Teaching Your Partner About Household Finances

Teaching Your Partner About Household Finances
by Amy Fontinelle (Contact Author Biography)


Often, only one person in the household is responsible for maintaining the family budget and managing the household's finances - and if you're reading this article, that person is probably you.

But what if you died or became incapacitated and could no longer manage the budget? Or what if you're just tired of managing everything yourself, or you partner wants to become more involved in your household's finances? How do you teach your partner everything you know?

This article will outline the areas you should be sure to cover and the steps you should take to give your partner a clear picture of your household's financial situation and the confidence to take over. (For more information on sharing the household finances, read Why You Shouldn't Let Your Partner Do The Books.)


1. Make a list of everything and where it's located.

While you may be able to finish each other's sentences, don't assume your significant other possesses the intuition to know where you keep sensitive information. You may think your filing system couldn't be any more organized and that your financial records are in a pretty obvious location, but your partner might not. While you probably have printed documents related to some of your financial affairs, there's a good chance some of your information is stored solely in your memory bank, as you probably manage some of your finances online. Without access to your email to receive monthly statement reminders, your partner probably doesn't know how to find all of your online accounts, and may not even know which banks and brokerage companies you use, not to mention all the bills you pay. A list of all of your accounts makes it easy for your partner to see everything that needs to be addressed. (For more, see Say "I Do To Financial Compatibility.)

2. Make sure your partner has access to everything.

Just knowing that these accounts exist won't be enough. If you want your partner to be able to take charge, you'll have to give him or her full access. Get your partner a set of keys to any safety deposit boxes, divulge the code to your safe and point out which tree in the backyard is beside where you buried the money. Make sure your partner is a named account holder or the primary beneficiary on all major accounts, life insurance policies and any property you own. Also, make sure he or she knows how to access any important computer files and online accounts. (Life changes may mean it's time to update you estate plan. For more information read Update Your Beneficiaries.)

If you're worried about writing your sensitive information down because of the possibility that the wrong person might find it, you're not alone. Here are some options for making your information available to the right person while keeping it safe from criminals (or ill-intentioned relatives).

Put your list in a safe deposit box at the bank. Make sure your significant other has a key and is listed with the bank as being allowed to access the box. Obviously, this is best for emergency situations, not daily use.

Make your list electronic and store it as an encrypted, password-protected file. Make sure your partner knows how to locate and access the file and that you have at least one backup copy in a separate location in case the first file is lost or corrupted.

Encrypt your list the old-fashioned way. Create logins and passwords that have meaning only to you and your partner. This way, your written list can consist of prompts or reminders to your logins and passwords instead of the complete codes. If one of your passwords was the name of the restaurant where you went on your first date plus the date you acquired your dog, the password prompt you wrote down could be "marcos07xxxx" or "first date restaurant+dogbday". (Learn more in Keep Your Financial Data Safe Online.)

3. Explain what everything is and why it's important.

People tend to complete tasks more successfully when they understand the purpose of what they are doing. Just telling your partner that "this account is where we put our savings," isn't as good as explaining why you choose to put your savings there ("we get the best interest rate at this bank"). Likewise, saying "we have to pay x dollars a month for y," isn't as helpful as explaining why you make the payment. For example, if your partner doesn't know what long-term care insurance is and why you're paying for a policy on your mother's behalf, he or she might cancel the policy. (For more, see A New Approach To Long-Term Care Insurance.)

4. Maintain a household budget.

Maybe you're not the type who needs to write everything down to successfully manage your money, but a budget is an excellent way to give your partner a big-picture idea of all the money in play - the income, the debts, the recurring expenses, the investments and so on. It can also help your partner pick up where you left off in managing the household's finances if you die or become incapacitated. (Learn more about household budgeting in our related articles: Six Months To A Better Budget and The Beauty Of Budgeting.)

5. Have your partner watch you handle the finances.

Explaining things is helpful, and written instructions/checklists/spreadsheets are even better, but nothing beats sitting down with your partner and talking through actually managing the finances. Let your partner observe the process while you explain it, and then have him or her practice it with your help and guidance.

6. Gradually give your partner some financial responsibility.

If your partner currently doesn't handle the money at all, start off with a small, manageable task - preferably one with low stakes. For example, make your partner responsible for paying one small bill each month - something with a generous grace period on the payment due date, like the electric bill. As he or she become more adept, give additional tasks to manage. Eventually, have your partner handle all the finances for one month (with your supervision, of course). Then, try switching off months, with your partner handling the finances every other month until you both feel completely comfortable.

7. Discuss contingency plans.

Make sure your partner knows what you would do in an emergency or unplanned financial event. Don't just be conceptual - discuss actual, concrete strategies to handle unplanned events. If you received a windfall, which debts would you want to pay off? What are your savings priorities? Is there any charity to which you would donate a significant sum? On the other end of the spectrum, if there was a sudden loss of income, which bills would need to be prioritized, and which expenses could be reduced or dropped altogether? (To learn more about dealing with personal financial changes, read Competing Priorities: Too Many Choices, Too Few Dollars.)

8. Encourage your partner's ongoing education.

Your partner may be loathe to pick up a personal finance book on a Saturday afternoon, but reading the occasional article will get your partner learning about money at a manageable pace.

Conclusion

To teach your partner how to handle the household finances, take the time to provide him or her with a complete picture of your household's financial situation and provide access to all important accounts. Then, gradually teach your partner enough to ease your financial management burden or get by in an emergency. These may not be the most entertaining activities, but they are key to taking the best possible care of one of the most important people in your life. (For more reading on managing your personal finances, check out Run Your Personal Finances Like A Business.)

by Amy Fontinelle, (Contact Author Biography)

Amy Fontinelle is a freelance writer and editor with clients located across the United States and in Canada. She has written over 300 published articles and blog posts for a variety of national and local publications and websites on topics including travel, restaurants, food and drink, fitness, budgeting, credit management, real estate, investing and historic preservation. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Yahoo! HotJobs, several local news websites and Forbes.com. You can read more of Amy's personal finance articles at Two Pennies Earned, her own personal finance website, and at PF Advice, one of the web's leading personal finance blogs.





http://investopedia.com/articles/pf/09/teaching-partner-household-finances.asp?partner=basics5

Market trend

Statues of the two symbolic beasts of finance (the bull and bear) in front of Frankfurt Stock Exchange.

Market trend

From Wikipedia, the free encyclopedia

A Market trend is the direction in which a financial market is moving. Market trends can be classified as primary trends, secondary trends (short-term), and secular trends (long-term). This principle incorporates the idea that market cycles occur with regularity and persistence. This belief is considered to be generally consistent with the practice of technical analysis and broadly inconsistent with the standard academic view of financial markets, the efficient market hypothesis. [1] Another academic viewpoint is that market prices follow a random walk model and that any apparent past 'trends' are purely an accumulation of random variations and do not serve as a predictor for future performance. Random walk theory suggests that it is therefore not possible to outperform the general market using traditional evaluations of its "fundamentals" or by using technical analysis. [2]

However, the assumption that market prices move in trends is one of the major components of technical analysis,[3] and consideration of market trends is common to most Wall Street investors. Market trends are described as sustained movements in market prices over a period of time. The terms bull market and bear market describe upward and downward movements respectively and can be used to describe either the market as a whole or specific sectors and securities (stocks). The expressions "bullish" and "bearish" can also mean optimistic and pessimistic respectively ("bullish on gold," or "bearish on technology stocks", etc).

