MarketRiders Blog

Why You Should Fire Your Investment Adviser Today

Saturday, April 9, 2011

Burton Malkiel’s famous tome, “The Random Walk Guide to Investing,” begins with the right exhortation for most investors: Fire your investment adviser today. Although it takes moxy to say “no” to that special someone who has earned your trust, the facts reveal that your investments will do far better with your wealth manager’s hands no longer dipping into your cookie jar.

The facts are plain to understand. According to the U.S. Securities and Exchange Commission (SEC), the average adviser charges 1.11 percent in annual fees to manage your money. This same adviser is likely to put you into a portfolio of actively managed mutual funds that average more than 1 percent in fees. That places a more than 2 percent burden on your portfolio and drags down performance.

Some investors think that 2 percent is a small price to pay for expert guidance. What many investors fail to realize is that 2 percent represents a shocking 25 percent business partner in your annual earnings. With the average diversified portfolio earning around 8 percent annually, with every dollar you earn you are paying 25 cents for “expert” help.

It is not uncommon for a business partner to invest large sums of money or to work for years to gain 25 percent ownership of a business. What is it that an investment adviser does that should result in such a favorable perch?

Performance? Active management was exposed as a loser game decades ago by the academics. If that is hard for you to accept, add in adviser fees, and it should be easy to see that your portfolio is doomed to underperform.

Trust? Advisers sell many things, trust being at the top of the list. How much can you trust a person that is willing to sell you high-fee, actively managed funds? Trust is a feeling that a smart investor should not trust. Strategy is key. If the adviser fervently recommends indexing, then you have the first building block of trust.

Allocations? How difficult is it in today’s information age to obtain sophisticated asset allocations designed for your needs? Not hard at all. At MarketRiders, you can obtain a globally diversified allocation customized to your needs and optimized for your broker. There is no longer a need to pay high fees for such guidance.

Personal Attention? The average adviser has more than 100 clients and is rewarded for new business development, not taking a deep interest in current customers. Ponder how difficult it must be to stay current on the specific needs of a client when you have 99 others to think about and five more this week you are trying to close. Where do you think that adviser will put his energy? Toward new business and new revenue. Think about it. When was the last time your adviser contacted you?

Although firing your adviser is probably the best thing you could do for your portfolio, some investors do benefit from outside management. Here are three reasons to keep your adviser on staff:

Problem solving. If you are faced with a unique set of problems, tax concerns, or major life decisions, an expert may be the perfect person to help you get on the right track. For problem solving, it is best to hire a financial planner who works by the hour. Get your problems solved and then move on.

Busyness. You may be so busy with your career and family responsibilities that the extra burden of managing your portfolio feels unbearable. Before you go with an adviser, be aware that managing a globally diversified indexed portfolio should take no more than a few hours a year. Even still, some may find the burden too heavy and want someone else to make the call. An adviser might be right for you.

Hand holding. The most notable reason to have an investment adviser manage your account is for behavior reasons. Research reveals that some investors have difficulty staying the course. Buying when the market is up and selling when it is down can be costly. Whipsawed by emotion and market hysteria, such investors would do far better having an adviser oversee the disciplines of smart index investing. While such oversight will cost, being suckered into the next stock tip, chasing trends, and timing the market will result in much greater damage than advisory fees ever could.

If you do hire an adviser, be sure he is committed to indexing, has reasonable flat-rate fees no greater than .25 percent of assets under management, and has transparent reporting and timely communication. Better yet, fire him and take control of your own retirement. Either way, index, stay the course, and retire on schedule.

What Is Asset Allocation Anyway?

Sunday, April 3, 2011

Yale professors studied money managers to uncover the source of their portfolio performance. They found that 90 percent of the returns came from the markets where they invested. Less than 10 percent came from the individual stocks they bought, and the timing of buying and selling investments. For example, if they owned small-cap value stocks and that group of stocks did well that year, the performance of that market was the source of their success, not the specific small-cap stocks they had chosen.

That’s why sophisticated investors focus heavily on setting well-defined targets for how they allocate assets. To be an “asset allocator,” you play by different rules. Every portfolio needs six or seven core asset classes. Conventional wisdom says you should have at least 5 percent of your portfolio—but no more than 25 to 30 percent—in a core asset class. A core asset class has three primary characteristics:

Unique purpose. Like each instrument in a jazz band, each asset class plays a valuable “role” in different economic circumstances. U.S. treasuries protect you against economic meltdowns like 2008, but they lose value from inflation and slow down overall portfolio growth. Real estate hedges against inflation, provides a steady income stream, and can appreciate like stocks, but is not immune to economic cycles.

