable cash flows; and, they say, it's simply fear that has gripped all corners of the market. In coming to grips with their own funds' performance, many note that the current stock market environment is unprecedented in our professional lifetimes (unless, of course, you are 100 years old and worked during the crash of 1929).
Technically, those managers are right in at least one regard: The S&P 500 Index has fallen nearly 55% since Oct. 9, 2007--an outcome worse than that of any other bear market since 1929 (when the Dow Jones Industrial Average plummeted more than 80% in less than three years). But there have been some periods with results similarly gnarly to the most recent drop, including the bear market that began in January 1973, which ultimately saw the S&P 500 fall nearly 50%. Granted, there were some other differences back then, including higher inflation and a drawn-out decline. (It's been faster this time around.)
Still, we wondered if funds led by portfolio managers that ran money in the 1970s have been better off in the latest downturn. There aren't many managers that have run the same mutual fund for that long (though more have been investing that long) and some that have are part of a team of managers on those funds. Below is a table showing which stock funds have the longest-tenured managers and some details on some of the best-known offerings.
Franklin Growth (NASDAQ:FKGRX - News)
Jerry Palmieri started on this fund in the mid-1960s. During the bear market that began in 1973, the fund lost nearly 48%--about in line with the rest of the market. But since then the fund has generally held up much better than the market in tough times. In 1987's quick drop, Palmieri kept the fund's losses to less than 20% between late August and early December. (The market dropped 33% during that period.) In 1987, Morningstar named Palmieri its first Manager of the Year, as he led the fund to a near-20% gain. One of Palmieri's tricks over the years has been to build cash, with varying degrees of success, but somewhat surprisingly, that's not what's helped the fund since late 2007. Rather, Palmieri's approach has kept him largely out of financial stocks and energy names--two areas that have been particularly hard-hit lately.
Nicholas (NASDAQ:NICSX - News)
Manager Ab Nicholas, who started his investment firm in 1967 with Dick Strong, has been running this fund since its inception two years later. During the 1970s bear market, this fund was burned badly, losing more than 70% of its value. Given that monstrous setback, it's no surprise that the fund has since been characterized by its defensive attributes. (Plus, Strong, whose investment philosophy was more growth-oriented, left Nicholas in 1972 and started his own firm in 1974.) While Nicholas Fund has proved to be a steady-Eddie--with less volatility, a lack of technology stocks, and an emphasis on valuations--it hasn't generated compelling returns over the long haul.
American Funds American Mutual (NASDAQ:AMRMX - News)
James Dunton has been part of this portfolio's management since 1971. Because each of the American Funds is run as a collection of independently run subportfolios, it's tougher to gauge the impact of just one of its managers on the overall portfolio. But all of the American Funds are characterized by a moderate strategy, with a contrarian streak, a sensitivity to valuations, and a customary stash of cash. In the 1970s bear market, the fund kept its loss to less than 33%, and the fund has continued to be a stable offering with good bear-market performance. With a limited stake in high-flying technology and telecom stocks, for example, it admirably lost less than 8% between early 2000 and late 2002. More recently, its regular bond stake and very limited investments in financials have worked to its advantage. Meanwhile, it has been a strong long-term performer.
Royce Pennsylvania Mutual (NASDAQ:PENNX - News)
This small-cap fund lost nearly 73% of its value in the 1973-74 bear market, though to be fair, manager Chuck Royce took over the fund two months after the decline began. It's thus no surprise that Royce has since regularly touted the benefits of a diverse portfolio and emphasis on valuations; these days, capital preservation and finding a way to buy lower-risk small caps are definite priorities.
Dodge & Cox Stock (NASDAQ:DODGX - News)
John Gunn's tenure on Dodge & Cox Stock begins after the 1973-74 bear market ended--he started on the fund in 1977--but Gunn was hired in 1972, so he experienced the drubbing while at the firm. Also, as the firm's chairman and chief executive officer, Gunn is part of a collaborative group of investment professionals, so it's tough to say how large an impact he has on the portfolio. As at the American Funds, though, Dodge & Cox's patient, against-the-grain investment approach had tended to keep its performance moderate, and it performed exceptionally well during the early 2000s bear market, when it lost less than 3%. In this latest downturn, however, several ugly financial stocks changed the story here.
Bridget B. Hughes, CFA does not own shares in any of the securities mentioned above.
