Income and Tax Stratification

According to the IRS:

* The top 1% of income-earners ($380,354 and up) earn 20% of income; they pay 38% of all income taxes.

* The top 10% ($113,799 and up) earn 46% of income; they pay 70% of the income taxes.

* The bottom 90% (earning below $113,799) earn 54% of the income; they pay 30% of the income taxes.

* The bottom 50% earn 13% of income; they pay 3% of the income taxes.

Active Management CAN work!

Despite what we read in the press almost every week, there are plenty of mutual funds and some money managers that, after fees and costs and expenses, have outperformed their benchmarks both purely and adjusted-for-risk for long and consistent track records.

Even in bonds, where the margins are probably a lot thinner than with equities.

I don't know how to do it myself, so I am not a fund manager. But I know how to separate managers like we are warned warning against from those with track-records worthy of my clients' and my own money.

The minute I lose confidence in my ability to discern between the consistently worthy managers and the rest, we'll all be using index fund portfolios, and I'll be shifting from being an investment advisor to being a financial planner.

But that's not happening yet. No way!

Here's an example of how my mutual fund portfolio for "moderate" investors compares to the U.S. stock market and to a portfolio of low-cost index funds from Fidelity that represent a similar 60% stocks, 40% bonds portfolio:

Average Annual Return Comparison

Time Frame      PWS' 60 Flex      S&P 500      Index Funds 60/40
1 yr                      14.10                     16.52            11.31
3 yr                        7.04                     -6.49            -1.88
5 yr                      10.47                      1.73              4.30
10 yr                    11.06                     -0.02              3.71

*Data is through 10/31/10; volatility (Standard Deviation) for mine is lower and Alpha his higher, too.

Where Do Millionaires Get Their Money?

Most get their money by working, earning and saving.

80% of US millionaires are the first-generation of their families to get to that level.

Only a very few of them are celebrities and athletes and Wall St all-stars. Most of them are just like you and me, but with a bit more luck, or a better idea, or a better work-ethic. Or a better savings/investment plan...

If you save 5% of your income, you'll have some extra money in retirement to supplement Social Security and any pension you might have. If you save 15%, there's a very good chance you'll be a millionaire.

Talk to me about your strategy. It's what we do, and it works.

The Financial Crisis Was Worse Than We Thought

Per the information released this week by the Federal Reserve, there was a lot more scrambling, perhaps panicking, in the financial markets that most even know. And we knew it was bad. Cases in point:

1) The Federal Reserve has released details on the $3.3T (TRILLION) it extended via more than 21,000 transactions during the financial crisis. The extent of the Fed's aid included help to foreign firms

2) The Fed's Primary Dealer Credit Facility was tapped 84 times by Goldman Sachs, 212 times by Morgan Stanley, and almost daily by Citigroup through April 2009. And most of us know about Bear Stearns and Lehman Brothers.

3) The Fed lent cash to more than a thousand companies, including McDonald's, GE, and Harley-Davidson. Those companies are extremely sound financially, or maybe they weren't. All say they have paid-back their loans.

4) UBS, a Swiss bank whose retail brokerage unit is one of the biggest in the US (comparable to Morgan Stanley, Merrill Lynch and SmithBarney), borrowed a total of $74.5B. Barclays borrowed $47.9B.

5) Nine of the ten largest money-market fund companies, including BlackRock, arguably the best in the business for that ultra-conservativ-but-not-government-guaranteed cash management stuff, turned to the Fed for support.

6) Foreign central banks received nearly $600B of credit.

Say what you want about the politics and economics of the rescue and recovery plans, but the whole entire "city" was on fire, and wondering how to pay the water bill was, at the time, a bit beside the point.

WHAT DO WE DO? Live within or even below your means, have an emergency reserve fund, prioritize your priorities (saving for college is great, but are you on-track for at least a half-decent standard of living in retirement, and do you have life and disability insurance policies that will provide enough to your family if you die or can't work?), and invest around the globe in diversified and nimble portfolios.

GM IPO For Insiders Only

The federal government used the public coffers to bail-out General Motors. Regardless of one's feelings about that government action, the fact is "we" all bailed-out GM, but only some of "us" are going to benefit directly from the Initial Public Offering of the newly-revitalized GM.

Ordinarily, this is fine. A company wants to issue publicly traded shares of its stock, hires a brokerage firm or investment bank to advise them and handle the sale of those shares. The folks who get to invest in the IPO shares are the bigger, more active clients of the companies running the IPO.

But this is not a private deal between firms. This is the resurrection of a company that, but for the help of the taxpayers, would not have even survived bankruptcy.

The US Treasury should have run this IPO the same way it issues bonds--buy allowing an auction. Big the right amount, ya get shares. Too little, you miss out. Too much and you overpay. But everyone who wants In on the deal would have a fair shot.

Now, though, you're only shot at the IPO is to be a big client of a big firm that the government and GM have selected. Nice if you are a zillionaire, I reckon.

10 Market Bubbles To Monitor

Here is another item that I think is worth just cutting/pasting. So much for blogging this month, but I do want to share keen and interesting insight:

10 Market Bubbles That Could Soon Burst
By Charles Wallace (via www.RealClearMarkets.com)

* Weak Start for Amazon
* Lowe's Prepares for Hibernation
* Don't Force It
* Go With Geithner on the GM Deal
* TJX Preview: Managing Expectations

The president of the Minneapolis Federal Reserve, Navayana Kocherlakota, recently published a paper in which he argues that government guarantees helped fuel the bubble in real estate. While his paper was largely aimed at prescribing solutions to this problem, it raises the question: What other bubbles are lurking out there in the global economy? We asked several experts and to our surprise, they had a long list:

1. Gold: The price of gold bullion has risen from $294 an ounce in 1998 to $1,404 last week, an increase of 377%. "It's the biggest, baddest bubble of them all," says Robert Wiedemer, author of Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown. Gold has no intrinsic value. A telltale indicator that gold is a bubble: incessant cocktail party chatter about buying gold and endless TV commercials offering to buy gold jewelry. The SPDR Gold Trust(GLD) ETF is up 28% since the beginning of the year.