Stocks have outperformed every other asset class since 1928, but as we’ve seen, they can become overvalued, and suffer a decade of volatility and mediocre performance. And if America is growing slowly and countries like India and China are outperforming, investing in foreign stocks gives you a hedge.

Market-based returns. Core asset classes generate returns from a market, not the skill of an investment manager. For example, venture capital, private equity, and hedge funds derive their returns based upon who the manager is and how accomplished he is. Thus, these are not “core” asset classes.

Access. While many consider fine art an asset class, most everyday investors just can’t build a diversified portfolio of paintings, coins, and antiques. The asset class must be broad and deep enough to invest in. It must have a well-established marketplace, not made up of trendy concoctions promoted by Wall Street financial engineers. Thus, managed futures are not considered an asset class.

Non-core asset classes satisfy two of the three characteristics above. Examples would be venture capital, private equity, and hedge funds. Endowments and wealthy families have the resources and expertise to build portfolios consisting of 20 to 25 percent venture, hedge, or private equity funds. But most of us can’t do this. Some investors are sold on using a fund of funds to invest in these asset classes, but never consider issues such as: Can you trust the sponsor? Do they have conflicts of interest in their fee structures?

Moving to the “art” of asset allocation shows how this gets tricky. Here are a few examples:

Sectors. There are 10 basic economic sectors, and within each sector there are industries. Communications equipment and software are industries within the technology sector. Sectors are not asset classes, except the real estate sector, which is a core asset class. The U.S. real estate sector includes apartment buildings, warehouses, office buildings, and retail malls. It tends to behave different than the overall U.S. economy. Your house is not an allocation to real estate because its “returns” are mostly psychological and are limited to residential real estate in your town.

Styles. For 30 years, a great allocation strategy has been to parse out small public companies that have a “value” bent, and allocate to “small-cap value” stocks. This has added significant returns to a portfolio.

Commodities. In the last five years, allocating to commodities has become more acceptable for portfolios. But the debate rages on how to allocate between gold, precious metals, energy, and agricultural products?

Start thinking about your portfolio through this asset-allocation lens. You’ll start wondering what you have, and how it will work in the next market rise or meltdown. Now we’re talking!

Filed in Asset Allocation | Comments (0)

Our Conspiracy Theory

Tuesday, March 29, 2011

Have you ever met the crazy conspiracy theorist who is convinced that a well-executed and malevolent plot lurks behind most events? These were the people whose eyes bugged-out during Y2K, who are convinced that Apollo 11 never landed on the moon, that the World Trade Center was actually blown up by the United States to garner support for invading the Middle East, and the list goes on. The conspiracy thread has woven a thick yarn throughout the ages. It would be worthy of a good belly laugh if it weren’t for the sick feeling you get when you realize that some people actually believe that stuff.

There is one conspiracy however, worthy of your attention: Those on Wall Street don’t want you to know that their industry is a sham. For Wall Street, the hypnotic malaise they cast over the unknowing investor is nothing less than an $11 trillion dollar shell game. Their gambit makes the baccarat table at the Bellagio look like the neighborhood lemonade stand.

And like any good shell game, they keep the pea moving so you never really understand what just happened. Hideous mutual funds vanish into thin air leaving only winners so that fund companies can claim their funds are leaping tall indexes in a single bound. High fees slip out the back-end of your account while you lie in bed asleep at night, thinking they got your back. And how about that reporting? It’s so convoluted you would have to be a Nobel Laureate in economics to even know what you made—or lost—after fees and taxes in any given year. Did you know that it practically took an act of Congress to force 401(k) providers to tell employees in plain language how much they are paying in fees?

Speaking of Nobel Laureates, fortunately there are a few that have been paying attention: Harry M. Markowitz, Merton H. Miller, William F. Sharpe, and Nobel candidate Eugene Fama, not to mention other notable luminaries such Princeton professor and author Burton Malkiel, John Bogle the founder of Vanguard, and William Bernstein, the acerbic author and truth teller. If you haven’t yet familiarized yourselves with their findings, the time has come to do so. They’ve blown Wall Street’s cover in reams of research. Never mind that they conclusively demonstrate that low-cost indexing beats active management by a long shot, or that the buy, hold, and rebalance style of investing trumps the vein-popping practices of Jim Cramer and crew.

Worse yet, the good guys’ PR campaign is weak. While they stutter in the corner, Wall Street is rolling out eloquent waves of hypnotic media, which roll over us as in a tsunami of minute-long TV ads, billboard artistry, and heart-grabbing radio spots. Each makes you want to pull out your hanky, pick up the phone, and call your mom to say you love her.