Morningstar Premium Members get access to over 3,900 Stock and Fund Analyst Reports, Analyst Picks, and award-winning portfolio tools. Learn More.
http://finance.yahoo.com/news/Do-BearMarket-Veterans-Manage-ms-14614245.html?.&.pf=retirement
Comment:
Bridget B. Hughes, CFA
Thursday March 12, 2009, 7:00 am EDT
As the markets continue to crumble, many mutual fund managers are scratching their heads. They say the markets aren't recognizing some companies' good fundamentals, including resilient earnings figures, strong balance sheets, and stable cash flows; and, they say, it's simply fear that has gripped all corners of the market. In coming to grips with their own funds' performance, many note that the current stock market environment is unprecedented in our professional lifetimes (unless, of course, you are 100 years old and worked during the crash of 1929).
Technically, those managers are right in at least one regard: The S&P 500 Index has fallen nearly 55% since Oct. 9, 2007--an outcome worse than that of any other bear market since 1929 (when the Dow Jones Industrial Average plummeted more than 80% in less than three years). But there have been some periods with results similarly gnarly to the most recent drop, including the bear market that began in January 1973, which ultimately saw the S&P 500 fall nearly 50%. Granted, there were some other differences back then, including higher inflation and a drawn-out decline. (It's been faster this time around.)
Still, we wondered if funds led by portfolio managers that ran money in the 1970s have been better off in the latest downturn. There aren't many managers that have run the same mutual fund for that long (though more have been investing that long) and some that have are part of a team of managers on those funds. Below is a table showing which stock funds have the longest-tenured managers and some details on some of the best-known offerings.
Franklin Growth (NASDAQ:FKGRX - News)
Jerry Palmieri started on this fund in the mid-1960s. During the bear market that began in 1973, the fund lost nearly 48%--about in line with the rest of the market. But since then the fund has generally held up much better than the market in tough times. In 1987's quick drop, Palmieri kept the fund's losses to less than 20% between late August and early December. (The market dropped 33% during that period.) In 1987, Morningstar named Palmieri its first Manager of the Year, as he led the fund to a near-20% gain. One of Palmieri's tricks over the years has been to build cash, with varying degrees of success, but somewhat surprisingly, that's not what's helped the fund since late 2007. Rather, Palmieri's approach has kept him largely out of financial stocks and energy names--two areas that have been particularly hard-hit lately.
Nicholas (NASDAQ:NICSX - News)
Manager Ab Nicholas, who started his investment firm in 1967 with Dick Strong, has been running this fund since its inception two years later. During the 1970s bear market, this fund was burned badly, losing more than 70% of its value. Given that monstrous setback, it's no surprise that the fund has since been characterized by its defensive attributes. (Plus, Strong, whose investment philosophy was more growth-oriented, left Nicholas in 1972 and started his own firm in 1974.) While Nicholas Fund has proved to be a steady-Eddie--with less volatility, a lack of technology stocks, and an emphasis on valuations--it hasn't generated compelling returns over the long haul.
American Funds American Mutual (NASDAQ:AMRMX - News)
James Dunton has been part of this portfolio's management since 1971. Because each of the American Funds is run as a collection of independently run subportfolios, it's tougher to gauge the impact of just one of its managers on the overall portfolio. But all of the American Funds are characterized by a moderate strategy, with a contrarian streak, a sensitivity to valuations, and a customary stash of cash. In the 1970s bear market, the fund kept its loss to less than 33%, and the fund has continued to be a stable offering with good bear-market performance. With a limited stake in high-flying technology and telecom stocks, for example, it admirably lost less than 8% between early 2000 and late 2002. More recently, its regular bond stake and very limited investments in financials have worked to its advantage. Meanwhile, it has been a strong long-term performer.
Royce Pennsylvania Mutual (NASDAQ:PENNX - News)
This small-cap fund lost nearly 73% of its value in the 1973-74 bear market, though to be fair, manager Chuck Royce took over the fund two months after the decline began. It's thus no surprise that Royce has since regularly touted the benefits of a diverse portfolio and emphasis on valuations; these days, capital preservation and finding a way to buy lower-risk small caps are definite priorities.
Dodge & Cox Stock (NASDAQ:DODGX - News)
John Gunn's tenure on Dodge & Cox Stock begins after the 1973-74 bear market ended--he started on the fund in 1977--but Gunn was hired in 1972, so he experienced the drubbing while at the firm. Also, as the firm's chairman and chief executive officer, Gunn is part of a collaborative group of investment professionals, so it's tough to say how large an impact he has on the portfolio. As at the American Funds, though, Dodge & Cox's patient, against-the-grain investment approach had tended to keep its performance moderate, and it performed exceptionally well during the early 2000s bear market, when it lost less than 3%. In this latest downturn, however, several ugly financial stocks changed the story here.
Bridget B. Hughes, CFA does not own shares in any of the securities mentioned above.