2. Real estate in China: Chinese real estate prices are up only 9.1% this year, which may seem more frothy than bubbly. But rising prices are generating rising demand, which is a clear sign of a bubble, says Vikram Mansharamani, whose book, Boombustology: Spotting Financial Bubbles Before They Burst, will be published early next year. The participation of amateur investors like waiters and maids in the property boom is a clear sign of a property bubble in China. The fact that developers are building more apartments than there are buyers is another giveaway.

3. Alternative energy: Solar technology is still uneconomic, yet governments all over the world are subsidizing solar energy firms. "There are plenty of people who shouldn't be in the solar energy industry who are," says Mansharamani. Do we really need 250 venture-capital-backed solar cell companies? The Market Sectors Solar Energy(KWT) ETF had a 100% gain this year, before dropping back.

4. Commodities: Blame it on the weather, China or the Fed, but commodities have shot higher in recent months. Wheat is up 60% this year, and other food commodities like corn have also risen dramatically. "The focus is on the food category for bubbles," says Wiedemer, but industrial metals like copper are also very frothy.

5. Apple(AAPL): OK, everybody loves their iPad and iPhone (except if they live in New York or San Francisco, where signal strength is a problem). But Apple shares are up 1,200% since 2001, which has to come close to being the definition of a bubble. "Apple is a high-fashion company," says Wiedemer. "If CEO Steve Jobs either leaves or dies, I think they will have trouble maintaining that incredible fashion sense, and as such it's time will go," he says.

6. Social networking: Sure, Facebook has 500 million members, but what is that worth? Some estimates put the company's market value as high as $35 billion, but shares in these social networking companies are not listed and are so far only traded by a few insiders. Twitter, with almost no income, is said to be worth $1.5 billion, and LinkedIn is also estimated to be trading at a market value of $1.4 billion. "There aren't any anchors or valuation methods to guide investors in terms of valuation," says Mansharamani. "When you have that lack of clarity, almost anything is possible." Many in the tech world try to figure out what these companies might be worth some day far in the future and then discount that back to some reasonable price today. Remember Boo.com?

7. Emerging market stocks: As an asset class, these shares have risen 146% in the past two years. "We're only halfway along the way to a gigantic eventual bubble in the emerging markets," says Barton Biggs, the former Morgan Stanley Asset Management chairman who accurately predicted the U.S. stock market bubble in the late 1990s. These countries, such as Indonesia, Australia, Russia and Brazil, are growing wildly even though there's no growth in the world economy. Much of their gains is backed by commodity prices, which are also a bubble (see item No. 4). "I have every reason to believe this will turn into a bubble," says Mansharamani.

8. Small tech companies: It's only been a decade since the tech bubble burst, but cash-rich large tech companies are gobbling up smaller firms without regard to price. For example, Hewlett-Packard(HPQ) got into a bidding war with Dell(DELL) over computer storage company 3Par and ended up paying a whopping $2.4 billion, 325 times the firm's earnings before interest, taxes, depreciation and amortization.

9. The U.S. dollar: Although the dollar is down 10% against the euro so far this year, Wiedemer believes the greenback is firmly in bubble territory. He believes it will pop when foreigners stop buying U.S. assets such as stocks and bonds. "Foreigners say, 'I'm worried about inflation -- you're going to pay me back in dollars worth less than when I invested'." While China may hold its dollar bonds forever, he says, pension funds in Japan and insurance companies in Europe will start dumping dollars as U.S. inflation climbs.

10. U.S. government debt: "When this bubble pops you're out of bubbles -- nothing is too big to fail any more," says Wiedemer. The debt bubble is growing very rapidly and will continue to grow, he says. Basically, there's no way the U.S. government can ever pay back the $13.7 trillion it currently owes (mainly to foreigners), and eventually they will stop buying. The bubble pops when the government has trouble selling its debt -- just like Ireland and Greece are experiencing at the moment. Instead of borrowing money, the government starts printing money, which is what's happening now. The Fed's balance sheet has gone from $800 billion in 2008 to $2.2 trillion, and the central bank just announced it was printing another $600 billion. Says Wiedemer: "The medicine starts to become poison."

Seven Biggest Mistakes Mutual Fund Investors Make

This such good advice I am simply cutting & pasting it right from the Charles Schwab web site:

The 7 biggest mistakes fund investors make
1:02 pm ET 11/07/2010 - MarketWatch Databased News
Editor's note: Chuck Jaffe is off this week. MarketWatch is presenting one of his favorite archived columns.

BOSTON (MarketWatch) -- There's a difference between trying to do the right thing and actually getting it done.The biggest mistakes mutual-fund investors make fall right in the middle, where an investor trips over the fine line that separates good investing habits from bad.

In talking to financial experts and fund specialists, as well as reviewing industry statistics about ownership and asset flows, it's clear that the investing public keeps trying to do the right thing, it just doesn't always get the best results.


Here are the seven biggest mistakes fund investors make. If they describe the way you have been investing, it might be time to check your portfolio -- and your mindset:

1. Chasing returns: Buying what's been hot makes intuitive sense -- you're riding the express train -- but all too often results in disappointment. Ideally, the idea is as simple as "buy low, sell high," but investors who chase performance typically are late to whatever market sector or investment style is hot. As a result, they buy at high prices, and when the market turns and starts to favor something else, these investors then sell low.

2. Rearview-mirror investing: It's hard to go forward when you are only looking backwards. This problem is related to performance-chasing. You can't just buy funds that did reasonably well in the past; you need to invest in parts of the market that are likely to do well going forward. Too many investors know what a fund has done recently but have little idea of the fund's prospects.