Who cares about facts when Smith Barney speaks? Why not talk to Chuck? He sure seems like a nice guy. His name is Chuck. Have you ever met a mean Chuck? Or what about the TD Ameritrade guy, Sam Waterston. He played stalwart Jack McCoy on the NBC series “Law & Order.” He sure cracked the code there, so he’ll be the guy I can trust for my retirement, right?

Yes, Charles Schwab, TD Ameritrade, and others are excellent brokers. For a fair, low price you can have excellent trade execution and fulfillment, as well as receive tremendous customer service and online reporting. But watch your pocket if you go to these firms for investment advice. Chances are they will roll out the four-color glossy print, full-court press, and slip you right into some mutual funds from their supermarket that drip, drip, drip away your hard earned savings in high fees and underperformance.

Conspiracy theories are for the birds. Ours, however, isn’t one of them. Facts are for the discerning. When it comes to Wall Street, the facts have been revealed by the best economic minds in the world. Are you listening?

Filed in About ETFs, Active Versus Passive Investing, Asset Allocation, Benefits of Asset Allocation, ETFs & Index Funds, How Wall Street Makes Money, Index Funds, Index Funds Versus Mutual Funds, Modern Portfolio Theory, Portfolio Diversification, Underperformance of Managers | Comments (0)

Tsunamis, Nukes, and Uprisings: Why Smart Investors Don’t Predict

Wednesday, March 23, 2011

This year has been full of the unexpected. The world is an unpredictable place. It was just a few weeks ago that Egypt and then Libya dominated the airwaves. Now they are distant memories with the horrific events in Japan this week. Who would have thought that an earthquake would lead to a nuclear meltdown? Who would have predicted that Arab dictatorships would topple because of Facebook and Twitter? What is an investor to do?

The answer lies in whether your investment focus is based upon predicting or positioning.

It’s a lot more fun to invest based upon predictions. Jim Cramer and pundits interviewed on CNBC are highly entertaining. They tell us with utmost certainty what will happen with a company, a sector, or an economy. And they know how to provoke our fear and greed so we’ll keep watching.

Most everyday investors only know an investment world based on predictions. They’ve heard about the mutual fund manager who finds undervalued companies by predicting cash flows, the Merrill Lynch broker who calls with his analyst’s latest tip, the Motley Fool newsletters, or the UBS economist who predicts a drop in the U.S. dollar.

But most of us are still smarting over our damaged portfolios from the 2008 financial meltdown that the forecasters failed to predict.

Another group of investors—institutional investors such as pensions, endowments, and foundations—believe that predicting the future is at best informed fortune telling. After decades of research and experience, they’ve concluded it’s better to focus on being positioned, instead of attempting to predict what will happen in the world. They know there are risks that can’t be articulated or imagined, let alone predicted. So they endeavor to build portfolios to withstand the unexpected.

Most of these institutional investors have fully recovered from the 2008 meltdown. They didn’t sell stocks in March 2009 in a panic—they bought them. What can we learn from them?

First, these investors face sobering tasks. Pension plans have to send checks to retirees every month. Managers at university endowments have to help pay scholarships and faculty salaries. They want a portfolio with a variety of assets that behaves differently depending upon any scenario. They reason through allocations to U.S. stocks, treasuries, foreign stocks, real estate, or commodities. When the world panics, investors flock to treasuries. When inflation worries are front and center, commodities and real estate benefit at the expense of treasuries.

They debate these issues and end up with a policy that can only be changed by committee. Once they agree on the policy, they look for the best ways to “get exposure” to each type of asset. They focus on fees. They only hire managers if they feel they can get outperformance, otherwise they buy index funds. They don’t care about Netflix or Apple. They care about whether they have the right allocation to U.S. growth stocks. And when the markets have big changes and the actual percentages differ from their recipe, they don’t panic. They don’t change the policy. They rebalance back to the policy. These investors are buying Japanese companies this week, probably because their allocations have changed since the panic there.

There is a quiet but growing revolution going on in American retirement investing. Baby-boomers need to retire and they don’t have enough. They’ve grown weary of expensive predictions. They want to be positioned. Earthquakes, tsunamis, and revolts become stress tests for how well a portfolio is positioned. Was your portfolio well-positioned over the last six weeks? Are you trying to predict what will happen next? Think about positioning, not predicting, and manage your family money like the smart guys.