Contents[hide]
1 Primary market trends
1.1 Bull market
1.2 Bear market
1.3 Market bottom
2 Secondary market trends
3 Secular market trends
4 Market events
5 Cause of market events
6 Technical analysis
7 Etymology
8 Historic examples
9 See also
10 References
11 External links

Primary market trends
A primary trend has broad support throughout the entire market or market sector and lasts for a year or more.

Bull market
A bull market tends to be associated with increasing investor confidence, motivating investors to buy in anticipation of future price increases and future capital gains. In describing financial market behavior, the largest group of market participants is often referred to, metaphorically, as a herd. This is especially relevant to participants in bull markets since bulls are herding animals. A bull market is also sometimes described as a bull run. Dow Theory attempts to describe the character of these market movements.

India's BSE Index SENSEX was in a bull run for almost five years from April 2003 to January 2008 as it increased from 2,900 points to 21,000 points. Another notable and recent bull market was in the 1990s when the U.S. and many other global financial markets rose rapidly.

Bear market
A bear market is a steady drop in the stock market over a period of time.[4] It is described as being accompanied by widespread pessimism. Investors anticipating further losses are often motivated to sell, with negative sentiment feeding on itself in a vicious circle. The most famous bear market in history followed the Wall Street Crash of 1929 and lasted from 1930 to 1932, marking the start of the Great Depression. A milder, low-level, long-term bear market occurred from about 1973 to 1982, encompassing the stagflation of U.S. economy, the 1970s energy crisis, and the high unemployment of the early 1980s. Due to the current economic conditions (be it the steady decline in value of the market or the high unemployment rate) the United States of America is currently in a bear market. High ranking economic evaluators as well as upper end public officials have coined America's current situation as a "recession."

Prices fluctuate constantly on the open market. To take the example of a bear stock market, it is not a simple decline, but a substantial drop in the prices of the majority of stocks over a defined period of time. According to The Vanguard Group, "While there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period."[5]

Market bottom
A stock market bottom is a trend reversal - the end of a market downturn and the beginning of an upward moving trend. "Bottom" is more than just a recent low in a stock market index, but a reversal of the primary trend. A "bottom" may occur because of the presence of a "cycle," or because of "panic selling" as a reaction to an adverse financial development.

It is very difficult to identify a bottom (referred to by investors as "bottom picking") while it is occurring. The upturn following a decline is often shortlived and prices might resume their decline. This would bring a loss for the investor who purchased stock(s) during a misperceived or "false" market bottom.

Some of the more notable market bottoms, in terms of the closing values of the Dow Jones Industrial Average (DJIA) include:
Black Monday: The DJIA hit a bottom at 1738.74 on 10/19/1987, as a result of the decline from 2722.41 on 8/25/1987 (Chart [6]).
The bursting of the Dot-com bubble: A bottom of 7286.27 was reached on the DJIA on 10/9/2002 as a result of the decline from 11722.98 on 1/14/2000. This included an intermediate bottom of 8235.81 on 9/21/2001 which led to an intermediate top of 10635.25 on 3/19/2002 (Chart [7]).
A decline associated with the Subprime mortgage crisis starting at 14164.41 on 10/9/2007 (DJIA) and caused a short term bottom of 11740.15 on 3/10/2008. After a rallying to a temporary top on 5/2/2008 at 13058.20 the primary trend of the declining, "bear" market, resumed. (Chart [8]).

Baron Rothschild is said to have advised that the best time to buy is when there is "blood in the streets", i.e. when the markets have fallen drastically and investor sentiment is extremely negative[9].

Secondary market trends
Secondary trends are short-term changes in price direction against a primary trend. They usually last between a few weeks and a few months. Whether a trend is a secondary trend, or the beginning of a primary trend, can only be known once it has either ended or has exceeded the extent of a secondary trend.

A decline in prices during a primary trend bull market is called a market correction. A correction is usually a decline of 10% to 20%, but some experts say it can be a third or more.[10] It differs from a bear market mostly in that it has a smaller magnitude and duration.

An increase in prices during a primary trend bear market is called a bear market rally. A bear market rally is sometimes defined as an increase of 10% to 20%. Bear market rallies typically begin suddenly and are often short-lived. Notable bear market rallies occurred in the Dow Jones index after the 1929 stock market crash leading down to the market bottom in 1932, and throughout the late 1960s and early 1970s. The Japanese Nikkei stock average has been typified by a number of bear market rallies since the late 1980s while experiencing an overall long-term downward trend.

Secular market trends
A secular market trend is a long-term trend that usually lasts 5 to 25 years (but whose distribution is more or less bell shaped around 17 years, in the stock market), and consists of sequential primary trends. In a secular bull market the primary bear markets have in the past almost always been shorter and less punishing than the primary bull markets were rewarding. Each bear market has rarely (if ever) wiped out the real (inflation adjusted) gains of the previous bull markets, and the succeeding bull markets have usually made up for the real losses of any previous bear markets. This is one of the reasons why a secular market trend may be said to encompass the primary trends within it. The United States was described as being in a secular bull market from about 1983 to 2000, with brief upsets including the crash of 1987 and the dot-com bust of 2000–2002.

In a secular bear market, the primary bull markets are sometimes shorter than the primary bear markets and rarely compensate for the real losses of the primary bear markets occurring during this extended cycle. For example, in the 1966–82 secular bear market in stocks, there was hardly any nominal loss. But in real terms the loss was devastating. (In the past most housing recessions were of a slow nature, thereby allowing inflation to keep housing prices steady.) Another example of a secular bear market was seen in gold during the period between January 1980 to June 1999. During this period the nominal gold price fell from a high of $850/oz ($30/g) to a low of $253/oz ($9/g),[11] and became part of the Great Commodities Depression. The S&P 500 experienced a secular bull market over a similar time period (~1982–2000).

Market events
Main articles: Stock market crash and Stock market bubble
An exaggerated bear market, that tends to be associated with falling investor confidence and panic selling, can lead to a market crash associated with a recession. By contrast, an exaggerated bull market fueled by overconfidence and / or speculation can lead to a market bubble — characterized by an extreme inflation of the price / earnings P/E ratios of the stocks in that market.

Cause of market events
Market movements may respond to new information becoming available to the market, but may also be influenced by investors' cognitive biases and emotional biases. Expectations play a large part in financial markets. Often there will be significant price reaction to financial data, information or news. Unexpected news or information that is perceived as positive for the economy or for a particular market sector or company will of course increase stock prices, and vice versa. Some behavioral finance studies (Richard Thaler) also point to the impact of the underreaction-adjustment-overreaction process in the formation of market movements and trends.