3. Overreliance on rankings and ratings: More than 90% of all new money into mutual funds go to issues that carry Morningstar's four- and five-star rating. Yet the investment research firm is quick to note that its star system is more "descriptive" than "predictive."

There is nothing wrong with buying only funds that do well according to stars, numbers or any system, but make sure the fund adds diversification and strategy to your portfolio, rather than bringing only a past that was good enough to earn a top grade,

4. Assuming you can buy and hold a fund forever: Funds change, markets change, people change; what's appropriate to buy at one point in your life may not be right later. Yet too many investors are married to their funds, hanging on in sickness and health, for richer or poorer, rather than always considering whether they would still buy the fund today. If key buying factors change -- everything from the manager, the asset class, costs and track record and ratings -- you shouldn't blindly stay put Read about bad mutual funds and the investors who love them..

5. Failing to understand what the fund does, how it invests or what it buys: When investors are surprised by a fund's lagging performance, it's often because they never clearly understood the fund's objective.

Too many investors can't explain what their funds do and why. They may know they own a large-cap growth fund or an index fund, and they'll review the ratings and performance, but when it comes to the nuts and bolts, they don't know where to start.

For example, a mutual fund is considered "diversified" once it has more than 16 stocks, but it can still be concentrated or focused in a certain market sector. Likewise, investors who buy funds that top the charts don't necessarily know what those funds did to stand out from the pack.

6. Letting emotions rule: It's hard to prove a system or stick to a discipline if you make changes on a whim or with every market hiccup. There's a natural human tendency to let the most recent experiences color judgment; as a result, investors typically give too much significance to current events and expect that trend to continue. Wanting to cash in on those trends or protect against them, they'll let fear or greed rule the day and invest with emotion rather than intellect.

7. Focus too much on a fund, and not enough on the portfolio: Finding good funds isn't that hard; putting them together in an effective, low-maintenance, diversified portfolio is a lot more difficult. Too many investors have a collection of funds, rather than a strategic portfolio, where every fund has a role and every new addition is evaluated not just on its own merits, but on what it adds to the big picture.

Owning five or 10 mutual funds does not make an investor diversified if most of those issues reflect one or two asset classes. Investors need more than a "good" fund; they need funds that enhance their holdings, diversify risk, bring additional asset classes into play and help the portfolio achieve their goals over time.

How To Prepare For the Storm We Hope Won't Hit Us

With a new round of "quantitative easing" (printing new money so the Federal Reserve Bank can buy US Treasury Bonds that investors and China don't want to buy at such low interest rates) threatening to cause potentially crushing inflation, albeit while it is intended to fight-off looming near-term DEflation, Americans and others around the world are afraid.

Rightly so, as this could get ugly. It's a big storm brewing, but we don't know if it will hit us or pass us by. For those who want to prepare for it hitting us, here are some action items I recommend:

1) Make sure you have life and disability insurance enough to pay the bills for the family if you die or can't earn your living any more.

2) Pay-down or pay-off any credit cards and personal loans, including 2nd mortgages and HELOCs.

3) If you accomplish #2 above, then build-up cash reserves, preferably a year's worth of necessary family living expenses (food, shelter, transportation, health insurance and medicine, but no need to budget, in this case, for vacations and clothes and spa treatments).

4) If you have investments, diversify globally; 50% of your stocks/stock-mutual-funds should be investing in foreign developed and emerging markets, and same with your bonds/bond-mutual-funds.

5) To make #4 really work, do not use index funds or even traditional style-pure mutual funds; find global and flexible mutual funds with consistent management and outstanding long-term track records--the best among them were down only 25% or less during the 2008 40% market crash, and many were actually UP during the early-2009 market crash, and they have kept-up pretty well during the post-March 2009 market rally; these funds also often invest in currencies and commodities better than most of us ever could.

6) Be prepared to do radical things, like the adult children moving home, or the elderly grandparents moving-in.

7) Stay optimistic. There are some good signs. Ford Motor Company has made an astonishing turn-around, so other manufacturers can also.

8) Take prudent advantage of current low interest rates--re-finance your house and investment properties, buy that new car if you need to, consolidate debt you can't pay-off.

9) Make sure you have that cushion described in #2 and #3 above.

Helpful?

The Foreclosure Fiasco!

This week has seen a new news issue on the top of the headlines: the "foreclosure fiasco".

Reportedly, some lending company managers and executives have been just basically robo-signing or rubber-stamping foreclosure documents. The concern, in case it's not readily apparent, is that such automated approvals could result in some folks being mistakenly or undeservedly kicked out of their homes.

So, there is a moratorium being imposed until the nature and depth of this issue is understood.

According to John Malloy, Executive Producer of the show "Fast Money" on CNBC, here are some recent data and observations:

"One in every 139 mortgages are currently in some state of foreclosure, an increase of 4% from last quarter. However, recently discovered issues within the foreclosure process at a number of large banks have politicians crying out for at least a brief moratorium on further foreclosures. Several of the bigger banks have already voluntarily slowed or stopped the process until procedures can be examined and improved."

And, "Without the moratoria, the percentage of foreclosures as a percentage of total loans outstanding is already at the extended rate of 4.6% - 288,000 homes were seized in third quarter alone."

Re-Fi Updates

Progress. The lending industry is still a shambles, but it is at least opening up a bit.

One client owns an investment condo and wants to re-finance into a shorter-term and a fixed interest rate, even though it would cost him more money each month (giving up some cash flow to obtain more stability). The condo is worth twice what he owes on it, and it's more than paying for itself for many years now as an investment property. Still, earlier this year, he was just-plain rejected... "We don't do investment condo re-fi right now. Sorry."

