Dawn Meson

Investing in tough ecconomic times – Part II

This is continuation of our last post.

Fine-Tuning Your Portfolio
Once you’ve made the big decision as to what your stock/bond allocation should be, it’s time to do your fine-tuning.

Just as stocks and bonds tend to poorly correlate, different kinds of stocks and different kinds of bonds similarly have limited correlation. That’s especially true on the stock side of the portfolio. Smart investors will make sure to have both domestic and foreign stocks, stocks in both large companies and small companies, and both value and growth stocks. Growth stocks are stocks in fast-moving companies in fast-moving industries, such as technology. Value stocks are stocks in companies that have less growth potential, but you may be able to get their stock on the cheap, at times making them better investments than growth stocks.

Just as you get more bang for your buck but also more bounce, with stocks versus bonds, you also get more potential return and additional risk, with small-company stocks over large-company stocks. Although international stocks aren’t any more volatile than U.S. stocks, per se, differences in exchange rates can make them much more volatile to U.S. investors. The greater your tolerance for risk, the more small-company stocks and more international stocks you might want to incorporate.

Once your portfolio grows, and you have all the broad asset classes covered, you might consider branching out into narrower (but not too narrow) kinds of investments. Possibilities would include high-yield bonds, small international company stocks, commodities and certain industry sectors of the economy, especially those that tend to have limited correlation to the market at large, such as real estate and energy.

The Mechanics of Investing
It is very hard to achieve good diversification, the kind described above, by investing in individual securities. “Unless you have a ton of money, it is impossible to own a sufficient number of stocks so as to be diversified across the board…domestic and international, companies of different sizes, and different industries. Owning mutual funds or exchange-traded funds makes achieving good diversification much easier,” says advisor Peters.

Exchange-traded funds (ETFs), are akin to index mutual funds, but they trade like stocks. You’ll pay a commission to buy an ETF, so mutual funds generally will make more sense if you are contributing regular small amounts to your account. When picking a mutual fund or ETF, you not only want to find one that represents a certain broad asset class (such as large American stocks, for example), but you want one with reasonable expenses and a solid management team.

One caveat: Pay little attention to which asset class happens to have run away in the past months. The vast majority of investors make the mistake of pouring money into “hot” sectors, and then selling off when those sectors cool. They are continually buying high and selling low…exactly the opposite of what you should do!

“Pick an allocation and stick with it,” says Johnson. “Don’t forget your goals. Don’t panic and sell when the market drops. To reap the maximum rewards from the markets, you need to ride out the lows and wait for your day to come.” She also cautions against market timing. “The best time to invest is always right now,” she says. “Lots of people sit on the sidelines, keeping their money in cash, waiting for the right moment to buy. That’s a mistake. You stand to lose more than you stand to gain.”

Johnson points out that idle cash loses money to inflation. Any money you won’t need for the long-haul is best invested.

Keeping An Eye on World Affairs
When things get out of whack, you’ll need to rebalance and get back to your original allocation. Most financial experts recommend that you look over your portfolio either once a year or once every year and a half.

If the urge strikes you to shuffle things around much more often than that, resist! “Buy and hold investors tend to be the most successful investors over the long run,” asserts Johnson.

Investing in tough ecconomic times – Part I

The past few years have been the ugliest thing to hit Wall Street in a very long time. We don’t need to tell you….Pick up a newspaper….Turn on the TV….Look at your dwindling account balance.

Some pundits are telling us that this is the end of everything, and the collapse of the entire economy is coming.

Know this: We’ve seen tough times before…many of them. And each and every time, there are those who pronounce the End of Capitalism, and swear up and down that the markets will never come back. Each and every time, they’ve been dead wrong. One of these days, they may be right. Is that time now?

Probably not.

If anything, the present crisis is not sending a message to sell everything and hide, but rather, a message to remain well diversified, and to keep our eyes on the long-term horizon.