Technical analysis
Main article: Technical analysis
Many investors and analysts use technical analysis to try to identify whether a market or security is likely to increase or decrease in value. They then generate trading strategies to exploit their conclusions and market insights. Some technical analysts believe that the financial markets are cyclical and move in and out of bull and bear market phases on a regular and consistent basis.

http://en.wikipedia.org/wiki/Market_trends

Also read:

What Is a Bear Market? http://www.fool.com/retirement/retireeport/2000/retireeport000717.htm

Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - Smoke and Mirrors

Some apparent asset plays can be a mirage. Find a company selling at a low price to book (P/B), look at assets, and notice that per-share assets are higher than the share price. Is it a good buy?

Depends on the quality and liquidity of the assets on the books.

Large manufacturers and other capital-intensive companies often have overvalued assets on the books. If the assets are largely based on buildings, equipment, and intangibles, watch out; but if they are cash, securities, marketable natural resourcees, land, and the like, there may be an asset-play opportunity.

If there is a large cash hoard exceeding debt, make sure the company is cash flow positive or nearly so. You don't want this cash to disappear as "cash burn."

Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - Cyclical Plays

Recognizing Value Situations - Cyclical Plays

Generally, cyclical companies shouldn't be confused with value investments. Growth, although apparent in the short term, usually isn't sustainable. Investors are getting wiser and aren't as likely to bid up prices in good times, nor bid them way down in bad times, so this form of market timing doesn't work as well.

But occasionally companies caught in the cyclical pool come up with strategies to climb out of it, and move more steadily up and to the right International expansion can reduce cyclical effects.

Manufacturing companies diversify into more recession-proof financial services (which make more money as poor business conditions beget lower interest rates). General Electric has figured this out, and Ford has tried. Other smaller companies may have more effective cycle-beating strategies, because it's hard to keep such big ships as Ford and GE from turning when the wind shifts. If a company seems cheap and has something new in its portfolio to avoid cyclical price and earnings behaviour, it may be worth a look.

Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - Turning the Ship Around

Recognizing Value Situations - Turning the Ship Around

Many companies go through restructuring, downsizing, and spinning off businesses deemed not vital to the core business. There is usually a "back-to-basics" and "focus" theme to these events, and they usually occur after extended periods of poor business results.

U.S. automakers (particularly Chrysler) went through this years ago and are obviously doing it again, exemplified by Ford's "Way Forward" campaign. Airlines have done it, albeit with mixed results, and it's likely that the banking and lending industrywill have to do the same.

Do turnarounds works? According to Buffett and many other professionals, generally not.

A few do succeed, and when they do, there's usually a big impact on shareholder value. It happened with Chrysler, and again with Hewlett-Packard (whose problems, notably, were not as severe).

Determining worthy value investments in these situations is difficult. Probably the best approach is to try to place a value on the core remaining business, as many did with HP's core printing business; then try to imagine how other units would fare either in a sale or with a successful turnaround. Again here, the work of professionals shouldn't be ignored.


Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - Growth Kickers

Recognizing Value Situations - Growth Kickers

From time to time, relatively steady companies come up with small subsidiary businesses, sometimes related and sometimes not, that can perk up business growth.

Telecom companies got into the cell phone business and 3M is sticking with the Post-It boom. Twenty years ago, the growthless Southern Pacific Railroad started using its right-of-way for telecommunications lines in a business that eventually became Sprint.

These kickers can kindle grwoth, rekindle growth, and provide good, saleable assets downstream. They may be like finding chunks of chicken in a bowl of soup - not there in every spoonful and maybe not there at all. But when a big company crows about a small new product or business development in its portfolio within its ranks, keep your eyes open.


Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - The Asset Play

Recognizing Value Situations - The Asset Play

Sometimes it isn't the growth but the value of current underlying assets that points to value.

Although in the mainstream case, assets are in place only as resources upon which to build business growth and thus aren't valued separately, there will be cases in which the assets themselves create the value. In other words:

• the company owns them, but they aren't involved - or aren't completely involved - in producing the company's revenue and profit stream.
• Or they could be used more effectively somewhere else,
• or they simply aren't valued correctly on the books.

The point is, their actual value exceeds reported value in the business as it is currently defined.

Actual value exceeds reported value usually in one of two forms:

• undervalued assets on the books or
• breakup values that exceed the assets' current value to the business.

Undervalued assets

Both physical and intangible assets can be undervalued, sometimes significantly. Frequently this occurs with nondepreciable assets that have been held for a long time, such as land. Land is often carried on the books at purchase value, which is almost always less than current market value, especially if held for a long time.

The classic example is railroads, which hold millions of acres originally granted for free when they were built. Some of this land is used in the business, but a great majority isn't, especially for western roads. Something like 1 percent of all land in California is owned by just a couple of rail firms. Similar situations occur in oil and other natural resource businesses.

Intellectual property can also be undervalued (although in many cases, especially with acquisitions, it is overvalued, watch out!). Patents and other unique, homegrown know-how can have significant value, although corporate history is littered with companies (Xerox, Bell Labs [Alcatel-Lucent], IBM) that failed to capitalize on the wealth potential.

The key to undervalued asset plays is whether the assets are really that valuable, and what the strategy is for unlocking that value. Railroads until recently have done little to try to realize the value of their land assets. (Now, we're starting to see rail yards converted to downtown plazas, but sometimes at great expense for environmental cleanups.)

Look for companies with million of acres or barrels on the books; examine current market prices; decide for yourself whether there's an opportunity. Then look for evidence that the company itself recognizes the opportunity. Union Pacific Corporation (a railroad parent company) for years not only looked to sell its rail-adjacent land but also to target potential customer companies who would build facilities along its lines and ship by rail. They had a whole real estate subsidiary set up around this idea. It was a good strategy, but so far, it's a drop in the bucket compared to potential.

When the sum of the parts exceeds the whole

Big, stagnant, set-in-their-ways companies sometimes offer hidden opportunities. If they were to break into parts, each part would be free to focus on its core opportunities. Improved focus and reduced corporate bureaucracy can work wonders toward rekindling growth, satisfying customers, and building successful new brands. The classic example is AT&T, whose breakup created billions in new business value (despite the fact that the breakup was far from voluntary).

We see it today in a lot of food companies (such as Kraft Foods) and even Procter & Gamble, which has spun off several important divisions to J.M. Smucker. And although the spinoff didn't go public, the Daimler-Chrysler breakup had a lot of value investors thinking about breakup value.

The key is to identify these companies; then try to visualize what they may look like as individual parts - as individual businesses. It isn't always a successful strategy, because new overhead must be created to run each business, and synergies are lost. A breakup of General Motors may not work because the dealer network and synergies of common parts platforms would be lost.

It makes more sense where multiple, unrelated, or poorly related businesses exist under one corporate umbrella. If the customers are different, technologies are different, or business models are different, separation sometimes leads to value. Hewlett-Packard and Agilent Technologies (one selling technology end products and the other selling ''things that make things work" to other technology companies) made a logical break, but it took a long time for both companies to hit their stride in their marketplaces.

Markets tend to undervalue huge conglomerates. It is hard to appreciate and understand the value of each component in detail, so the investing and analysis public tend to discount what they don't understand.