Filed in Active Versus Passive Investing, How Wall Street Makes Money, Underperformance of Managers | Comments (0)

Picking ETFs: The Good, The Bad and The Ugly

Monday, March 14, 2011

In the mid 1990s, exchange-traded funds came riding down Wall Street like Clint Eastwood in an old spaghetti western—fearless and ready to take on the bandits who had been terrorizing the townsfolk. For years prior to the arrival of ETFs, average investors were held hostage by obscene fees while mutual fund robbers brashly collected their booty, threw back some expensive whiskey, and then shamelessly shot up the town.

In 1989 the first ETF—Index Participation Shares—came to the rescue. This S&P 500 proxy traded on the American Stock Exchange but was quickly gunned down by the Chicago Mercantile Exchange who quickly perceived the threat. It wasn’t until 1993 that the real gunslinger rode into town and changed the order of the fund industry forever.

The Good ETFs. In 1993, SPDR S&P 500 (symbol SPY) was launched on the New York Stock Exchange. Known as SPDRs or “Spiders,” the fund became the largest ETF in the world. In just over 15 years, there are now close to 1000 ETFs with more than $1 trillion in assets and growing at a breakneck pace close to 30 percent year-over-year.

But just when ETFs were winning the day, the ETF industry drifted from its sound mooring after the SEC approved a redefinition of the term “index” in 2003. Before then, ETFs were limited to holding baskets of stocks that tracked broad market indices such as the S&P 500 or MSCI EAFE for foreign developed country markets. After 2003, the SEC allowed ETF providers to create any set of guiding rules to form newfangled “indices.” This changed the definition of an index and allowed the Wall Street crowd to run wild creating the latest, greatest “index” de jour, cluttering the universe of good ETFs with a never-ending wave of convoluted, bad, and in some cases, downright ugly ETFs.

When trying to make sense of the world of ETFs, there are five simple principles that will guide you to the good and away from the bad and ugly:

Index construction. Evaluate each ETF for the quality of the index it tracks and how well the provider replicates the given index’s performance over a long period of time. A bad index means a bad ETF.
Low management fees. Be sure that you are paying rational management fees for the asset class under consideration. In general, the lower your fee the more you stand to make over time.
High volumes. Quality ETFs often average billions of dollars in net assets where daily volume runs very high. This affords sufficient volume and liquidity so that the bid/ask spreads are narrow.
Low turnover. More turnover means more taxable income. Look for turnover to be very low, about 10 percent for equity ETFs. Turnover is generally greater for bond ETFs because bonds mature and need to be continually replaced.
Quality sponsors. Look to Vanguard, iShares, SPDRs, and Schwab ETFs for quality funds. These four firms account for close to 90 percent of all ETF assets and are highly regarded in the industry. Since Vanguard is a not-for-profit institution with the lowest fees in the industry, they tend to keep the other ETF providers “honest.”

The bad and the ugly ETFs. With new indexes popping up daily, the original “purity” of ETFs as suitable building blocks for asset allocation has been polluted. One of the most extreme examples of this is an ETF released in 2007 (now closed) by FocusShares, which developed an index of mid- and large-sized companies consisting of casinos, producers of beer and malt liquors, distillers, vintners, as well as cigarette manufacturers, and called it a “sin” index. Below is a list of potentially bad and ugly ETF categories to watch out for:

Leveraged ETFs. While ProShares launched the first leveraged ETFs, a subsequent wave of leveraged products have followed. Strangely, these leveraged products have been known to sometimes severely miss the index over the long haul. Because daily returns are compounded, the returns of leveraged ETFs over periods longer than one day will likely differ in amount. And leverage is dangerous. Take for instance Direxion Daily Financial Bear 3X Shares (symbol FAZ), which plunged 95 percent, earning it the ignominious title of worst performing ETF in 2009.
Actively-managed ETFs. It has been said that “if you can’t beat ‘em, join ‘em.” Well this seems to be the case with many active money managers that are now moving their practices from the mutual fund industry over to the ETF space. ETFs with a portfolio manager face the same challenges that mutual funds face—high fees and poor long-term performance records.
Commodity ETFs. These hold futures contracts. Avoid ETFs that buy future contracts to achieve commodity exposure. Futures-based funds can fail to track their target index and are vulnerable to problems such as contango and backwardation. It is best to avoid such ETFs and stick with commodity ETFs that actually hold the underlying assets.

For you investment geeks who want a more comprehensive discussion on how we’ve used this to pick the ETFs for our MarketRiders portfolios, click here. When it comes to ETFs, invest in the good and avoid the bad and ugly. As tempting as the newfangled ETFs can be, the details reveal serious investment risks. By sticking with the five principles to finding good ETFs you can invest with confidence knowing that you have kept the bandit out of your portfolio.