Morningstar Premium Members get access to over 3,900 Stock and Fund Analyst Reports, Analyst Picks, and award-winning portfolio tools. Learn More.
http://finance.yahoo.com/news/Do-BearMarket-Veterans-Manage-ms-14614245.html?.&.pf=retirement
Comment:
Investments: Spread the risk to maximise returns
Investments: Spread the risk to maximise returns
Getting the balance right could make the difference between a winning and a losing portfolio.
By Paul Farrow
Last Updated: 4:52PM GMT 13 Mar 2009
You will often have heard investment professionals talk about the need to build a balanced portfolio spread across a variety of asset classes.
It is, therefore, perhaps surprising that research reveals that many private investors know next to nothing about asset allocation when it comes to building their investment portfolio.
Research has shown that nearly four out of 10 investors admit that they have little idea how their portfolio is split between equities, bonds and cash.
Even fewer investors are aware of the split in their portfolio by geography, sector or size of stock. Half of those polled confessed that they did not know how their portfolio was structured by country, while 49pc admitted to a similar ignorance about sector exposure, and 48pc were not sure how the portfolio was split between large, mid and small-cap stocks.
Put simply, asset allocation is the balance between the major asset types of property, cash, fixed interest and equities in an investment portfolio.
Getting the balance right is vital if you want to achieve your financial objectives. Fail to do so and it is easy for you either to buy the wrong kind of investment or to create a portfolio of investments that is unlikely to generate the desired results.
The stock market turmoil between 2000 and 2003 showed just how important it is to have a balanced portfolio. People whose portfolios were heavily exposed to equities suffered disproportionately large losses as share prices plummeted.
On the other hand, those with balanced portfolios that had decent exposure to fixed-interest investments such as corporate bonds, property and cash would have fared a lot better. The three asset classes produced positive returns as share values fell, which would have helped offset the stock market losses and eased the pain.
In recent years it has been harder to call – most assets have fallen in value. Overexposure to assets such as emerging markets and commercial property would have hurt you more than exposure to safer investments such as cash and gold.
In real life, the eventual mix of assets in your portfolio will depend on your own personal circumstances, such as your age, earnings, attitude to risk and financial objectives. People with more substantial portfolios, for example, are sometimes advised to introduce more sophisticated investments such as hedge funds and structured products into the mix.
Building a portfolio is also a question of managing risk versus return.
Risk is not just about potential capital losses – you also have to consider the risk of inflation and a potential reduction in income if circumstances go against you. For example, people in their thirties and forties may be prepared to have a greater exposure to equities because they can afford to take a longer-term view and will be looking to grow their portfolio.
People who are nearer to retirement are more likely to want to preserve the capital they have got and adopt a more cautious strategy, with a bigger exposure to corporate bonds. The sensible investor takes into account the amount of risk they are able to tolerate, both psychologically and in terms of their individual needs.
It is therefore vital to understand the different levels of risk inherent in various types of investment. Overly concentrating on a single asset class will increase the risk to a portfolio unnecessarily.
Investors have traditionally adopted a pyramid strategy for building a portfolio, starting with cash, then fixed interest, with equities at the peak. The consensus is that you start with a solid foundation of cash before dabbling in equities or bonds – some say a cash nest egg should represent three, or even six, months' salary.
It is difficult to generalise as individual circumstances will be different, but broadly speaking many experts agree that people seeking medium to low-risk capital growth should aim to have a portfolio that is 60pc invested in equities, 25pc in bonds and 15pc in cash. Those seeking a high, regular income, on the other hand, would do better with just 20pc in shares, 20pc in cash and the remaining 60pc in bonds.
As mentioned earlier, the balance of assets will depend on factors such as age, attitude to risk, financial objectives and the length of time over which you intend to invest.
For example, equities should be viewed as long-term investments – that is to say, held for at least five years. If you cannot afford to wait for that long, you should concentrate on lower-risk, fixed-rate investments such as bonds. If you are looking at less than three years, you should probably limit yourself to cash-based investments.
In the past, as people grew older their investment portfolios became risk averse. They reduced their exposure to equities and generally avoided investments that put their capital at risk. But times are changing and this may not be the right strategy to adopt.
In real life, it is not just the asset mix that investors need to consider when building a portfolio. There are also tax implications, be it capital gains, inheritance tax or income tax liabilities.
For example, it is prudent to make sure you are not handing over more money to the taxman than you need. Individual savings accounts (Isas) allow you to invest up to £7,200 each financial year and gains are free from capital gains tax.
The tax credit on dividend income has recently been scrapped, which means basic-rate taxpayers get no income tax benefit with Isas, but higher-rate taxpayers still do. This is because they will still get a net dividend payment worth 25pc more than they would if their investments were outside an Isa and they had to pay tax.