So put all this together, and you may look at a General Electric or Procter & Gamble and wonder whether there is more value than meets the stock pages. Listen to rumors, picture the transition, look for clues that management may be thinking along the same lines (a few small divestitures may be an experiment). This is an area where professional analysts can provide good information on which companies are "in play" and what their breakup vlaue may be.


Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

Recognizing Value Situations - The Fire Sale

Recognizing Value Situations - The Fire Sale

Occasionally companies experience deep price declines due to actual or anticipated news or announcements. These declines can get out of hand, as more and more bad spin circulates in the market and investors (and institutions) head for seemingly safer waters.

The decline is either a one-shot affair or a longer, momentum-driven decline.

The one-shot affair is usually more attractive to the value investor, as it is often more of a short-term overreaction to news than a fundamental shift in the business.

Getting creamed

The one-shot hit was recently exhibited by company XYZ. Even though XYZ has no debt, pays a dividend (rare for a small cap growth stock), and has over $5 in net cash, the stock lost 40 percent of its value, from $28 to $16 over three trading days with concerns about the economy and an ambiguous earnings outlook (the quarterly report actually beat expectations).

The shrewd value investor doesn't just go out and buy; he or she researches a situation to determine whether the business model really is broken. Running the numbers, visiting the stores, and researching the industry are all appropriate steps in this situation.

Anytime a stock loses a quarter, a third, or half of its value in one day, it may be worth a glance. Just keep in mind that the reasons for these slaughters are sometimes justified, and the road to recovery may be difficult. There may be more touble than meets the eye. At the same time, a value investor may find bargains among such distressed inventory.

Misreading the tea leaves

Longer declines are illustrated by nearly the entire telecom and fiber optics sector in the 1998 - 2003 era: Long, slow persistent declines driven by ever increasing negative sentiment. The reasons are fairly obvious considering the history of telecom deregualtion, the Internet boom, over-ordering, excess capacity, excess expectations, and subsequent bust. But still, most market players were focused on the short-term write-offs, layoffs, and lack of visibility; few looked at the long-term prospects for these businesses. These bust cycles happen all the time. Some are company-specific; others are inherent in their industry. Widespread negative sentiment can produce attractive buying opportunities.


Also read:
Recognizing Value Situations
Recognizing Value Situations - Growth at a Reasonable Price
Recognizing Value Situations - The Fire Sale
Recognizing Value Situations - The Asset Play
Recognizing Value Situations - Growth Kickers
Recognizing Value Situations - Turning the Ship Around
Recognizing Value Situations - Cyclical Plays
Recognizing Value Situations - Smoke and Mirrors

A phenomenon called "herding."

Why You Shouldn't Follow Warren Buffett
By Tim Hanson and Brian Richards April 30, 2009 Comments (7)

Have you ever bought a stock because Warren Buffett bought a stock? You know, like Coca-Cola (NYSE: KO) or Wells Fargo (NYSE: WFC)?

If so, you're not alone. In fact, thousands of investors follow Buffett's every move, and that's such a hassle for the Oracle of Omaha that he has actually (unsuccessfully) lobbied the SEC to give him a dispensation from disclosing his stock picks.

Heck, it got so bad that in 1999, Coca-Cola was trading for as much as 40 times earnings -- an unbelievably high number for a steady consumer staple that sells sugar water.

Yet, if you believe Alice Schroeder's account in her Buffett biography The Snowball, Buffett wouldn't sell Coca-Cola even then because "the price of Coca-Cola could plunge as a result."
After all, if folks had mindlessly followed Buffett in, thereby driving up the price, they would just as surely follow him out.

This has a name When investors follow other investors into and out of stocks, or use another investor's decision to buy or sell to justify their own decision to buy or sell, you have a phenomenon called "herding."

While Buffett has been wary of passing along his stock ideas since the 1950s and '60s, it wasn't until 1990 or so that financial research established herding as a prevalent and powerful day-to-day force in the market's gyrations.

And recent research from professors Amil Dasgupta, Andrea Prat, and Michela Verardo of the London School of Economics allows us to quantify how herding affects stock prices over both the short and long terms.

We'll spoil the ending for you: Herding isn't much benefit to anyone.

Survey says ... It turns out that institutional herding around a few supposedly great ideas ultimately leads to overvaluation and underperformance.

Money managers -- in trying to avoid being outdone by their colleagues -- flock to the same sets of stocks. In the words of the professors, "money managers tend to imitate past trades (i.e., herd) due to their reputational concerns, despite the fact that such herding behavior has a first-order impact on the prices of assets that they trade."

It's a broken system that punishes investors who aren't courageous enough to think on their own.

But wait!
Not everyone agrees that herding depresses the returns investors can look forward to. Just look at "Imitation Is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway."

The authors studied Berkshire Hathaway from 1976 to 2006 and found that "a hypothetical portfolio that mimics [Berkshire's] investments at the beginning of the following month after they are publicly disclosed also earns significantly positive abnormal returns of 10.75% over the S&P 500 index." Wow.

So, we should all be poring over Berkshire's 13-F filings and buying what Buffett and team did, right? Not so fast.

Those findings are eye-opening and impressive, but in our view, they don't offer much for prospective investors for two reasons:

Berkshire circa 2009 is much different than the Berkshire of the 1970s, 1980s, and 1990s. For one, Berkshire is huge now and can only trade in mega-liquid, mega-cap stocks. More important, because of this herding behavior and its effect on stocks he likes, Buffett now favors private deals or full acquisitions over common stock purchases.

The Internet has revolutionized stock investing, making more information more readily available -- at a faster pace. In other words, informational advantages are likely lessened in the digital era.

It's this latter point that got us to thinking about one of our favorite Web resources, GuruFocus.
What now? GuruFocus is a website that tracks "the buys, sells, and insights" of the world's "investment gurus." This is a list that includes long-term outperformers like Warren Buffett, Wally Weitz, and Seth Klarman.

It's a neat website that sends out neat monthly emails, but we waver on this question: Is it a truly valuable service, or is it merely an interesting service?

After all, you shouldn't be buying or selling stocks because other investors are, and doing so may give you a false sense of security about your decision. As Ben Graham once said, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." And that's true even if it's a really smart crowd.

So, what are the current "Consensus Picks of Gurus" (i.e., the stocks the most gurus are buying)? The list includes MasterCard (NYSE: MA), Walgreens (NYSE: WAG), Best Buy (NYSE: BBY), Sun Microsystems (Nasdaq: JAVA), and Canadian Natural Resources (NYSE: CNQ) -- a nice list of businesses, to be sure.

But are these sure winners over the next year, or five, or 10? No.

Who knows why these gurus bought them, or when or why they'll sell them? Was it macro opportunities/concerns? Bottom-up fundamental insights? Something they saw during a meeting with management? Are they selling because of investor redemptions?

Heck, it may be that Ron Muhlenkamp bought MasterCard because he saw that Steve Mandel bought it, or that John Hussman got Best Buy because he figured George Soros knew something.
Again, who knows? The point is: Don't buy stocks because others are buying the same stocks. Don't simply follow Warren Buffett's publicly disclosed stock trades -- following the Oracle's moves, herd-like, is likely to lead you down an unprofitable road.