Filed in About ETFs, Dangerous ETFs, ETFs & Index Funds | Comments (0)

How To Build Your Own Energy Portfolio

Sunday, March 6, 2011

Oil prices recently broke $100 a barrel and the stock market tanked. Last week, Federal Reserve Chair Ben Bernanke proclaimed that increasing commodity prices could negatively impact the U.S. recovery. Moments like this are instructive for observing our own emotional schizophrenia. On one hand, our greed glands are pumping, and we want to get in on the action. We don’t want to feel stupid by missing a further run up in oil prices. On the other, we still have memories of 2008 and recall the panic of a falling market, which keeps us fearful of buying at the top. And let’s throw in the envy factor: Most of us have a friend that will inevitably disclose how he or she predicted this and bought oil stocks a year ago.

What’s an investor to do? Bulls say that the world needs more oil than producers can pump, refine, and distribute, and this is getting worse as the Chinese start owning and driving cars. What about alternative energy? They claim that these sources won’t make a meaningful impact for years. Bears say that OPEC will just turn on more oil because if they let prices get too high, their customers will have more incentive to find alternatives.

There are no easy answers to these questions which is why we build some energy exposure in to most of our portfolios. But if you want to place a “side bet” on energy you can use the MarketRiders service to invest in an energy portfolio we’ve made available to our members. This portfolio will can give you a reasonable hedge against rising energy prices with ownership in over 300 operating companies, that are impacted by prices of oil and gas in various ways and allocated as follows:

Diversified global companies (20 percent). You want to own the largest globally-diversified oil and gas companies. If you buy iShares S&P Global Energy (IXC), you’ll buy stock in all of the 95 large players like ExxonMobil, Chevron, and BP. We include this ETF or one like it, in most MarketRiders portfolios.

Exploration and production (20 percent). These large companies that exclusively own and produce oil and gas are fully exposed to energy prices. The higher the price of oil and gas, the more they earn. Instead of trying to understand each company, buy the iShares Dow Jones US Oil & Gas Exploration Index (IEO), and you’ll own 60 companies like Occidental Petroleum and Apache.

Services (20 percent). These companies support the energy industry through services and equipment. They charge their customers more as energy prices increase. Buying the iShares Dow Jones US Oil Equipment Index (IEZ) gives you ownership in 44 energy services companies like Schlumberger, and Halliburton, and mid-sized ones like Noble and Helmerich & Payne.

Alternatives (10 percent). Alternative energy sources may save us from the eventual depletion of fossil fuels and if so, we want exposure to wind, solar, and Tesla cars. By owning the PowerShares WilderHill Clean Energy Index (PBW), you buy a stake in 60 companies all over the world that focus on greener and generally renewable sources of energy, and technologies that facilitate cleaner energy.

Pipelines (15 percent). Owning master limited partnerships (MLPs) gives you ownership of pipelines that transport crude oil, natural gas, and other refined petroleum products. MLPs generate fee-based revenues, which tend not to be directly tied to changes in commodity prices. Much like how Simon Malls owns shopping malls, which provide distribution for retailers like Macy’s, these companies provide distribution for energy companies. The JPMorgan Alerian MLP Index ETN (AMJ) gives you exposure to the large U.S. pipeline companies like Enterprise Products (EPD) and Kinder Morgan (KMP). And it pays over a 6 percent dividend.

Utilities (15 percent). The Utilities Select Sector Index (XLU) includes electric and gas utilities, independent power producers including PG&E, Southern Company, and Duke Energy. XLU pays over a 4 percent dividend.

Note that we are not recommending energy ETFs that own futures contracts like United States Oil (USO) or United States Natural Gas (UNG). These ETFs are baskets of contracts (not companies) to buy actual gas and oil in the future. For many technical reasons, these contracts can lose value irrespective of oil and gas prices, and they have not performed as advertised. Our Energy Hedge Fund only consists of operating companies that participate in the sector.

To see this portfolio. log into your account and click on “Create A Portfolio” and then click on “Let Me Build It.” Click on the first radio button “I would like to build an ETF portfolio using a Template” and find the template portfolio called “Energy Hedge Fund.”

At MarketRiders, we stress a “core and explore” philosophy and our core model portfolios have energy included. But if you want to “explore” energy, up or down, this is the most logical and low-cost way (0.52 percent annual fees) to apportion a “side bet” on the sector. Hopefully you’ll be the one bragging at a party in 2015.