“I see this as a time to either buy, sell or hold!” quips Rose Johnson, CFP, an independent investment advisor based in York Harbor, Maine. “Markets go up and down. We can’t predict what the coming months will bring. Nor should we be overly concerned,” she says. “If we’re long-term investors, we build a portfolio that will see us through up times, down times, and flat times.”

The key to building such a portfolio starts with a bit of introspection. “First, you need to have a long-term plan. You need to know why you’re investing, and what you’re investing for,” says Johnson. “Second, you need to select diversified investments that together provide an appropriate level of risk and potential return.”

Know Where You’re Going
Are you saving up for a new car? A new home? Your grandchild’s education? Eventually, of course, you’ll need to build a nest egg to carry you through retirement. How do your future needs match up with the amount you’re currently saving? These are just some of the questions you’ll need to ask yourself while constructing your optimal portfolio.

Perhaps the most important question of all – but one that can only be answered by first tackling the others – is to know your time frame. In other words, when might you need to first pull from your savings? And how much might you need at that point?

“When I help people design portfolios, I first ask them to identify short-term and long-term goals,” says Michael Peters, CFP, a fee-only (takes no commissions) registered investment advisor in Seattle, Washington. “We try to identify future capital expenditures – a home purchase, college tuition, a new car. For most people, the biggest expenditure by far will be getting through the retirement years.”

The need for cash…today, tomorrow, and 20 years from now…is largely what should determine which investments to plug into a portfolio, says Peters.

An Introduction to Asset Allocation
Although the world of investments offers countless opportunities – and dangers! – all investments qualify as either equity, which means something you own (stocks, real estate, gold) or fixed income, which represents money you’ve lent in return for interest (bonds, CDs, money-market funds).

Historically, equity, especially stocks, have provided much greater returns than fixed income investments, but they have also been considerably more volatile. (As we’ve seen of late.) Since 1926, the average annual return of the S&P 500 (an index of large-company U.S. stocks) has clocked in at an impressive 10.4 percent. The average annual return of long-term government bonds, 5.5 percent. But the bond market rarely goes into negative territory, and has never dipped more than 10 percent in a single year. The stock market, in contrast, loses money in almost one of every three years, and this year has lost a lot.

Any good portfolio will have both stocks and bonds. Investment professionals say that these two kinds of investments have “poor correlation.” Poor correlation is a good thing! It means that stocks and bonds tend to perform better at different times. In a year that your stocks are shooting high, your bonds may lag. The next year, stocks may fall, but bonds may rise. (Treasury bond prices, especially, have been on a tear lately.) Having both stocks and bonds in a portfolio smooths out your returns, and helps you sleep better at night.

But what is the best ratio of stocks to bonds to cash…70/25/5?…50/45/5?….30/60/10? That’s where your time frame becomes an essential factor.

“Generally, any money that we might need to tap within the next four years, we want to keep in cash or fixed-income investments, such as bonds” says Peters. “Money that won’t be needed for five or more years, such as money for retirement, if I’m working with 30- or 40-something people, we want primarily in equity, such as stocks.” A typical 35-year-old saving for retirement, for example, might have a “target asset allocation,” or ideal investment mix of about 80 percent stock. A typical 45-year old might want closer to 70 percent.

Peters explains that the money needed in the next four years should be invested so that there is minimal risk to the principal. Beyond four years, taking the added risk of the stock market is usually a fair trade-off for the expected greater return. “But people have very different risk preferences,” adds Peters. “You need to ask yourself how much you’re willing to see your portfolio drop in any one or two year period.”

Please Read the Part II of our story next.

520 College Savings Plan

Written and Submitted by Robert Sarian of Education Industry News

When Kelly Davitian, a retiree, decided she was going to help fund her grandson’s college education, she knew she’d have to go about it in a tax-efficient manner, one that would also benefit her. She also knew that pursuing this venture would potentially impact her estate limitations, so she met with her Smith financial advisor to develop a strategy that would help enable her to assist her grandson.