If you want to profit from Buffett's brain, you have two choices.
Buy shares of Berkshire Hathaway.
Study Buffett's shareholder letters, magazine articles, and body of work, and apply those lessons to your investing.

Both are good courses of action
While buying a share or two of Berkshire is a prudent course of action (Tim added to his position just a few months ago), it is worth noting that Berkshire today is very different from the more nimble version that bought shares in tiny companies such as Blue Chip Stamps, Associated Retail Stores, and Illinois National Bank.

Back then, Buffett was able to focus on good businesses at great prices regardless of size, industry, or geography -- and thus got some great deals on the very small-cap end of the spectrum.

That's what we do each and every day at Motley Fool Global Gains. As co-advisor of Global Gains (Tim) and a contributing author to the international investing chapter of our most recent book (Brian), we believe the good businesses at great prices are the small and foreign companies that American investors largely don't think are worth their time.



Already subscribed to Global Gains? Log in at the top of this page.
Tim Hanson owns shares of Berkshire Hathaway. Brian Richards does not own shares of any companies mentioned. Best Buy and Berkshire are Motley Fool Stock Advisor and Motley Fool Inside Value recommendations. Coca-Cola is an Inside Value selection. The Motley Fool owns shares of Berkshire Hathaway and Best Buy and would like you to meet its disclosure policy.

http://www.fool.com/investing/international/2009/04/30/why-you-shouldnt-follow-warren-buffett.aspx

Investment Advice from Jack Bogle

In Depth
April 9, 2009, 5:00PM EST

Investment Advice from Jack Bogle

The father of indexing cautions against trusting money management firms, market timing, or underestimating the potential for stock gains

By Roben Farzad

Jack Bogle turns 80 this May. Last summer his body started to reject his 13-year-old transplanted heart, a turn of events that landed him in the hospital four times as the financial world was melting down. Bogle should be in bed. He has every reason to just sit back and reflect on his career as the father of indexing and as the conscience of the individual investor.

But with the stock market not far from a 12-year low—and banks the world over taking ever-larger bailouts—he'd rather spend these delicate days raising hell (much to his wife's consternation). He thinks mutual funds totally blew it by spending untold sums on supposedly deep-digging in-house research only to totally miss the leverage time bomb. This might be a tad more tolerable, he says, if they didn't pass those costs on to customers, who ended up losing even more.

Bogle is pressing Washington for explicit regulation concerning fiduciary responsibilities. Here is some of Bogle's advice for investors in these turbulent times.

The Stock Market
"If you can't afford to lose one more penny," says Bogle, "get out. But, if you're in your 20s to 40s, keep going. These are good values. The stock market has taken an awful lot of this mess into account, and it's hard for me to believe that common equities won't do better than Treasuries from this point on." Bogle thinks that a 7% nominal return—more than twice Treasury bonds—is realizable over the next decade.

Simple Math
Bogle's "relentless rules of humble arithmatic" show the importance of being vigilant about costs. A dollar invested over 50 years at 8% a year compounds to just under $47. But dock just 2% for expense ratios and transaction costs and you're down to $18. Back out another three percentage points for inflation and you're at $4.38—less than a tenth of your potential catch.

On Timing and Chasing the Sector du Jour
"The stock market's day-to-day is actually a distraction to the business of investing," according to Bogle. His point: The past century of data show that American businesses have grown at an annual rate of about 9.5%, with 4.5% from dividend yields and the remaining 5% from earnings growth. The simultaneous aggregate return on bonds averaged 5%. These are the realistic benchmarks to focus on. "It's all simplicity, mathematics, and common sense," he says. In other words, calibrate your expectations to these long-term figures, a discipline that requires you to ignore the pull of solar, B2B, nanotech, or whatever last year's hot sector was.

Sales Ethics and Practice
Caveat emptor for investors: Don't assume your retirement provider or money management firm espouses a standard of honesty, full and fair disclosure, or putting its clients' interests first. The industry is quietly bifurcated into salesmen and professionals. That is why Bogle is urging Washington to enact a federal standard of fiduciary duty to mandate prioritizing clients, avoiding conflicts, and disclosing all fees.

Overextended Treasuries
"Bond prices are already high. Stocks should do 3 or 4 percentage points better than bonds."

Act Your Age
The percentage of your portfolio in bonds should roughly match your age. For example, a 30-year-old investor would be 30% in fixed income—a 75-year-old, 75%.

Where's the End?
This downturn could last 1½ years to 2 years. But the stock market will recover months before a turnaround comes. Don't try to time your entry.

Plan More Wisely: Your Savings Are Likely Inadequate
At the end of 2008, the median 401(k) balance is estimated at just $15,000 per participant. Even if you project this balance for a middle-aged employee with growth over time via presumed higher salaries and investment returns, that figure might rise to some $300,000 at retirement age (if the assumptions are correct). But while that hypothetical accumulation may look substantial, it would be adequate to replace less than 30% of preretirement income—a help, but hardly a panacea. (The target suggested by most analysts is around 70%, including Social Security.)

Contribute More
One reason for today's modest 401(k) accumulations is inadequate participant and corporate contributions made to the plans. Typically the combined contribution comes to less than 10% of compensation, while most experts consider 15% the appropriate target. Over a working lifetime of, say, 40 years, an average employee contributing 15% of salary, receiving periodic raises, and earning a real market return of 5% per year, would accumulate $630,000. An employee contributing 10% would accumulate just $420,000. If those assumptions are realized, this would represent a handsome accumulation, but substantial obstacles—especially the flexibility given to participants to withdraw capital—are likely to preclude their achievement.

Get Out of Your Own Way
There is excessive flexibility in 401(k) plans. Designed to fund retirement income, they are too often used for purposes that subtract directly from that goal. One such subtraction arises from the ability of employees to borrow from their plans, and nearly 20% of participants do exactly that. Even when and if these loans are repaid, investment returns (assuming they are positive over time) would be reduced during the time that the loans are outstanding, a dead-weight loss in the substantial savings that might otherwise have accumulated by retirement. Even worse is the dead-weight loss—in this case, largely permanent—engendered when participants "cash out" their 401(k) plans when they change jobs. The evidence suggests that 60% of all participants in defined-contribution plans—i.e., a 401(k)—who move from one job to another cash out at least a portion of their plan assets, using that money for purposes other than retirement savings. To understand the baleful effect of borrowings and cash-outs, just imagine in what shape our beleaguered Social Security system would find itself if the contributions of workers and their companies were reduced by borrowings and cash-outs flowing into current consumption rather than into future retirement pay. Bogle wants a new, streamlined, and unified retirement savings system to be stripped of so many confusing options. He says it should be replaced with a handful of conservatively calibrated choices that are clear in their risk profiles and the expectations they can satisfy.

Mandatory Allocation?
One reason that 401(k) investors have accumulated such disappointing balances stems from unfortunate decisions in the allocation of assets between stocks and bonds. While virtually all investment experts recommend a large allocation to stocks for young investors and an increasing bond allocation as participants draw closer to retirement, a large segment of 401(k) participants fails to heed that advice.