Filed in Asset Classes, Portfolio Diversification | Comments (0)

Analysis Paralysis: 3 Ways Investors Can Break Free

Monday, February 28, 2011

Since March 2, 2009, a significant investor demographic has sat frozen on the sidelines while the S&P 500 has soared skyward by more than 95 percent. To get a sense of just how much cash left the market and headed for the sidelines, a September 2009 Bloomberg study reported that record levels of bank deposits and money market funds reached a shocking $9.55 trillion—enough to buy all the companies in the S&P 500 at the time.

Considerable portions of these reserves have courageously found their way from the sidelines and into the market over the past 18 months. Still, many investors remain skeptical. To their consternation, these befuddled bystanders have witnessed the Dow Jones industrial average march steadily past 8,000, through 9,000, then 10,000, 11,000, and finally the 12,000 barriers.

For such investors, each new milestone has been both painful to witness as well as hard to believe. The market’s growth appears unsustainable and tenuous at best. The unemployment numbers are dismal. The backlog of bad debt still awaiting destruction is formidable. An impressive litany of other very real national and international economic concerns leave these would-be stockholders frozen in place, unable to make any investment decision. These investors remain motionless, paralyzed by uncertainty, unable to do anything more than simply watch the markets fade away in the distance while they stand holding their diminishing bag of cash.

How can investors suffering from paralysis of analysis break free and once again participate in the markets? Here are three approaches to consider:

Jump into the market. Jumping into the markets with a Dow average north of 12,000 may feel akin to jumping into Lake Michigan for the annual Polar Bear Plunge—in other words, crazy. But before you write off the idea, step back and consider the possible wisdom of this approach.

Wading into these frigid waters becomes more rational if you do so clothed in the warmth of a truly globally diversified portfolio. By adding U.S., foreign developed and emerging market stocks, commodities, U.S. treasuries, foreign and corporate debt, Treasury Inflation-Protected Securities (TIPS), and more to your portfolio, you stand largely protected from your worst fears. Additionally, disciplined rebalancing will allow you to do what few investors have the true grit to pull off—trim winners and buy losers, thereby reducing risk and positioning your portfolio for future market shifts.

Finally, an investor should not lose sight of his time horizon. If a retirement investor has a time horizon of 10 years or more, a 10 percent downside move in the markets will not ultimately adversely affect that investor’s retirement dreams. Eventually, markets will sort themselves out and offer rewards to those who participate in their efforts.

Dollar-cost average into the market. Jumping into the markets isn’t for everyone. That is why advisers have recommended the practice of dollar-cost averaging for years. The idea behind dollar-cost averaging is that the investor will purchase fewer shares when prices are high but more when prices are low by investing a fixed amount of money at regular intervals. This will eventually drive the average cost per share down to lower levels. Dollar-cost averaging is a time-honored investment technique and it helps prevent investors from investing large amounts of money at the wrong time.

The challenge with dollar-cost averaging is the potential negative effects of transaction costs related to each trade. These effects can largely be minimized, however, if you employ the many quality exchange-traded funds that trade for free at brokers such as Charles Schwab, Fidelity, and Vanguard. The approach does require discipline and a predetermined plan, but can prove to be an effective cure for investor paralysis.

“Put” your way into the market. Selling puts to move into a stock position is a sophisticated trading technique requiring education and diligence. If used wisely, however, selling puts can be an effective way to move from the sidelines and into a stock you are already planning to buy.

When you sell a naked put, someone is paying you to enter into a stock position you already intend to own. If the put expires worthless and fails to hit your strike price, you simply collect on the value of the put, allowing you to pocket the profit and write a new put for the future. If the stock hits your strike price, you then own the stock you intended to buy all along, but were paid a premium along the way in the form of the put. If the market crashes and your stock goes dramatically down, you are forced into the stock at your strike price and will lose money, but only money you would have also lost by simply buying the stock outright.

This sophisticated trading technique is risky, but for the educated and astute, it can help you move from the sidelines back into the market. It is extremely important to do your research before employing this technique.

Breaking free of the paralysis of analysis is essential if an investor wants to enter and benefit from the eventual growth of economies and markets. A globally diversified and rebalanced portfolio will provide protection and participation in the market’s growth. Whether you jump in, wade in, or get clever with puts, getting in is a good thing for long-term investors.

Filed in Portfolio Diversification | Comments (0)

Why 1 Billion IQ Points Know More Than You

Tuesday, February 22, 2011

“Nobody knows nothing” is a statement made by screenwriter William Goldman about the movie business. He meant that even after making movies for more than 100 years, no one actually knows exactly how to make a successful movie. Sometimes sure things bomb. Sometimes long shots win big.