He suggested that a 529 College Savings Plan—named after the section of the IRS code that authorized their creation—would be the best way to meet Kelly’s education-funding goals. Kelly set up a 529 plan for her grandson and launched a systematic investment plan to help her potentially maximize the account’s value. Kelly’s Five Year Plan was well under way, but there was one thing she hadn’t planned for: right before she was slated to pay the school, Kelly’s grandson, received admission to another institution—in London.

Luckily, Kelly had saved for her grandson’s graduate degree in a 529 account, so she could use the funds at any accredited university in the world. Kelly’s grandson is now pursuing his MBA at the London Business School—one of the top three MBA programs in the world—and using Kelly’s 529 plan assets to pay for his tuition and related expenses.

In today’s rapidly globalizing economy, Kelly’s situation is not unique. Each year, thousands of American students either participate in study abroad programs, or enroll full-time in colleges and universities outside of the United States. In fact, according to a recent poll of college-bound students, 55 percent indicated that they are certain or fairly certain they will participate in a study abroad program, and another 26 percent indicated a strong desire to study abroad.

In response to the high demand, many higher education institutions now offer a number of international learning programs, ranging from semesters at sea to cultural immersion and multi-city programs. However, despite the many international programs available, students (38 percent) still cite high costs as the top reason for lack of participation in study abroad programs. In addition, using financial aid for international studies presents its own challenges: additional eligibility requirements—residency, grades, credit hours, and age, to name a few—must be met, and foreign and US semester schedules differ which can delay loans and other federal aid.

Still, there are options for those who want to finance an education abroad, including 529 College Savings Plans. The plans allow tax-free accumulation of assets and federal tax-free withdrawals for qualified higher education expenses, and the features (flexibility, control, and multiple investment options) which make 529 plans attractive for funding stateside education are also available when the plans are used with accredited foreign institutions.

How It Works
More than 400 foreign higher education institutions are eligible under the rules permitting federal tax-free withdrawals from a 529 plan. A list of eligible foreign institutions is available in the Federal School Code Lookup database on the Free Application for Federal Student Aid (FAFSA) website.

“The test for any particular school’s inclusion is its eligibility to participate in Title IV federal financial aid programs,” says Joseph Hurley, founder of SavingforCollege.com. “Most degree-granting four-year schools, junior and community colleges, and graduate schools will qualify, as will many proprietary and vocational schools.”

Is A 529 Plan Right For You?
A 529 savings plan is one of the best tax-advantaged ways to save for higher education—whether you plan to study in the US or abroad. Most plans offer several asset allocation options, and also allow you to contribute via lump sum or through a systematic investment plan such as a payroll deduction. You should consider investing in a 529 plan if you are:

• A parent concerned about the rising costs of college,

• A grandparent who wants to help save for your grandchildren’s future education expenses

• A retiree who would like to develop an existing hobby into a serious, full-time interest

• An “Empty Nester” who is still active in the workforce, but needs to return to school to remain competitive

• A professional who is considering going back to school to pursue a second degree, change careers, or to enhance your professional skills

• An adult who wants to help a child in your life— a niece, nephew, or godchild—save for future college expenses

As more higher education institutions implement international programs to address the growing demand, opportunities to study abroad are more available than they were twenty years ago. If you already have an education plan, consider whether studying abroad is an option you’d like to pursue in the future. If you need help developing an education plan, a Financial Advisor can help you get started, and can even customize a proposal based on projected costs at the schools you’re considering.

Whether you plan to study stateside or beyond the country’s borders, one thing is certain: college costs are on the rise, so it’s important to start early. The world is your oyster; take advantage of all it has to offer.

IMF Slashes Growth Forecasts

Forex continues to be predictably grim. Last month, the International Monetary Fund (IMF) slashed its growth forecast for every major country and predicted that the global economy will contract 1.3% this year, although the IMF did issue a sliver of hope that it would grow 1.9% next year, depending on the state of the financial system. Until then, however, forex trading is expected to remain volatile.