Last week, though, the same person got some traction. "We can do that. The rate for investment properties is a lot higher than if you lived in the condo, and we can't let you take any cash out. But we can definitely re-finance it for you if you like the numbers we offer."

Not great, but progress, and I am trying to monitor the key economic signs for us.

New Normal, No Normal, or Old Cyclical?

What sort of economy is the USA and the rest of the developed-economy world facing now and for the next number of years?

Bill Gross and Jeffrey Gundlach, two of the best bond fund managers on the planet, are the proponents of "new normal" and "no normal" theories, respectively, of the near- and intermediate-term economic outlook for the USA.

New Normal, by Gross and his team, is about persistent low-growth economics coupled with high unemployment over the next half-decade or so. Not another collapse, but hardly much of a recovery situation. Here in the developed world, that is. Opportunities abound eleswhere.

No Normal, espoused by Gundlach, is more about there being so much uncertainty that we can't be sure what will happen. Inflation or deflation? Recovery or double-dip, and with old jobs returning or there being a need for brand-new jobs?

Former economic advisor to president Obama, Christina Romer, thinks we are in the "old cyclical", not a new/no normal environment. She seems to think this is similar to what's happened in the past. Maybe so, but I think Gundlach and Gross have a better feel for what is actually going on in the real economy.

Politicians and ivory tower-dwellers are not to be ignored, but when there is a difference of opinion this significant, the investment experts with awesome track records, like Gross and Gundlach, probably are more worthy of our attention.

Ten Reasons to Be Optimistic

Jim Cramer is the enigmatic on-air and online investment "guru" whose specific advice I generally avoid but whose ability to see from a distance trends in the economy is often quite impressive.

He recently he spoke of 10 reasons why we can afford to be optimistic. Here they are:

1. The euro is higher against the dollar. European debt is now off the table and fears of a high dollar are not abating.

2. Back-to-school sales beat estimates.

3. Unemployment is "on a gentle slope downward."

4. The commercial property market is showing an "unexpected firmness."

5. Copper, oil and the Baltic Dry Index are at high levels.

6. Auto sales have been strong.

7. Mortgage applications have been up 9% this week.

8. Obama has a better relationship with the business world.

9. Big-Cap tech, like Cisco (CSCO), Intel (INTC), Oracle (ORCL), IBM (IBM) are showing unexpected strength.

10. The S&P 500 chart is in a reverse head and shoulders pattern, signaling a bottom.

#5 is the most interesting and appealing to me. Copper and the Baltic Dry Index, especially.

I am pessimistic about the U.S. economy, but I am bottom-up bullish on the stock markets. There is always a chance to get in early and make long-term money, even in bad markets. If Jim Cramer thinks the U.S. market is looking like a good bet, so much the better.

The "529 Plan" Isn't Dead... But It Needs Help

The 529 higher-education savings/investment type of account is losing popularity despite its tremendous tax advantages. Folks are worried because of what happened to their balances during the recent market collapse.

Contributions are down. Fewer 529 accounts are being opened. Folks are looking for more conservative places to invest money for college, like CDs and bank savings (nevermind that most 529s offer a "stable value" investment option).

Understandable reaction, but the wrong strategy. Most people will need to earn a lot more than bank interest, so they need to be investing for real, and ideally they will do so in tax-advantaged investment accounts. The 529 is one of the few places to do that...

But the 529 is far, far from ideal, and that is completely separate from the market value declines the investments therein suffered in 2008 along with most of the rest of the investment marketplace. 529s have other, perhaps bigger, problems that must be fixed.

Limited investment selection, and limited portfolio adjustments, are the biggies. Specifically, here is what needs to be fixed:

1) Scrap the state-sponsorship of 529 plans. We should not be stuck with investment choices limited to those offered by investment firms that get sweetheart deals from the sponsoring states. For example, if you are in the Alabama 529 plan, you're stuck with Van Kampen mutual funds. Nice deal for Van Kampen, and that's a decent fund company, but why should folks from Alabama have to suffer investment choice limitations in the first place just to get the in-state tax deductions? Not having free access to your money before college is a fair trade-off for the tax breaks, but there's no such logical relationship with social policy and a mutual fund dealer.

2) Lift the transaction restrictions. Most (all?) 529 plans restrict how often the owner of the account can rearrange the portfolio. In Virginia's 529 from American Funds, for example, ya get one annual re-jiggering of your portfolio. What if the markets are volatile that year and you want to move in or duck for cover? Folks, in this day and age, we need to be nimble and flexible. I'm not advocating frequent trading of mutual funds, as you probably already know, but I do not want my hands tied. Most 529s tie your hands.

Instead of this arbitrary and dubious 529 structure, let's open-up Education Savings Accounts (formerly known as Coverdell IRAs, after the late-Paul Coverdell, a Senator from GA who championed the idea of higher contribution limits on tax-deferred contributions for college savings). They are better than 529s, except you may contribute only a small fraction as much as to a 529.

"ESAs" can be established at almost any financial services institution, on your own or with the help of a financial advisor. You can invest in just about any stock, bond, mutual fund or exchange-traded fund. The contribution may or may not be tax-deductible, but any growth is tax-deferred, and withdrawals for approved higher-ed expenses are tax-free.

Don't let this deter you. Save for college. But voice your opinions. We should be allowed to save more, more freely and dynamically, in tax-advantaged accounts for college. Open-up the 529s, or shut 'em down and open-up the ESAs instead.

Bug your U.S. Representative about it by calling (202) 225-3121 and asking to be connected to your congressman/woman's office. Find your U.S. Rep at www.house.gov

What I'm Tracking Now--Interest Rates

I'm keeping my eye on interest rates. If they appear to be going up, we may need to adjust the bond portion of our portfolios, potentially rapidly and significantly.