The investment business is like the movie business. While you sit on your couch watching the dizzying array of security prices on CNBC there are many forces in the background. Every day, all day, thousands of experienced, highly educated investors from all over the world are working to find inefficiencies in the prices of everything from stocks in Egypt to municipal bonds in California. They are researching every security in the world from Dell Computers to Japanese debt to Euros to gold to pork bellies. They often know more about a company than the management teams running them.

They rarely take vacations. Armed with the most expensive computing power in the world, they are poring over data trying to figure out what a particular security is worth. They are setting up Google alerts to learn about an incremental piece of information from a remote blogger. They are hiring private investigators to check sell-through of products at retail. Some will stop at nothing to find the slightest edge. Recently, several hedge fund managers were arrested for insider trading because they paid moles inside of public companies to give them information that others didn’t have.

With this research, they form opinions and bet millions and billions of dollars on those opinions. They trade. They agree on a price. The buyer thinks there is upside, and the seller doesn’t believe there is enough upside—or he has lost so much he can’t take it. And that price changes in a nanosecond based on any new piece of incremental data—Steve Jobs’ health, a protest in Yemen, or even a bug found on an Intel chip.

You can think whatever you want about the price of bonds, gold, or U.S. stocks, but these investors have already thought about it, their computers have thought about it, and they’ve bid against one another to determine whether they are a buyer or a seller. All of that information is embedded in the price you see.

So what do the smartest investors do knowing all of this? They own a little of everything in proportions that make sense for their individual situation—knowing that in the next year, some of their holdings will rise and others will fall. Smart investors own stocks from the U.S., through a fund like Vanguard Total Stock Market ETF (symbol VTI), and around the world through funds like VGK and VPL. They own bonds through Vanguard Total Bond Market ETF (BND), and get commodities exposure through SPDR Gold Shares (GLD) or iShares S&P Global Energy (IXC), and real estate exposure in an ETF fund like RWR. They have the discipline to trim what is going up and buy what is going down. These investors bought more stocks when the S&P went below 700 in March of 2009 and trimmed their bond holdings. And today, they’re adding to their bonds and trimming their stocks.

It boils down to two choices as a retirement investor. You can have faith that capital markets will grow over time and generate a reasonable return without knowing where those returns will come from in a given year, or you can actively shift your money around, like a kid avoiding obstacles in a car racing video game.

In the end, the first choice yields tranquility and the second, heart palpitations. Don’t fight with a billion IQ points. Own a little of everything because “nobody knows nothing.”

Filed in Benefits of Asset Allocation, Portfolio Diversification | Comments (0)

Retirement’s New Normal

Tuesday, February 15, 2011

The Great Recession has caused many to rethink their retirement plans. According to TIAA-CREF, the economic downturn has caused 37 percent of Americans to put off retirement. With nest eggs depleted, the prospect of dropping the 9-to-5 grind in favor of leisure and the glory of the golden years is now a distant dream.

Recent research, however, reveals that early retirement may not be the panacea many have hoped. A slew of negative health effects have been correlated to early retirement starting with memory decline. And, unfortunately, mental exercises don’t seem to help. Lisa Berkman at Harvard’s Center for Population and Development states, “If you do crosswords or Sudoku, you get better at crosswords and Sudoku. You don’t get better at cognitive behavior in life.”

Stanford’s Center on Longevity discovered that maintaining the rigors of work actually keeps people functioning optimally. Richard Suzman of the National Institute on Aging says, “It may be the mental rigors, the social engagement, or even an aerobic component of work itself.” Whatever the exact reason, getting out of bed each morning to face the workday creates a healthier and happier you.

It has also been noted by many of the world’s great religions that humanity was created to be productive and live with a sense of purpose. Whether due to science or religion, work seems to benefit the human psyche. Retirees are the most vulnerable societal group to become restless and struggle with depression. “Only when we’re retired do we discover what we’ve lost,” says Christopher Sharpley, professor of psychology at the University of New England. “Immediately after retirement, there’s a strong upsurge in well-being for the first six or so months, commonly known as the honeymoon period. After one or two years, there’s a decrease in well-being, which can often turn into serious depression.”

Possibly, work isn’t as bad as we have been lead to believe. A University of Chicago study revealed the influence of the prevailing cultural stereotype that work is bad and leisure is good. Researchers gave men and women of various ages and occupations a pager that would randomly beep eight times a day. They were each required to keep a log of their emotional state when the pager went off. When at work, 54 percent of respondents reported feeling “strong, creative, motivated, active, and positive.” When away from work, a mere 18 percent noted these same positive emotions. When asked how they felt about work, however, the overwhelming majority of respondents said they would rather not be at work, but engaged in leisure activities.