Obvious practicalities dictate that our Fantasy Fund Manager game will be played over the short period of less than a year, rather than a decent real life investment horizon of five years. Many investors are buying corporate bond funds and equity income funds – whether they will be the winners come next year, who knows.
The shrewd professionals are usually ahead of the game – they take profits before the price has peaked and often buy before values have bottomed.
http://www.telegraph.co.uk/finance/personalfinance/investing/4984569/Investments-Spread-the-risk-to-maximise-returns.html
Getting the balance right could make the difference between a winning and a losing portfolio.
By Paul Farrow
Last Updated: 4:52PM GMT 13 Mar 2009
You will often have heard investment professionals talk about the need to build a balanced portfolio spread across a variety of asset classes.
It is, therefore, perhaps surprising that research reveals that many private investors know next to nothing about asset allocation when it comes to building their investment portfolio.
Research has shown that nearly four out of 10 investors admit that they have little idea how their portfolio is split between equities, bonds and cash.
Even fewer investors are aware of the split in their portfolio by geography, sector or size of stock. Half of those polled confessed that they did not know how their portfolio was structured by country, while 49pc admitted to a similar ignorance about sector exposure, and 48pc were not sure how the portfolio was split between large, mid and small-cap stocks.
Put simply, asset allocation is the balance between the major asset types of property, cash, fixed interest and equities in an investment portfolio.
Getting the balance right is vital if you want to achieve your financial objectives. Fail to do so and it is easy for you either to buy the wrong kind of investment or to create a portfolio of investments that is unlikely to generate the desired results.
The stock market turmoil between 2000 and 2003 showed just how important it is to have a balanced portfolio. People whose portfolios were heavily exposed to equities suffered disproportionately large losses as share prices plummeted.
On the other hand, those with balanced portfolios that had decent exposure to fixed-interest investments such as corporate bonds, property and cash would have fared a lot better. The three asset classes produced positive returns as share values fell, which would have helped offset the stock market losses and eased the pain.
In recent years it has been harder to call – most assets have fallen in value. Overexposure to assets such as emerging markets and commercial property would have hurt you more than exposure to safer investments such as cash and gold.
In real life, the eventual mix of assets in your portfolio will depend on your own personal circumstances, such as your age, earnings, attitude to risk and financial objectives. People with more substantial portfolios, for example, are sometimes advised to introduce more sophisticated investments such as hedge funds and structured products into the mix.
Building a portfolio is also a question of managing risk versus return.
Risk is not just about potential capital losses – you also have to consider the risk of inflation and a potential reduction in income if circumstances go against you. For example, people in their thirties and forties may be prepared to have a greater exposure to equities because they can afford to take a longer-term view and will be looking to grow their portfolio.
People who are nearer to retirement are more likely to want to preserve the capital they have got and adopt a more cautious strategy, with a bigger exposure to corporate bonds. The sensible investor takes into account the amount of risk they are able to tolerate, both psychologically and in terms of their individual needs.
It is therefore vital to understand the different levels of risk inherent in various types of investment. Overly concentrating on a single asset class will increase the risk to a portfolio unnecessarily.
Investors have traditionally adopted a pyramid strategy for building a portfolio, starting with cash, then fixed interest, with equities at the peak. The consensus is that you start with a solid foundation of cash before dabbling in equities or bonds – some say a cash nest egg should represent three, or even six, months' salary.
It is difficult to generalise as individual circumstances will be different, but broadly speaking many experts agree that people seeking medium to low-risk capital growth should aim to have a portfolio that is 60pc invested in equities, 25pc in bonds and 15pc in cash. Those seeking a high, regular income, on the other hand, would do better with just 20pc in shares, 20pc in cash and the remaining 60pc in bonds.
As mentioned earlier, the balance of assets will depend on factors such as age, attitude to risk, financial objectives and the length of time over which you intend to invest.
For example, equities should be viewed as long-term investments – that is to say, held for at least five years. If you cannot afford to wait for that long, you should concentrate on lower-risk, fixed-rate investments such as bonds. If you are looking at less than three years, you should probably limit yourself to cash-based investments.
In the past, as people grew older their investment portfolios became risk averse. They reduced their exposure to equities and generally avoided investments that put their capital at risk. But times are changing and this may not be the right strategy to adopt.
In real life, it is not just the asset mix that investors need to consider when building a portfolio. There are also tax implications, be it capital gains, inheritance tax or income tax liabilities.
For example, it is prudent to make sure you are not handing over more money to the taxman than you need. Individual savings accounts (Isas) allow you to invest up to £7,200 each financial year and gains are free from capital gains tax.