The Wrong Mix
Nearly 20% of 401(k) investors in their 20s own zero equities in their retirement plan, instead holding outsized allocations of money-market and stable-value funds—options that are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30% of 401(k) investors in their 60s have more than 80% of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30% or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when members of this age group are preparing to draw on them.

The Under-20% Rule
Company stock is another source of unwise asset allocation decisions, as many investors fail to observe the time-honored principle of diversification. In plans that offer company stock as an investment option, the average participant invests more than 20% of his or her account balance in company stock, an unacceptable concentration of risk. If you feel you must, dabble in company stock with not more than a sliver of fun money. You're already overweighted in your exposure to the company's fate by way of employment and income.

The Old College Try
"Mutual funds can make no claim to superiority over the market averages," argued Bogle in his 1951 Princeton senior thesis, The Economic Role of the Investment Company. In other words, good luck beating the indexes. If anything, his prophecy was understated. Of the 355 equity funds in business in 1970, 223 have since gone bust. Of the 132 that survived, only 24 beat the Standard & Poor's 500-stock index and only seven did so by more than (a statistically significant) 1% per year.

It Runs in the Family
"Gentlemen, lower your costs!" urged Philander Banister Armstrong, Bogle's great-grandfather, in an 1868 speech to fellow insurance executives. In 1917, Armstrong published the book A License to Steal: Life Insurance, the Swindle of Swindles: How Our Laws Rob Our Own People of Billions. "He's my spiritual progenitor," says Bogle.

BusinessWeek Senior Writer Farzad covers Wall Street and international finance.


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http://www.businessweek.com/print/magazine/content/09_16/b4127040249262.htm

Top Investors: How They Beat a Scary Market

Top Investors: How They Beat a Scary Market

Ben Steverman
Monday, April 27, 2009
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BusinessWeek asked successful portfolio managers how they navigated a nasty recession and financial crisis

Hardly anyone predicted the size and scope of the recent market meltdown. At the depths of the crisis, which started in 2007 and continues today, there was almost no place for investors to hide.

Still, some investors protected their portfolios far better than others at a time when the concept of investment risk seemed to take on a new dimension. BusinessWeek talked to these investing pros in search of their secrets to success.

The bottom line: There was no simple solution. Successful investing strategies in the past couple of years represented a wide range of philosophies and investment choices. Yet nearly all these top investors, relying on years of experience, sought out only high-quality investments, and many of them were aware of financial and housing difficulties early.

Who Dodged a Bullet?

Which pros managed to sidestep the worst of the market mayhem? What were their strategies? Here's a look:

Ann Benjamin and Thomas O'Reilly, Neuberger Berman High Income Bond Fund (LBHBX)

For Benjamin and O'Reilly, investing is about keeping an eye on the big picture. In 2005, their Neuberger Berman High Income Bond Fund pulled out of bonds exposed to the overheated housing market.

They didn't predict a big housing crash, Benjamin says, but "we thought there was significant oversupply being built in the market."

In 2007 they lightened exposure to more cyclical industries—the sort that would be hurt by the coming recession. "You have to be ahead of the curve," O'Reilly says. "You can't sell on the news." Rather, you need to anticipate the news.

Last year was tough on high-income bond funds, but the Neuberger Berman High Income Bond Fund fell 19% in 2008, beating its Morningstar (MORN) category by 22.5 percentage points. The fund is rated five stars by Morningstar.

Benjamin and O'Reilly are looking ahead, trying to predict the market and the economy's next moves. Fearing the economy could keep dragging longer than predicted, they carefully examine companies to make sure their investments "make it through the cycle," Benjamin says.

Rich Gates, TFS Market Neutral (TFSMX)

By contrast, Rich Gates doesn't shift approaches depending on his predictions of the future. His TFS Market Neutral fund has used the same quantitative strategy since it was started five years ago. It's an approach similar to the hedge fund strategies TFS has run since 2001.

This U.S. equity fund fell just 7.3% in 2008, beating the broad Standard & Poor's 500, which dropped 37.2%, and doing 7 percentage points better than its Morningstar category.

The fund protects assets not just by buying stocks, or going "long," so the fund benefits when prices rise. It also shorts other stocks, by borrowing shares and selling them so the fund benefits when prices fall. The fund stays three-fifths in long positions and two-fifths short.

The fund's computers automatically rank equities according to consistent (and proprietary) criteria, seeking out stocks to buy and short for a few days or up to a month. The shorting strategy limited losses in a tough year, but TFS has also chosen the right stocks to outperform the market in good years like 2006. "It's definitely harder in an up market than a down market," Gates says.

Eric Cinnamond, Intrepid Small Cap Fund (ICMAX)

For Cinnamond, investing starts with close examination of individual companies. "We're just focusing business by business," Cinnamond says. The Intrepid Small Cap Fund buys a stock if it is a "good business"—with a strong balance sheet and consistent cash flow—and if it's priced 20% less than Cinnamond thinks it's worth.

In 2007, when stocks peaked, Cinnamond says nothing was meeting his criteria. "I couldn't find anything," he says. He also avoided financial stocks, believing the rapid increase in mortgage debt was a bubble that would burst.

With much of the market overvalued, Cinnamond had much of his portfolio in cash—perhaps the safest place to be—as the market slid during 2008. At the start of 2008, cash was almost 40% of his portfolio.

In the past 12 months, the fund, rated five stars by Morningstar, has lost just 2.5%, 36 percentage points better than the S&P 500. In early March, when stocks hit their bear market lows, the fund had almost no cash at all, because it was fully invested in equities.

"Now we're able to buy some great companies at deep discounts," he says. "It's the perfect scenario."

Roger Vogel, Silvercrest Asset Management

Vogel also focuses on individual companies, and especially their management teams.

"We get our feel for what's happening in the economy from our companies," Vogel says. Like most "value" investors, he looks for companies trading at a discount. But his fund is "quality-oriented." Sticking with financially secure firms has helped during the credit crisis.

As the crisis unfolds and recession continues, "the strong will emerge stronger and the weak will go away," Vogel says.

He judges firms not just by their numbers but also by their executives. More than two decades of experience help in evaluating management presentations, he says. "If you're an experienced investor, you tend to come out of those with a different mindset," he says.

Silvercrest's small-cap value portfolio—managed for the firm's private clients—is down 6.7% in the past three years, compared to a 17.5% decline for the Russell 2000 Value index.

Jim Moffett, UMB Scout International Fund (UMBWX)

Moffett also focuses on quality, though he does so in international stocks.

Quality "means starting with a balance sheet with not too much debt," Moffett says. His UMB Scout International Fund has traditionally avoided financial stocks because of their reliance on debt and their lack of transparency, he says.

He also avoids too much risk by, for example, staying out of China and Russia, which saw huge market declines. "That's where the reward is, but that's also where the risk is," he says. "We thought the risk was higher than people appreciated."

His fund picks stocks for the long term only after careful vetting, he says. There's "not a lot of razzle-dazzle," he says. "Just stick to the basics."

Moffett's fund, rated five stars by Morningstar, fell 38% in 2008, a disastrous year for overseas stocks, but it beat its benchmark and Morningstar category by more than 5 percentage points.