Remember, bond prices drop when interest rates rise. Imagine fleeing the stock market for the bond market in order to preserve your nest egg, as millions of investors have done with zillions of dollars in recent years, only to have the nest egg reduced by bond prices dropping if/when interest rates rise? Pretty awful scenario, but also not unlikely to happen.

To defend against this "hurt even though I sought shelter" potential, we need to anticipate the interest rate moves.

If the Fed changes its language vis a vis fed funds rate, basically from the current "low for an extended period of time" to something like "for a while longer", that will have my attention.

If the newly-issued US Treasury bonds don't sell as much or as quickly at auction, indicating we might need to offer higher interest rates in order to "move the product", that will have my attention.

The Fed is unlikely to raise rates proactively until the economy is growing enough for inflation to become a concern. But rates may rise in the auction markets anyway, if our bond buyers (like China) determine that investing in the USA is more risky than usual. You see, they'll demand more for their investment, and we'll have to offer higher rates.

Either scenario will do damage to the net worth and account balances of investors positioned in the wrong kind of bonds or bond funds.

I seek to protect clients by keeping eye on what might cause the fire, not just by looking for clouds of smoke.

The Rich and Their Taxes

There is a lot of talk these days about who is rich and whether or not they are paying their fair share of taxes here in the USA.

This is my business blog, so personal opinions on politics are pretty much not offered. But here are some facts to consider:

Now, the top 5% of income earners pay 44% of the income taxes.
Now, they earn 32% of the income.

Under president Reagan, they paid 32% of the income taxes.
Under Reagan, they earned 23% of the income.

So, since Reagan, the top 5% have seen a 39% increase in their share of the income we earn.
And, since Reagan, they have seen a 38% increase in their share of the income taxes we pay.

What to think of the concentration of income is the subject of serious debate. And what to think of "progressive" or "graduated" tax systems like ours is an equally serious subject.

But the tax burden has evidently kept up with the income distribution.

(My information comes from an article written by MarketWatch's Brett Arends: http://www.marketwatch.com/story/7-myths-and-realities-about-taxes-2010-09-28)

Basic Budgeting

How much of your income should you spend on what and where? This is a huge deal, and too many otherwise capable people just don't know.

35% or less of your gross income (salary, for most people) into housing, long-term debts, ongoing obligations (like daycare or alimony), and car payments.

15% into retirement savings.

25% to federal, state and local taxes

25% leftover for food, clothing, utilities, social life, home and auto maintenance, etc.

If you make $120k/year, you can probably spend $3000 on housing and $500 on cars.

If you make $60k/year, it's more like $1500 and $250.

If you $30k/year, you probably need to share the rent with some friends and take the subway and the bus around town.

And let's not forget the financial priorities we've raised here in the past. At the very least, folks should have 3-6 months of emergency reserves at the bank or in a conservative/liquid investment at their brokerage firm (a SchwabOne account for most Potomac Wealth Strategies clients).

How Much Do You Need To Be "Rich"?

What is "rich"? Well, that's pretty nebulous, but the bottom line is that you need to make about $250k per year from working, or you need about $9mm invested to produce that income.

Interest rates are very low right now. If they go back up to normal levels someday, that $9mm might only need to be $5mm.

$250k covers most families and individuals in the top-two US income tax brackets, and that's as good a way as any to put a number on this subjective term.

Why $9mm to be rich? Isn't $1mm a ton of money, too? Sure, most folks don't have anywhere near $1mm, nevermind $9mm, but $1mm invested safely for the long-term in US Treasury securities will generate only about $25-30k per year. Uhh, that's not exactly "rich", is it?

This is why it's so important to evaluate and plan your financial future--people too often underestimate how much they need in the bank to replace the income from their working-years.

How Can We Be Smart and Stay Invested?

Billionaire/loudmouth/genius Mark Cuban recently offered keen insight into how the stock market is a dangerous place, especially for average investors.

Basically, he said we should be cutting back our exposure to stocks and increasing our cash, and paying off our debts.

But he also admits he just doesn't know when things will change for the better.

He is right to say things are difficult, and he may be right to say the system is tilted toward the professionals. But it is not hopeless, and it is not time to head for the exits. I think long-term investors have a great chance to grow their wealth, instead of merely preserving cash, if they "stay invested". But we can still heed Cuban's warning to keep some "dry powder"--that's the great thing about how I am investing for my clients.

For the record, I am pessimistic about the U.S. stock market and the U.S. economy in general, but I remain optimistic about long-term investing, especially for investors willing to go around the world to allocate their portfolios.

I have also regularly, and in recent years quite significantly, adjusted the portfolios I run for my clients. In particular, here are two major changes in the last three years to how I do business for my clients:

* I have increased the cash/money market allocations.
* Since mid-2008, I use mutual funds and managers that have global/flexible mandates.

Unlike typical portfolio managers and mutual funds that are required to stay fully-invested in specific areas of the market, these "global/flexible" managers can get out of weaker areas and into stronger areas, AND they can stockpile cash. The ones I use all have outstanding track records and consistently out-perform benchmarks by a lot, and with a level of risk that is worth taking for the better performance.

I still use a long-term "strategic" asset allocation in order to structure portfolios with the overall risk/reward balance suitable for each client. But the portfolio components have a lot of flexibility, so while I might recommend a strategy that calls for 5% in cash and 15% in bonds, the actual portfolio could have a lot more of both, depending on current market conditions.