The tax credit on dividend income has recently been scrapped, which means basic-rate taxpayers get no income tax benefit with Isas, but higher-rate taxpayers still do. This is because they will still get a net dividend payment worth 25pc more than they would if their investments were outside an Isa and they had to pay tax.
Obvious practicalities dictate that our Fantasy Fund Manager game will be played over the short period of less than a year, rather than a decent real life investment horizon of five years. Many investors are buying corporate bond funds and equity income funds – whether they will be the winners come next year, who knows.
The shrewd professionals are usually ahead of the game – they take profits before the price has peaked and often buy before values have bottomed.
http://www.telegraph.co.uk/finance/personalfinance/investing/4984569/Investments-Spread-the-risk-to-maximise-returns.html
Long-term investing doesn't work!
Don't Invest Like Jon Stewart's Mom
By Tim Hanson
March 13, 2009 Comments (15)
Hey, that was a lot of awkward fun, wasn't it?For those of you who missed The Daily Show with Jon Stewart last night, you'll have to turn to one of a million or so links on the Internet to see the rousing conclusion to "Basic Cable Personality Clash Skirmish '09," a.k.a. the weeklong feud between TheStreet.com's (Nasdaq: TSCM) Jim Cramer and Comedy Central's Jon Stewart. For those who would rather waste that 22 minutes of their life on Minesweeper or NCAA basketball, here's what we learned.
1) Yes, Jim Cramer is a manic clown.2) Jim Cramer's nephew writes the Mad Money show while wearing his pajamas.3) CNBC is not good at hard-hitting reporting.4) Jon Stewart's pretty peeved about all this and ready to drop a few f-bombs to let folks know it.5) Long-term investing doesn't work.
Wait, what?As a practitioner of long-term investing here at The Motley Fool, I was pretty shocked by this revelation. But there it was as the interview was wrapping up. Let's go to the transcript:
Jon Stewart: My mother is 75. And she bought into the idea that long-term investing is the way to go. And guess what?
Jim Cramer: It didn't work.
[Jon Stewart assents with some Arthur Fonzarelli-type hand motion and concurrent clicking noise.]
We'll assume that was an assent Now, I'm not going to pull a Rick Santelli and call Jon Stewart or his mother a loser because that would bring down the wrath of The Daily Show and Dora the Explorer (who my nephews envy, and if they saw her swearing at me in Spanish it would absolutely kill them) upon me. But even if Jon Stewart's mom -- like all of us long-term investors -- has lost a great deal of money over the past 16 or so months, that's not evidence that long-term investing doesn't work.
In fact, long-term investing is the only way to protect yourself from the manipulations, machinations, and generally idiocy that drive stock price movements on a day-to-day basis. And if Jon Stewart's mom truly is/was a long-term investor, then she should have come through this current calamity relatively ok provided she has been a long-term investor for the long-term and had been sticking to a disciplined multi-decade asset-allocation game plan. That means keeping a mix of stocks and bonds, and within that stock allocation having a mix of asset classes. It doesn't mean simply loading up on General Motors (NYSE: GM), Eastman Kodak (NYSE: EK), and Bear Stearns because Jim Cramer told you "Bear Stearns is fine!" -- and only those three stocks -- and throwing up your hands because it doesn't work.
Here's why
Let's assume Jon Stewart's mom started investing 30 years ago, in 1979, at age 45. Let's further the following simple allocation strategy:
She invested simply in the Vanguard 500 Index (Nasdaq: VFINX), a low-cost market-tracker that holds giants today such as ExxonMobil (NYSE: XOM), General Electric (NYSE: GE), and Wal-Mart (NYSE: WMT).
At age 55, she realized that she was nearing retirement and should be increasing her allocation to principal-protecting bonds, using the rule of thumb that her bond allocation should be equal to her age.
Finally, let's assume that she invested the same amount of money, be it $1, $100, $1,000, or $10,000, at the beginning of each and every year.
Where would she be today following a greater than 50% collapse in the stock market?
I realize that's a lot of assumptions
Now, portfolio simulations like this are tricky to pull off and don't account for all the details -- such as, in this example, frictional costs or dividend yields which I'm assuming canceled out -- but they are illuminating. And according to my conservative math, for every $1 that Jon Stewart's mom put in over the trailing 30-year period, she would have $1.63 today. So, if all told, she had deposited $500,000 over the years (in annual $16,667 increments), she would have $815,000 today.
Now, let's be honest, that's not great.
It's not 10% or 20% annual returns, it's not turning thousands into millions, and it's not an enormous stock market success story. But it is certainly enough to live on and evidence of how long-term investing -- provided it's practiced with discipline and an eye toward asset allocation -- can protect your wealth and give you the opportunity to make money.