Emmanuel Ferreira, Oppenheimer Quest Opportunity Value Fund (QVOPX)

For Ferreira, the key to investing is flexibility. The Oppenheimer Quest Opportunity Value Fund can buy or short almost any asset, from bonds to stocks to commodities.

"It's really a mutual fund format where we are allowed to have hedge fund flexibility," he says, adding, "When you have a fund that's flexible, you can take advantage of a lot more opportunities."

Ferreira spotted problems in housing and mortgage debt early. In 2005 and 2006, the fund started shorting—or betting against—subprime mortgage securities. By the time the fund had unwound those bets, it had earned about $200 million—"30 times the money we put at risk."

By the end of 2006, the worry was "too much excess in the financial system and the global economy," Ferreira says. The fund's response was to shift assets into cash.

The fund, rated five stars by Morningstar, is down 17% in the past 12 months.

Michael Cuggino, Permanent Portfolio (PRPFX)

Expect no bold predictions from Cuggino, who says his fund is "based on the premise that the future is unpredictable and investors should prepare themselves for a variety of a different outcomes."

People—even and especially portfolio managers—are bad at predicting the future, he says. So, the Permanent Portfolio is diversified in a wide array of asset classes, a classic risk-management strategy. Gold is 20% of the portfolio, silver 5%, and Swiss-denominated assets are 10%. Equities based on natural resources are 15%, while U.S. growth stocks are 15%, and 35% of the fund sits in U.S. and corporate bonds.

The fund might underperform in a fast-rising bull market for stocks, but there's stability and protection in its broad strategy.

There's little room for managers to make a big bet on one lucrative strategy, but on the flip side, the chance for big losses is reduced. The approach has worked: The five-star Morningstar fund lost just 8.4% in 2008.

Steverman is a reporter for BusinessWeek's Investing channel.

http://finance.yahoo.com/special-edition/active-investor/7_market_pros;_ylt=A0S00ta4tfpJcngBG3dsLKJ4

Don't Be Long and Wrong

Active Investing: Managing Risk

Don't Be Long and Wrong

David Serchuk
Thursday, April 30, 2009EmailIMBookmarkdel.icio.usDigg

Think like an institutional investor in order to avoid being either all long securities or all in cash.

Recently we laid out strategies for better ways to buy and hold securities, the idea being that even though the markets have taken a pounding over the past year, you don't have to lose your shirt should you stay long.

Now, however, we are showing the other side of the argument, which is how to avoid being long and wrong. The idea being that while buying and holding--or conversely moving to cash--may be good strategies for some, markets investors should realize that there are other ways to manage portfolios. Just as it can be a mistake to trade in and out of positions as the wind changes, it can also be a mistake to feel that during tough times, you either have to stay long, or move all your assets into savings.

But how to do it? Here is where the Forbes Investor Team steps in. Stephen Roseman, the head of hedge fund Thesis Capital, says that investors should look to have some kind of diversity among their assets. During a downturn, or at least during this most recent downturn, the correlation between all asset classes becomes especially strong, so you want to get out of this trap. The key for individual investors is to try and take a page from institutional investors, who have a large arsenal of tools at their disposal.

Individual investors can follow this model by employing asset managers with a more institutional focus, who look for opportunities in more sophisticated areas including merger arbitrage, statistical arbitrage and venture capital. These would be hard areas for the average investor to tap into, so it's best to seek professional help in order to invest here. Roseman says he expects to see more asset managers offer this type of guidance in the coming quarters.

In total, Roseman recommends investors have between 10% and 30% of their portfolio in something other than long stocks or bonds. Often homeowners already have this base covered in the form of real estate.

Ken Shubin Stein, of hedge fund Spencer Capital Management, adds that a basic but under-appreciated way to lessen the impact of being long and wrong is simply to pay off outstanding debt. Combine that with living beneath one's means, and it can give individuals the emotional fortitude to stick to an investment plan through volatile times. This is key because investors are prone to abandoning their rationally hatched investment plans during turbulent times--not because the plan is failing, but because the investor panics. They pay for this fear when markets rebound, and they miss the upswing.

John Osbon, the head of Osbon Capital Management, makes his living by investing primarily in indexes and exchange-traded funds. He says a diverse portfolio of ETFs can help protect investors through times good and bad. He also says that even though U.S. equity markets have been not done well in the past 10 years, other markets like Latin America have.

One way to play this diversity is through the iShares S&P Latin America 40 Index Fund ETF (ILF). This ETF tracks firms in Mexico, Brazil, Argentina and Brazil. Over the past decade it's up 240.1%, although its down 50.0% over the past 12 months.

One intriguing play noted by Osbon is the new IQ Hedge Multi-Strategy Tracker ETF (QAI), an ETF that seeks to mirror the performance of hedge funds. This is an exciting investment because hedge funds represent a potentially lucrative yet dangerous place to invest. On the one hand, hedge funds have shown strong recent performance as the markets have stumbled, and through mid-March they were down 1.1% versus 18.2% for the S&P Total Return Index.

On the other hand, hedge funds have onerous expenses, are lightly regulated, require large investments and can go out of business. So owning a hedge fund index allows you to tap into an exotic world with few of the obvious downsides. Having said that, the ETF has only been in existence for less than a month, so you might want to wait a little while to see how it actually does before taking a step in.

Diversify Like A Pro

Forbes: What are some ways that traditionally long-only individual investors can use the strategies employed by places like, ahem, hedge funds to diversify their risk, and lower their correlations between stocks and bonds? Stephen laid out a few, what do you think? What can individual investors be expected to reasonably crib from more sophisticated players to diversify?

Stephen Roseman: The biggest impediment that the individual investor has faced is an inability to be anything other than "long and wrong." What I mean by that is that the individual investor has historically had two choices: 1) to be long stocks and bonds, or 2) to make a market call and move their assets into cash. Of course, many individual investors are also diversified in the form of some real estate holding, typically a primary residence.

Institutional investors often have a much more "complete" view of the world. They position their assets across disparate and typically less correlated asset classes and strategies. So while they may have exposure to stocks and bonds through traditional asset managers who are long-only, they also have exposure to less correlated strategies like activism, merger arbitrage, statistical arbitrage, convertible arbitrage, short-biased, private equity, venture capital, real estate, etc. They also tend to give some thought to geographic exposure and investment duration.

In the coming quarters, you will see more asset management companies offer institutional-type products, with the aforementioned strategies, to the retail investor. Retail investors, and their advisers, will come to realize the benefit of diversifying away from long-only strategies. While this won't necessarily be a panacea for a world in which correlations all converge toward "one" as they did over the course of the last 18 months, these products will help investors mute portfolio volatility and contribute to more consistent returns.

Ken Shubin Stein: I agree with Stephen, but to date, the market does not yet offer good alternatives for individual investors.

Another risk for individuals is their view on volatility, risk and investment time horizons. The psychology that makes people chase returns is deeply rooted and probably impossible to change on a population basis. This leads to abandonment of sound strategies during inevitable periods of disappointing returns and is why the average investor earns returns well below the average mutual fund returns.

One alternative is for people to seek out expert help from financial planners and wealth managers, and follow a disciplined plan. This should include managing their liabilities as well as their assets.