Case in point, take my "moderately aggressive" mutual fund portfolio compared to a similar 80% stocks 20% bonds/cash portfolio of highly-regarded, widely-touted index funds from Fidelity:

ALLOCATION AS OF 8/31/10
Cash = 25% vs 9%
US Stocks = 27% vs 39%
Foreign Stocks = 23% vs 39%
Bonds = 15% vs 13%
Alternatives = 10% vs >1%

RETURNS
10 yr avg return = 10.5 vs 1.2
5 yr avg return = 8.9 vs 1.3
3 yr avg return = 5.9 vs -6.5
1 yr ret (thru 8/31) 9.9 vs. 3.1
last quarter = 2.4 vs. 1.2

The key is two-fold:

* My guys don't mimic indexes but, instead, carefully select stocks, bonds and alternative investments, and they employ a defined sell-discipline.
* My guys raise cash when they don't see anything better to buy, and they deploy cash into concentrated positions where/when their conviction is highest; they are patient and disciplined.

With the right tools and motivation, I have found ways that work better than just staying on the sidelines, better than generic "indexing".

A better portfolio, even for this difficult time, is out there, folks. Find it yourself, or get a pro like me to find it for you.

Bill Gross' Big Idea

Bill Gross, the "Warren Buffett of Bonds", is in the news this week. He has a radical idea to help "Main Street" and boost the economy.

In short, the tremendously successful billionaire, who runs what is the largest and, arguably, the best mutual fund in the country, wants Fannie Mae and Freddie Mac to lower the interest rates on all mortgages they hold now. Significantly. Like 6% loans would go down to 4%.

This would massively reduce the monthly payment obligations of the borrowers while still requiring they pay-back all of what they borrowed.

This would not require lenders to write-down the value of assets, either. They'd have to suck it up and plan on 1/3 less income, though.

Let me know what you think.

Retirement Account Contribution Priorities

You have a job. You can pay all of your necessary bills each month. Now you want to save for retirement. Good. You should!

But how? So many different accounts, so many ways to save.

Well, I'm here to help. And today let's forget about the investments. Let's just focus on where to put the money.

Here are the usual retirement savings choices:
1) employer-sponsored retirement plans (like 401k, 403b, TSP, 457b, and pensions)
2) individual retirement accounts (IRA, Roth IRA)
3) taxable brokerage accounts

All of these accounts allow you to hold cash or invest. Investment options vary, but typically you can at least use mutual funds.

Options 1 and 2 offer tax-deferred investment growth, and you may also be able to deduct your contribution amount from your taxable income each year.

Option 1 sometimes offers additional contributions from your employer--a very nice fringe benefit!

So, how to do all this?

First, take the "free money". If your employer offers "matching" or "profit sharing", contribute enough to earn the maximum offered. That's a no-brainer, but I'm saying it anyway!

Second, if you are eligible to contribute to a Roth IRA, do it. Any investment growth is free of capital gains taxes, AND the money comes out of the account tax-free in your retirement years. You can put in up to $5000 per year ($6k if you're 50+ yrs old). If you can't use a Roth IRA, then go to the next step.

Third, go back to the plan at work and top it off. You can contribute up to $16,500 per year. If you make $100k and get a "match" on the first 6% of your salary contributed, then you put in $6k right away. Then you put in $5k to the Roth. So, here now you can put in another $10,500 into the plan at work.

Fourth, if you can't use a Roth and have more than $16,500 to save each year, now is when you should fill-up your traditional IRA. $5k max per year, $6k if you're 50+.

Fifth... it gets complicated, and most folks do not get this far. But try!

If you can afford to save into the 401(k) and the IRA--a total of $21,500 per year--congrats! You are among the few and the proud.

If you make less than $200k per year and you are saving over $20k per year while still in your 30s, you are definitely on the right track.

If you're one of the so-called "rich" earning more than $250k per year, though, you may still need to save more. Think in terms of at least 10%, preferably 15%, and if you're getting a late start, 20% of your income should go into your retirement accounts.

Call me and we'll run a retirement projection so ballpark whether or not you're on track.

Tax Cuts: Do They Pay For Themselves?

Maybe, maybe not. This is a tough question to answer definitively, and the subject almost always gets political, and I prefer to keep this blog about sound ideas and facts instead of political stances.

Okay, with the American business sector acting as if it's on "hold" until government policy changes (taxes, regulation, etc.) are clear or in effect, we wait and debate. One huge debate is whether Congress should allow the "Bush Tax Cuts" of 2001 and 2003 to expire as scheduled, or if we should raise some rates and not the others or maintain status quo.

It is widely held, by those who believe cuts in marginal income tax rates will stimulate the economy and thus actually increase tax revenues, that there's a lag-effect for the stimulative results to appear. Some of the most ferocious debating and punditry right now is whether such tax cuts really do lead to higher, not lower, federal revenues.

With that in mind, here is some data right from the CBO and OMB:

US Budget Receipts (just from individual income taxes)
2000 was $1,004 billion
2001 was $994 billion, down 1.0%
2002 was $858 billion, down 13.7%
2003 was $794 billion, down 7.5%
2004 was $809 billion, up 1.9%
2005 was $927 billion, up 14.6%
2006 was $1,043 billion, up 12.5%
2007 was $1,163 billion, up 11.5%
2008 was $1,219 billion, up 4.8%

Tax cuts were approved in '01 and '03, so their effects likely started being felt in '02 and '04.

Federal receipts from income taxes grew a lot each year starting in 2004, while the economy did not grow at the same rate. Way too many variables would factor in here for the results to be conclusive, but the income tax cuts do correspond to increased revenue to the government.

(Here's the US GDP data for the same time-frame)
2000 was $9.76 trillion
2001 was $10.1 trillion, up 3.5%
2002 was $10.4 trillion, up 3.0%
2003 was $10.9 trillion, up 4.8%
2004 was $11.6 trillion, up 6.4%
2005 was $12.4 trillion, up 6.8%
2006 was $13.1 trillion, up 5.6%
2007 was $13.7 trillion, up 4.5%
2008 was $14.6 trillion, up 6.6%

Financial Priorities to Keep You On Track

Here is how I think folks should prioritize their financial matters:

1) Term life insurance. If you have anyone depending on you as their financial provider and you do not already have a big enough nest egg to provide for them after you're gone, you need to create a nest egg that will fund those needs.