Because let's be honest, though the stock market is down today, it will rebound. Commerce around the world is too strong for it to be otherwise. And the worst thing Jon Stewart's mom could do today is -- at her son's behest -- give up faith in long-term investing as the market stands at a 10-year bottom.
In sum
Numbers, jokes, and snarky comments aside, what I'm saying is this: Rather than be angry, let's recognize that the stock market, like most human endeavors, is flawed. There will be disasters and blow-ups from time to time, just as there will be bubbles. Let's use this as an opportunity to educate more Americans about how to take control of their finances and ignore the market's manic day-to-day movements.The solution is not to scare Americans into thinking the stock market is some Ponzi scheme controlled by immoral cretins that can never work for them. See, over time, those cretins are found out. And over time, everyone can make money in the stock market and enjoy a more secure retirement by having a long-term investing timeline and sticking to a disciplined asset allocation plan. That means not abandoning bonds when stocks are outperforming and not abandoning stocks when bonds are outperforming.
Read/Post Comments (15) Recommend This Article (21)
http://www.fool.com/investing/general/2009/03/13/dont-invest-like-jon-stewarts-mom.aspx
By Tim Hanson
March 13, 2009 Comments (15)
Hey, that was a lot of awkward fun, wasn't it?For those of you who missed The Daily Show with Jon Stewart last night, you'll have to turn to one of a million or so links on the Internet to see the rousing conclusion to "Basic Cable Personality Clash Skirmish '09," a.k.a. the weeklong feud between TheStreet.com's (Nasdaq: TSCM) Jim Cramer and Comedy Central's Jon Stewart. For those who would rather waste that 22 minutes of their life on Minesweeper or NCAA basketball, here's what we learned.
1) Yes, Jim Cramer is a manic clown.2) Jim Cramer's nephew writes the Mad Money show while wearing his pajamas.3) CNBC is not good at hard-hitting reporting.4) Jon Stewart's pretty peeved about all this and ready to drop a few f-bombs to let folks know it.5) Long-term investing doesn't work.
Wait, what?As a practitioner of long-term investing here at The Motley Fool, I was pretty shocked by this revelation. But there it was as the interview was wrapping up. Let's go to the transcript:
Jon Stewart: My mother is 75. And she bought into the idea that long-term investing is the way to go. And guess what?
Jim Cramer: It didn't work.
[Jon Stewart assents with some Arthur Fonzarelli-type hand motion and concurrent clicking noise.]
We'll assume that was an assent Now, I'm not going to pull a Rick Santelli and call Jon Stewart or his mother a loser because that would bring down the wrath of The Daily Show and Dora the Explorer (who my nephews envy, and if they saw her swearing at me in Spanish it would absolutely kill them) upon me. But even if Jon Stewart's mom -- like all of us long-term investors -- has lost a great deal of money over the past 16 or so months, that's not evidence that long-term investing doesn't work.
In fact, long-term investing is the only way to protect yourself from the manipulations, machinations, and generally idiocy that drive stock price movements on a day-to-day basis. And if Jon Stewart's mom truly is/was a long-term investor, then she should have come through this current calamity relatively ok provided she has been a long-term investor for the long-term and had been sticking to a disciplined multi-decade asset-allocation game plan. That means keeping a mix of stocks and bonds, and within that stock allocation having a mix of asset classes. It doesn't mean simply loading up on General Motors (NYSE: GM), Eastman Kodak (NYSE: EK), and Bear Stearns because Jim Cramer told you "Bear Stearns is fine!" -- and only those three stocks -- and throwing up your hands because it doesn't work.
Here's why
Let's assume Jon Stewart's mom started investing 30 years ago, in 1979, at age 45. Let's further the following simple allocation strategy:
She invested simply in the Vanguard 500 Index (Nasdaq: VFINX), a low-cost market-tracker that holds giants today such as ExxonMobil (NYSE: XOM), General Electric (NYSE: GE), and Wal-Mart (NYSE: WMT).
At age 55, she realized that she was nearing retirement and should be increasing her allocation to principal-protecting bonds, using the rule of thumb that her bond allocation should be equal to her age.
Finally, let's assume that she invested the same amount of money, be it $1, $100, $1,000, or $10,000, at the beginning of each and every year.
Where would she be today following a greater than 50% collapse in the stock market?
I realize that's a lot of assumptions
Now, portfolio simulations like this are tricky to pull off and don't account for all the details -- such as, in this example, frictional costs or dividend yields which I'm assuming canceled out -- but they are illuminating. And according to my conservative math, for every $1 that Jon Stewart's mom put in over the trailing 30-year period, she would have $1.63 today. So, if all told, she had deposited $500,000 over the years (in annual $16,667 increments), she would have $815,000 today.