Roseman: While, in theory, individual investors can, on their own, emulate some of the strategies that hedge funds use, in practice, it would be very difficult if not impossible. This is because of a smaller asset base, access to the tools needed to execute some of these strategies and ability to focus on strategies that are not well understood.

Even most institutional investors (pensions, endowments and the like) allocate out to specialists in their respective areas of expertise and don't try to emulate the myriad approaches on their own.

The average investor will be better served by seeking out fund managers that employ some of these strategies in an open-end fund format (i.e., a mutual fund). The typical investor can achieve the benefit of meaningful diversification by having some percentage of their assets, probably between 10% and 30%, in something other than long stocks and long bonds.

Of course, it also bears mentioning that most institutional allocators use little to no leverage, or borrowed money, in their own portfolios (although those they allocate to may). The individual investor can emulate that portion of the institutional approach by paying down any outstanding debt. This is especially true of high-cost debt like credit cards, which really undermines good financial planning on the portfolio side.

Shubin Stein: Exactly. I think it is under-appreciated that paying down debt and generally living below one's means allows investors to have the emotional strength to stick to a plan, even during periods of extreme volatility.

John Osbon: It is a nicely flung gauntlet, so let's examine it ... Let me begin by asking Stephen two questions, and then I will weigh in:

1. Which institutional investor do you admire, or think has done a good job, who you would like to see manage money for individuals?

2. What's your after-tax return on such a strategy?

Obviously, I have loaded the questions in my favor because I respectfully and resolutely believe the institutional route is the wrong way for individuals. "Completeness" does not seemed to have redeemed even the shrewdest professional investors, such as Harvard, Yale, et al., nor has it prevented the purveyors of knowledge, like Wall Street banks, from arranging their own funerals from the piles of research they produce.

Nor has non-correlation been a refuge because suddenly ... everything is correlated and heads straight down at the same time. When you most need it, correlation vanishes as quickly as your capital. In fact, Rich Bernstein, formerly of Merrill Lynch/Bank of America, showed how equity correlation is now over 80%, from 60% in the '80s, and that correlation in down markets approaches 95% for all asset classes. There is literally no place to hide. That's no wonder in an investment world dominated by shadow banking.

Lastly, taxes matter, and are likely to matter more the way our government is spending money. There is a big difference between agents of money (institutions) and owners of money (individuals), and that difference is the owners of money pay taxes on their investments, while institutions defer taxation forever. A pre-tax strategy may look quite attractive--and could belong in your IRA or 401(k)--but after-tax the return story is quite different when you have to give up 20% to 40% of the gain.

Stephen is mining a deep and rich lode with diversification, however, which is the one proven way investors can manage risk and return. As an indexer, we pick index materials via ETFs. But it is the architecture of the portfolio--the diversification of "glass, steel, wood and plastic" ETFs that dominates the risk and return. I would look at the whole building of one's portfolio, not just the components. Not all markets have done poorly in the last 10 years. High-quality fixed income has done extremely well, as has most of Latin America. China has positive returns, too, as you might expect.

You can index virtually anything these days via ETFs, even hedge funds with the new QAI, the IQ Hedge Multi-Strategy Tracker ETF. I am not necessarily recommending it, but it's there, and sub-strategies such as the ones Stephen mentions are also coming in ETF form.

I have to say that ETFs are superior to mutual funds for individuals in our view, because with an ETF you own your own basis, whereas with a mutual fund you own everyone else's tax bill.

Ken, what is your recommended debt-to-capital ratio for an individual? I suspect most people would be very interested to hear your notion applied to them personally.

Shubin Stein: I think it is difficult to have one ratio for all individuals. What may be conservative for someone with a very stable income source, say a dentist or doctor, may be aggressive for an artist or advertising executive or finance professional. A principle-based approach is easier to discuss--live life realizing that sudden, and sometimes severe, reversals can happen to any of us, and try to be as immunized to this risk as possible. For some, it means no debt, for others it may mean moderate levels.

The common mistake is to extrapolate near-term experience into the future. When times are good, lots of people assume the good times will last forever and behave accordingly, and when times are tough, like now, it is a challenge to realize that things will get better.

John, given how poorly diversification worked this year, have you changed your opinion on the importance of diversification, or do you think it is important but nothing works all the time?

Osbon: Your principles are widely applicable, and hopefully will be applied!

I do believe some numbers add insight, however. If you run your financial life like Me, Inc., and subject it to discipline and guidelines just like you would any company, your results, and your happiness, might improve. Think, for example, if you limited your total debt to no more than 50% of your capital--ever, including real estate, how much trouble could have been avoided. Likewise, limiting debt service to no more than 20% of cash flow would be a conservative, prudent limit to observe. In fact, these two limits would make Me, Inc. look quite attractive in today's environment. One would also be free to lower those limits with the passage to time so that by age 65, there would be zero debt and zero debt service.

Ken, just so I understand, why do you say diversification worked poorly? Treasuries of all types and stripes did fabulously last year. Are you referring to equities only?

Shubin Stein: Not just equities. Credit, real estate, hard assets of all types did poorly. The bubble in Treasuries did offset the pain in all other areas unless someone had a very large percentage of their assets in them.

Also, I agree some numbers are helpful. This why people need wealth managers! I would probably advise even lower ratios than the below, but that is just because I am very conservative.

Osbon: More clients should come to you!

I believe, and it can be shown, that the added value of non-correlated equities is approaching zero. Common sense explains why: globalization and the Internet. It is no exaggeration to say that almost any company, no matter how small, competes globally. Why? Because you can get it cheaper on the 'net, and your customers will buy it there unless you give them a reason not to, like service, reliability, quality, status or others.

The real non-correlation and its value as expressed in diversification, I believe, comes from truly equity-unalike assets--bonds, commodities, and real estate.

Roseman: In an attempt to speak to all of John's points I will touch on them in order.

I think any conversation needs to begin with the definition of investing "success." While Harvard, Yale et al. suffered declines in the value of their endowments, I would point out that they outperformed the respective underlying asset classes handily in an environment where, to your point, correlations were converging to one. I think it's also important to remember that one year does not a track record make, and these endowments have extraordinary long-term returns. That's a fact, not opinion. Most people are investing for some horizon that exceeds one year so, again, I think the conversation about success first needs to be framed by the definition of "success."

It probably also bears mentioning that we have just suffered the fastest and most catastrophic destruction of wealth since the Crash. This has been the 100 year flood.

As for ETFs, they are appropriate when and if they are used by individuals with the tools to divine how and where they should be positioned. Moreover, many of them suffer tracking errors. I am not suggesting they don't have a place in someone's portfolio, but the point of investing (in any asset class) is to do one's homework and carefully and judiciously allocate capital to the highest return opportunities. As it relates to investing successfully over the long term, an ETF is a shotgun approach to what I believe requires a scalpel.

As for which investors I admire, since many of my competitors are also friends of mine, I am going to refrain from naming names for fear of insulting anyone by omission.


http://finance.yahoo.com/special-edition/active-investor/buy_hold_rip;_ylt=A0WTUTofufpJVPMAHB9sLKJ4