2) Disability insurance. If you need to work for a living, presumably you'd still have those bills to pay even if you are hurt and can't work. Long-term disability coverage is very important, but also look at short-term and "gap"/"supplemental" coverage.

3) Emergency Reserves. Everyone who needs to work for a living should have at least three-months, and preferably more, of necessary living expenses in savings. You can also "invest" the money, but be sure to use very conservative investments that are readily accessible without penalty.

4) Pay-down "bad" debts. Credit card, personal loans, and loans or in-use credit lines against the equity in your home are on the agenda here. If you have them, you're probably spending more than you should for normal living expenses (so fix your budget if you can, and these are debts that usually charge high rates. A fixed-rate mortgage you can afford, a reasonable car payment, and student loans that are being paid back on schedule, are definitely debts, but they can be treated like living expenses rather than unnecessary burdens.

5) Retirement savings. Now we start investing. Start with contributing the minimum necessary to your retirement plan at work to earn the maximum "company match", if offered (no sense leaving "free money" on the table). Then max-out a Roth IRA ($5k), if you're eligible. Then top-off the plan at work, up to the $16,500 federally-mandated maximum tax-deductible contribution. If you earn enough to put away more than that $21,500, great! Call me and I'll show you what you can do...

6) Other high priorities. Saving for your children's education, contributing to charities, retiring early, buying a second home or a fancy car or a boat... this gets personal. I won't presume to tell anyone how to prioritize in this area, but let's just say "there's no work-study or student loans for retirement." This is where you might sock-away more money in your brokerage account. You can use it to invest in speculative stocks you think have "home run potential". Or you might use a variable annuity to provide a level of safety for that chunk of your portfolio. Lots to consider here.

If you have a grip on this already and also know how to invest your portfolio effectively with the best balance of risk and reward using the best available money managers and/or mutual funds, you should be fine on your own.

If you do not possess the knowledge to prioritize your financial life and to invest your money... or if you do not have time to act on the knowledge you may possess... or you do not have the wherewithal to stay on top of it... you should hire a financial advisor.

China's Advancement

According to a scholar and an investment manager I just saw interviewed, both of whom are experts on China, 300,000,000 Chinese people will move into the urban/suburban middle-class in the next 15 years.

That's as many people as we have in the entire USA. That's almost 400,000 people per week.

China will need houses, roads, bridges, hospitals, schools, water-treatment, telecommunications, electricity, cars, computer systems...

My clients and I are and will continue investing in China, both in China-based firms and firms that do business with China.

Chasing Returns vs. Identifying Skill: Picking Good Mutual Funds

We are often advised to not "chase returns" when looking for mutual funds. Don't go for the funds that are doing great in the past year--they're ripe for a fall.

Fair enough. But that does not mean we should avoid those funds. We just need to see more info before deciding.

When I choose mutual funds for the portfolios I run for clients (and myself--I eat off of the same plate from which I serve), there are many factors and data points I consider. One is the relative performance history over numerous, not just recent, time periods.

Almost every mutual fund I use has been a top-quartile performer in its category in the 10-year, 5-year AND 3-year periods. Every fund can have a good or bad stretch, but the ones that are basically always doing better than most of their peers... those are appealing.

The process is rigorous. If you can do it yourself, great! If not, though, it is worth the money to hire someone like me to do it for you.

Top-Down Bears vs. Bottom-Up Bulls

Where will the stock market go now? There is a battle between the Bulls and the Bears. Bulls think we have good things ahead, and Bears think otherwise. This is normal. Reports are that pessimism was palpable, but not insurmountable, at the recent Morningstar Investment Conference.

Given the state of the U.S. economy, portfolio managers who take a top-down view, looking at economic conditions as the primary basis of their investment decisions, were gloomy. In short, they see that the U.S. government has become dangerously overlevered in order to bail out a number of fatally overlevered private institutions.

But some managers who take a bottom-up view, searching for good investments to make now, regardless of the bigger picture, are optimistic. Recent volatility has presented the chance to buy some high-quality stocks at good discounts to their fair value.

While bigger and more intractable, macroeconomic problems are not as imminent as the dangers of the subprime-catalyzed credit crisis that started to boil over in 2007. That means we might still have time to get in while the getting is good, as long as we are flexible and can be nimble.

This is not the time to have a static portfolio. We need to use funds and managers with flexible and global mandates. They need to be able to go to the sidelines or change their game plan as conditions require.

The Top-Down Bears are probably right that the economy is precarious and investment opportunities dubious right now. But the Bottom-Up Bulls intend to take advantage of great opportunities nonetheless.

Newsflash: It Was Not Just "Sub-Prime"

It never was, but it was easy for pundits, and more convenient for politicians, to say it was.

Saying it's just the "sub-prime" borrowers that are defaulting allows Left-wingers to manufacture a victim in this mess, and it enables Right-wingers to blame it on the less-able or more lazy among us.

But get this: one in seven mortgages over $1mm is "seriously delinquent", while only one in 12 mortgages below $1mm fit that bill.

You read that right. The more affluent borrowers are almost twice as likely to be up a creek on their mortgages than everyone else.

From a "what the heck were the banks thinking" standpoint, Sub-Prime is a much larger share of this mess, and so that issue is not to be ignored. But what does it say about the direction and mindset of our country when the more successful among us are more likely than the masses to do the wrong thing with their financial lives?

"The Index": Should You Really Own It?

According to William Hester, CFA and Senior Financial Analyst at Hussman Funds:

"The shares of companies deleted from the S&P 500 have consistently outperformed those that took their place. Since the beginning of 1998, the median annualized return of all stocks deleted from the index and held from their exit date through March 15 [of 2010] was 15.4 percent. The median annualized return of all stocks that were added to the index was 2.9 percent."