Now, let's be honest, that's not great.
It's not 10% or 20% annual returns, it's not turning thousands into millions, and it's not an enormous stock market success story. But it is certainly enough to live on and evidence of how long-term investing -- provided it's practiced with discipline and an eye toward asset allocation -- can protect your wealth and give you the opportunity to make money.
Because let's be honest, though the stock market is down today, it will rebound. Commerce around the world is too strong for it to be otherwise. And the worst thing Jon Stewart's mom could do today is -- at her son's behest -- give up faith in long-term investing as the market stands at a 10-year bottom.
In sum
Numbers, jokes, and snarky comments aside, what I'm saying is this: Rather than be angry, let's recognize that the stock market, like most human endeavors, is flawed. There will be disasters and blow-ups from time to time, just as there will be bubbles. Let's use this as an opportunity to educate more Americans about how to take control of their finances and ignore the market's manic day-to-day movements.The solution is not to scare Americans into thinking the stock market is some Ponzi scheme controlled by immoral cretins that can never work for them. See, over time, those cretins are found out. And over time, everyone can make money in the stock market and enjoy a more secure retirement by having a long-term investing timeline and sticking to a disciplined asset allocation plan. That means not abandoning bonds when stocks are outperforming and not abandoning stocks when bonds are outperforming.
Read/Post Comments (15) Recommend This Article (21)
http://www.fool.com/investing/general/2009/03/13/dont-invest-like-jon-stewarts-mom.aspx
Avoid This Triple Whammy to Your Wealth
Avoid This Triple Whammy to Your Wealth
By Dan Caplinger
March 13, 2009 Comments (1)
In the latest installment of our series on government reports that make you say "duh," the Federal Reserve announced today that on the whole, American households were poorer at the beginning of 2009 than they had been the previous year.
That's not news to anyone. But the key lesson you should take from the report may not be so obvious. While falling real estate values and dropping stock prices are mostly beyond your control, you can help reverse the trend of falling net worth by focusing on the one thing you can do to improve your finances: cutting your debt.
Some ugly numbers
The Federal Reserve's flow of funds report typically makes great reading material if you're short on sleeping pills. But recently, those with a morbid sense of curiosity have pored through the document looking for further proof of just how bad the current economic climate really is.
The most recent release doesn't disappoint on that score. Total assets amounted to $65.7 trillion at the end of 2008, down nearly 8% in just the fourth quarter and almost 15% for the year. As you'd probably expect, the losses spanned across household balance sheets -- real estate values fell about 11% in 2008, while financial assets dropped 18%.
On the liability side, although households' overall debt levels finally ended a streak of large annual gains, they certainly failed to shrink significantly, clocking in at $14.2 trillion. Mortgage debt fell very slightly, but consumer credit more than offset those losses.
The net result was an $11 trillion loss in net worth, to $51.5 trillion. That's an 18% drop just since last year and the lowest level since 2003, representing the undoing of five years' worth of appreciating wealth for American households.
Impact on business
Even worse, though stable debt levels may not sound like great news, they're having a huge negative impact on businesses that count on consumer or corporate spending -- in other words, just about the entire economy. Here's just a sample of warnings about first-quarter earnings that companies have announced so far this year:
Company
Date Announced
Growth Estimate for Current Quarter
Growth Estimate for Next Quarter
Applied Materials (Nasdaq: AMAT)
Feb. 2
(141.7%)
(157.1%)
Procter & Gamble (NYSE: PG)
Jan. 30
(1.2%)
(10.9%)
Novartis (NYSE: NVS)
Feb. 24
(18.6%)
(20.4%)
Intel (Nasdaq: INTC)
Jan. 19
(92.0%)
(78.6%)
Adobe (Nasdaq: ADBE)
March 4
(8.3%)
(30.0%)
Source: Company press releases and Yahoo! Finance.
In addition, the debt freeze among consumers could spell more danger ahead for companies that rely on debt financing for sales, including homebuilders like Pulte Homes (NYSE: PHM) and high-end electronics and appliance seller Best Buy (NYSE: BBY).
How to keep getting richer
Unfortunately, out of the three main areas the report identifies, you can't do much about two of them. Real estate prices won't set a bottom until they're good and ready, and most homeowners have little choice but to sit and wait for a recovery. Similarly, investors in stocks have seen big losses, and while this week's bounce in stocks has been encouraging, it's likely that there will be more volatility before stocks establish a strong foundation for more extensive gains.
What you can do, however, is to do your part to keep the other side of your personal balance sheet in line. Although some may blame rising savings rates for continued weakness in the economy, that's no excuse for you to maintain irresponsibly high debt levels for yourself.