The U.S., which the IMF said is at the epicenter of the crisis, is expected to contract 2.8% this year, and recovery is unlikely until 2010. However, the U.S. recession may ease before the Eurozone recession due to earlier distribution of stimulus funds and the U.S. government’s aggressive actions to restore liquidity. In comparison, the Eurozone economy is expected to contract 4.2% this year and another 0.4% next year, signaling the need for EU countries to coordinate a comprehensive, collective response to the crisis.

Analyst: “The Dollar is No Longer as Good as Gold”

Earlier this month, an AP article painted a bleak picture of the dollar’s current and future status as the world’s reserve currency and the most powerful currency in online forex. The proliferation of stimulus efforts has left analysts worried about both the U.S.’ ability to control its ballooning deficits and the greenback’s position in relation to those debts. Both Russian and Chinese officials have intimated that it might be time to start evaluating alternatives for the world’s forex reserves in case the dollar implodes.
Peter Schiff, president of the Euro Pacific Capital brokerage, told the AP, “I think the dollar will continue to drop. Based on what we’ve done, it could lose 70% to 80% of its value over the next five to 10 years. The dollar is no longer as good as gold. It’s no longer better than any other currency.”

Others disagree, saying that the Obama administration’s efforts have helped the dollar maintain relative strength against the euro, yen, pound, and other currencies. Or, at the very least, the dollar’s proponents contend, the dollar isn’t in danger of slipping anytime soon. “I liken the dollar to an aging boxing champ in terms of being a reserve currency,” said executive director of The Economic Outlook Group Bernard Baumohl.  He told the AP, “It survives because there’s no other contender out there.”

First In, First Out for U.S. Economy

That’s the conclusion reached by this GFT Forex Blog post. The author says that as the first G7 economy to enter recession, back in 2007, the U.S. will also be the first to make a full recovery. The author continues, “The other way to look at the current economic situation is that if the U.S. economy does not recover, no one else will. Globalization has increased the mutual dependency of many countries. For export dependent countries in the Eurozone and Asia, a rebound in U.S. demand is essential for a recovery.”

That thinking is likely at the root of the dollar’s perennial status as a forex trading safe haven.  Even though there are periods when it’s seen as riskier than other currencies, traders keep coming back to the USD for safe (well, safer) online trading. However, will the USD maintain its strength when the global economy stabilizes? The author says that recovery will lead to “a new shift toward fundamentals” and a resulting focus on the large amount of U.S. government debt.

Economists have predicted that recovery could begin as early as 2010, so in the next few months, it’ll be interesting to track the USD and see if the “first in, first out” phenomenon also means that the USD is the first one to lose some of the spoils of the recession.

Posted By: The Great American Small Business Challenge

Consumer Confidence at All-Time Low

The January plunge in consumer confidence to touch an all-time low of 37.7 sparked a rally for the USD in online trading, although GFT Director of Currency Research Kathy Lien called the trend a “reflection of more panic selling and not optimism about US economy.” She cautioned that confidence may not be restored until job security is no longer an issue—but with unemployment spiking to 7.2% and most analysts predicting that recovery will not be possible until 2010 at the very earliest, increased consumer confidence may be very far off indeed. In the meantime, any dollar gains in online forex trading are expected to be ultimately insubstantial.

Given the dreary consumer outlook, it’s not surprising that fourth-quarter GDP also fell to the weakest level in 26 years and house prices dove another 18.18% in November for the largest recorded decline. The sole bright spot, according to Lien, is the projected increase in car sales in the next six months as consumers look to capitalize on the discounts being offered to move inventory.

Recession Outlook Grim

Most analysts agree that the dollar’s rally in online forex trading throughout the fall was bound to be ephemeral, and with 2009 underway, the EUR/USD climb back upwards has begun. In December 2008, the dollar was up almost 20% against a basket of currencies, but since then, the weakening forex trend has taken hold as the economy continues to worsen on rising unemployment numbers that reached a 26-year high last month, a still-soft home market, volatile stocks, and the increased risk of deflation.