These findings and others call into question the institution of retirement itself. Strangely, retirement wasn’t a cultural concept until the 1880s when Germany introduced the institution into its social structure. Before that time, people worked until death—something that may seem like a terrible plight to some, but that research is showing to have substantial benefit.

Today, however, baby boomers are creating a new normal for retirement—scaling back on work hours while staying professionally engaged. Whether through consulting, reduced hours agreements with their current employer, or branching out as a “seniorprenuer” by starting a new business venture, increasing numbers of seniors are finding an enjoyable work and life balance. The new retirement is no longer trading work for leisure, but trading work you no longer want to do for work you love to do at the rate you want to do it.

When you look at the facts, it becomes compelling to reject the idea of traditional retirement. Whether you lean into to the tenets of ancient religions, which state that humanity was designed to live purposefully, or to science, which shows that unused systems run down and go dormant, the results are clear: use it or lose it.

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ETF Basics: Invest Globally, but Cautiously

Monday, February 7, 2011

Not all foreign stock investments are created equal. A few weeks ago, we wrote about owning stocks in companies based in emerging markets (Brazil, Russia, India, China) and the different types of risks and returns one can expect. The exciting growth in these countries also comes with a fair amount of risk, including governments with onerous tax rates, state-imposed price controls, outdated securities laws, corruption, or risk of wars and violence.

Egypt brings these risks home. If you want to invest in the Egyptian stock market, you can purchase shares of an exchange-traded fund (ETF) called the Market Vectors Egypt Index ETF (symbol EGPT), which holds all the important stocks in Egypt. When protests broke out last week, the markets decided that all of the largest companies in Egypt were worth 25 percent less than they were a day before, and EGPT fell by that amount!

Investing in foreign companies in the 27 developed countries (such as the UK, France, Germany, Japan, Australia, and Canada) gives you further diversification and is much less risky. In fact, over long periods of time, these economies perform like the U.S. stock market. Between 1970 and 2004, those stock markets appreciated 10 percent per year compared with the S&P 500 growth of 11 percent.

Every retirement investor should own these foreign stocks because they reduce risk in a portfolio in two key ways. First, you’ll own stocks in other currencies. If the U.S. dollar declines against the Yen or the Euro, these stocks will appreciate. Second, other countries have their unique responses to their own economic circumstances, their governments, their populations, and tax rates-all of which are different than the U.S. In the 1980s, the experts said Japan was going to take over the world and their stock market rose 28 percent versus the U.S., which returned 17 percent. In the 1990s, Japan’s markets tumbled and only recently have begun to recover. Demographics can also impact a country and the value of its companies. For example, other countries don’t have “baby-boomers” and their populations are aging in different ways.

Therefore, owning a basket of developed foreign stocks provides equity ownership that doesn’t always have the same fluctuations as U.S. stocks, which reduces risk in a portfolio.

In our MarketRiders retirement portfolios, we allocate about 30 to 35 percent of our equity exposure (not fixed-income), to non-U.S. stocks. Most of that allocation goes to developed countries instead of emerging-market countries.

Investors should own foreign developed country stocks through ETFs instead of mutual funds. The costs are low and active mutual fund managers statistically don’t do better than the indexes they attempt to beat. Also, foreign country mutual funds tend to have very high fees-it’s expensive to fly fund managers all over the world to research companies in foreign countries. Instead of paying high fees, just buy an ETF that holds all of the stocks in all of the countries that matter.

We recommend three ETFs in most of our portfolios. By owning shares in Vanguard European ETF (VGK), you own a basket of 481 large companies in 16 European countries and pay only 0.16 percent in annual fees, which is 10 percent of the cost of comparable mutual funds. Adding Vanguard Pacific ETF (VPL) gives you ownership of 493 large companies in Japan, Australia, Hong Kong, Singapore, and New Zealand. We allocate a small amount to iShares MSCI Canada Index (EWC), which charges 0.53 percent in annual fees.

Here’s the best part: With these three ETFs, you don’t have to worry about which country will grow faster, or whether Toyota will do better than BMW because you will own all of these stocks and capture the growth of these countries and their currencies. As for uprisings, you might sleep better with less risk of that occurring in these countries.

Filed in Asset Classes, Benefits of Asset Allocation, Portfolio Diversification | Comments (0)

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