If you dedicate yourself to reducing debt and keeping your savings levels up, then you'll be better able to weather a storm of decreasing asset values. Although you still may not see your net worth recover to year-ago levels in the near future, keeping debt under control will make that eventual recovery a lot faster -- and easier to achieve.
Read more about how to keep your finances healthy:
Four ways you may be destroying your retirement.
Where smart investors are putting their money today.
Don't rely on this retirement plan.
Fool contributor Dan Caplinger has mostly stayed out of debt, at least for now. He doesn't own shares of the companies mentioned in this article. Novartis is a Motley Fool Global Gains pick. Procter & Gamble is a Motley Fool Income Investor recommendation.
http://www.fool.com/retirement/general/2009/03/13/avoid-this-triple-whammy-to-your-wealth.aspx
By Dan Caplinger
March 13, 2009 Comments (1)
In the latest installment of our series on government reports that make you say "duh," the Federal Reserve announced today that on the whole, American households were poorer at the beginning of 2009 than they had been the previous year.
That's not news to anyone. But the key lesson you should take from the report may not be so obvious. While falling real estate values and dropping stock prices are mostly beyond your control, you can help reverse the trend of falling net worth by focusing on the one thing you can do to improve your finances: cutting your debt.
Some ugly numbers
The Federal Reserve's flow of funds report typically makes great reading material if you're short on sleeping pills. But recently, those with a morbid sense of curiosity have pored through the document looking for further proof of just how bad the current economic climate really is.
The most recent release doesn't disappoint on that score. Total assets amounted to $65.7 trillion at the end of 2008, down nearly 8% in just the fourth quarter and almost 15% for the year. As you'd probably expect, the losses spanned across household balance sheets -- real estate values fell about 11% in 2008, while financial assets dropped 18%.
On the liability side, although households' overall debt levels finally ended a streak of large annual gains, they certainly failed to shrink significantly, clocking in at $14.2 trillion. Mortgage debt fell very slightly, but consumer credit more than offset those losses.
The net result was an $11 trillion loss in net worth, to $51.5 trillion. That's an 18% drop just since last year and the lowest level since 2003, representing the undoing of five years' worth of appreciating wealth for American households.
Impact on business
Even worse, though stable debt levels may not sound like great news, they're having a huge negative impact on businesses that count on consumer or corporate spending -- in other words, just about the entire economy. Here's just a sample of warnings about first-quarter earnings that companies have announced so far this year:
Company
Date Announced
Growth Estimate for Current Quarter
Growth Estimate for Next Quarter
Applied Materials (Nasdaq: AMAT)
Feb. 2
(141.7%)
(157.1%)
Procter & Gamble (NYSE: PG)
Jan. 30
(1.2%)
(10.9%)
Novartis (NYSE: NVS)
Feb. 24
(18.6%)
(20.4%)
Intel (Nasdaq: INTC)
Jan. 19
(92.0%)
(78.6%)
Adobe (Nasdaq: ADBE)
March 4
(8.3%)
(30.0%)
Source: Company press releases and Yahoo! Finance.
In addition, the debt freeze among consumers could spell more danger ahead for companies that rely on debt financing for sales, including homebuilders like Pulte Homes (NYSE: PHM) and high-end electronics and appliance seller Best Buy (NYSE: BBY).
How to keep getting richer
Unfortunately, out of the three main areas the report identifies, you can't do much about two of them. Real estate prices won't set a bottom until they're good and ready, and most homeowners have little choice but to sit and wait for a recovery. Similarly, investors in stocks have seen big losses, and while this week's bounce in stocks has been encouraging, it's likely that there will be more volatility before stocks establish a strong foundation for more extensive gains.
What you can do, however, is to do your part to keep the other side of your personal balance sheet in line. Although some may blame rising savings rates for continued weakness in the economy, that's no excuse for you to maintain irresponsibly high debt levels for yourself.
If you dedicate yourself to reducing debt and keeping your savings levels up, then you'll be better able to weather a storm of decreasing asset values. Although you still may not see your net worth recover to year-ago levels in the near future, keeping debt under control will make that eventual recovery a lot faster -- and easier to achieve.
Read more about how to keep your finances healthy:
Four ways you may be destroying your retirement.
Where smart investors are putting their money today.
Don't rely on this retirement plan.
Fool contributor Dan Caplinger has mostly stayed out of debt, at least for now. He doesn't own shares of the companies mentioned in this article. Novartis is a Motley Fool Global Gains pick. Procter & Gamble is a Motley Fool Income Investor recommendation.
http://www.fool.com/retirement/general/2009/03/13/avoid-this-triple-whammy-to-your-wealth.aspx
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