A UCLA Anderson Forecast report in mid-December said that although crude oil prices have dropped dramatically, the resultant fall in the absolute level of consumer prices is likely to do damage to the GDP in the next three quarters, causing it to shrink by 4.1%, 3.4%, and 0.8% respectively. The report also predicts that spike in unemployment will continue through 2009, hitting a projected 8.5% in December 2009.

Risk, Returns, and Regret in Bond Investing

“It’s a conundrum.” This is what ex-Federal Reserve Chairman Alan Greenspan said of the state of long-term interest rates. The situation that exists—with short-term rates getting measured increases, while long-term rates haven’t moved much—is a topic of confusion for many people, not just Greenspan.

Now we are concerned with another conundrum: Principal guarantees within bond investments.

A new client of ours whom we will call Bob is retired, and relies heavily on a fixed-income. Recently, while rebalancing his investment portfolio, he expressed confusion over the status of certain bond funds that he has held for years. Bob told us he heard from a former colleague that his principal might not be guaranteed, even though he had invested in government-bond funds, which he assumed were safe. Now we had the difficult job of explaining to Bob that perhaps he had become tangled in a common misconception — that government bond mutual funds do not guarantee principal. Furthermore, income distributions that such bond funds provide are both inconsistent and unpredictable.

Government bonds and government bond trusts are principal guaranteed. But investing in bond funds is not done on the same terms. While an individual bond pays the owner a consistent amount on each coupon date, there is nothing “consistent” about a bond fund, and distribution depends entirely on how well each of the bonds within the fund fare. At any given distribution date, the amount of money received can vary greatly. Therefore it is not even appropriate to label a bond mutual fund a fixed-income product.

This means a lot to Bob, because he and his wife depend on a predictable number of dollars at consistent intervals throughout the year. If that income doesn’t come in as anticipated, his lifestyle can be affected dramatically.

We’ve seen misunderstanding of bond-fund investments perpetuate itself over the years. The reason why mutual funds do not guarantee principal is because they are open-ended. Shares are offered continuously, and have no maturity date. If there’s no maturity, there’s no date for principal repayment. Hence, no principal guarantee. Conversely, government treasury bonds, bills, and notes, and government-bond trusts do have a finite life, or a fixed maturity date. When these bonds mature, the principal is repaid. Hence, a guarantee of principal.

Let’s look at a specific example. When Bob spends $10,000 on 10-year government treasury bonds at 5-percent yield, he will receive $500 dollars of fixed income annually, and is guaranteed every dime of his initial principal at maturity — 10 years from the date of issue. These bond investments are backed by the full faith and taxing power of the United States federal government. If, on the other hand, Bob buys into a mutual-bond fund, even though the bonds in the fund are government treasury bonds, the fund itself has no maturity date. And there is no exception to this rule. The same system applies to corporate, municipal, and “junk” bonds; the issuing institution backs those bonds and the rating is determined by the institution’s ability to pay.

Bottom line: We are not trying to turn people completely off from investing in bond mutual funds. There are some appropriate uses (and we stress the word some) for bond mutual fund investments. The key is to understand what you’re doing. The potential risk and rewards need to be weighed so that no matter what the outcome of the investment, feelings of regret (from not being properly informed) won’t seep into the equation. If, like Bob, you are on a fixed income and therefore require a predictable and continuous stream of income throughout your retirement years, we urge you not to panic; but rather to review your portfolio and seek advice from a financial professional.

Rate cuts halt EUR/USD fall

Over the past few days, the euro has finally broken out of its weeks-long slump against the dollar. Federal Reserve Chairman Ben Bernanke announced on Tuesday that the Fed would be taking the unprecedented act of buying three-month commercial paper, and today, central banks around the world made coordinated reductions in the target lending rate. Anticipating an easing of the credit squeeze that has driven the dollar’s recent rise against the euro, traders sold USD and bought EUR in today’s forex trading. As of 4PM EST, the euro had made its biggest gain against the dollar in more than two weeks, moving from 1.3585 yesterday to 1.3658.