Many pundits and advisors advocate "owning the index""--saves ya money, keeps ya diversified, takes the emotion out of investing...

The most popular ways to "own" an index in your portfolio is via an "index fund" or an "exchange-traded fund (ETF)". The most popular ETF is the SPDR S&P 500 (SPY). The second-most popular index fund is Vanguard 500 Index (VFINX or VFIAX).

Lots of people are missing a lot of opportunities by using just index funds. Especially those who are only using the S&P 500.

Mutual Fund Costs: Saving Money While Making Money

Most of us use mutual funds for our investment portfolios. We get professional management and diversification that way. If we had millions of dollars, we could afford private portfolio management in order to obtain those important benefits.

Either way, there are costs. Some funds, or managers, are more expensive than others. But funds and managers generate unique investment performance, and they establish unique track records. So, cost alone is not the right factor to consider when selecting our investments.

It really should be about "cost-justification". I've said this here before, but I just read yet another magazine article that I think sends the wrong message: "Shop around for inexpensive investment options in order to maximize returns."

That's dubious advice. When put that simply, it will lead folks to use only the cheapest funds.

Let's compare two very popular mutual funds and test that advice: PIMCO Total Return C (PTTCX) vs. Vanguard Total Bond Market Index (VBMFX), both of which are bond-oriented mutual funds intended to provide broad exposure to income-producing, low-volatility fixed-income investments. Neither charges a front-end sales "load", and they have almost the same amount of volatility/risk.

PTTCX has a pretty high "expense ratio" of 1.65%. This would make Suze Orman pretty emotional.

VBMFX has a very low "expense ratio" of .22%. This would make Suze Orman pretty happy.

PTTCX vs. VBMFX over the past 10 years? 6.46% per year to 6.10% per year. PTTCX wins!

Over the past five years? 6.29% to 5.55%, and PTTCX wins again.

Three years? 9.77% to 7.45%. PTTCX, again.

The last 12 months? 10.82% to 8.00%. PTTCX

And how about the last month? 1.33% to .84%. Yes, PTTCX won again.

(all of those returns are inclusive of the "expense ratio", or "net of fees")

That's a great example of "cost-justification vs. cost alone". And something else to consider is this: VBMFX is an index fund that must stay fully-invested all the time in a specific group of investments, while PTTCX can keep money on the sidelines or move around within the fixed-income arena to avoid problems or take advantage of opportunities. While that would be a problem if PTTCX "bets wrong", that fund has an extremely long and successful track record.

Now, this is the rare case, but don't let its rarity deter you. You should pursue the best product available. Sure, about 80% of mutual funds fail to beat their benchmarks, but you can find out on your own which ones do beat their benchmarks.

Or, you can hire a financial advisor to figure that our for you. Not all of us are diligent about it, but some of us really are, and it's to your benefit.

Troubling Signs: The No-Go Re-Fi

More signs pointing to economic trouble ahead... A client was rejected, flat-out, this week in two attempts to re-finance the mortgage on an investment property. Surprised? No. But this is not good news.

In short, the condo he bought as a bachelor is now an investment property he rents-out. It pays for itself, and then some, from rental income. It is also worth about twice what he owes on it. His credit rating is top-shelf, and his wife's is even better. They make enough money to do all the things they do, and they carry no debts other than their mortgages.

Nonetheless, he was rejected. The superstar mortgage broker he went to, who is one of the best salesmen you'll meet and a great guy, looked at his situation and said, "no dice." Then he went to Morgan Stanley Credit Corp, where the mortgage is right now. No dice--"we don't do any investment condos right now".

Folks, under Bush, and now Obama, Bernanke's Fed and Paulson's/Geithner's Treasury have flooded our economy with liquidity to get it going again. It comes in the form of actual money being sent out of government coffers, in the form of absolute rock-bottom interest rates, and in the form of regulatory adjustments. The intention is to spur the economy in the right direction.

It may well have prevented a Great Depression II so far, but it's not working beyond that. If this guy's own lender won't let him re-fi a loan that has a spotless record when he's in better financial condition than at the outset of the loan years ago, and when--get this--he was basically offering to pay them MORE money, something is not working. That's right, he wants to re-fi out of a 30-year loan and into a 15- or 20-year loan that would give them a higher interest payment from him each month. Since most mortgages don't last more than 5-10 years, it's arguably irrelevant that they'd normally rather have him for 30 years than for 15 years.

My point? Drop your politics and look at the reality on the ground. Whatever "They" have been doing so far is just not working. The economic activity in this country depends greatly on confidence and credit. When banks won't even make solid bets on existing customers who are willing and able to pay more, we're not yet back on track.

Debt-to-GDP Ratio: Great Recession vs. Great Depression

The US government entered the current "Great Recession" with $65 of debt for every $100 of Gross Domestic Product. That ratio has exploded to 90%. Meanwhile, household debt (the sum of the personal debts of all of us individually) hit close to 100% of GDP early on in the Great Recession and has dropped to about 92% as the Great Recession has continued.

At the beginning of the "Great Depression", on the other hand, the debt-to-GDP ratio was 16%, and it was 44% when the Great Depression ended. But while household debt was around 100% at the onset, like it was recently, it went down to about 20% as Americans deleveraged themselves.

In one scenario our government borrowed less than the other scenario. And, respectively, We the People unwound a lot more of our personal household debt then than we have thusfar.

Problem: the measures taken by the government to stimulate the economy have, arguably, the desired result for a period of time, but they then lead to significant economic contraction. When the economy slows, individuals may have the option to leverage-up their personal balance sheets to pick up the slack... if they have room to spare.

The Strength of Our Economy Now...

...is not looking good. It's palpable to many, and all too real to still many more. But the numbers are showing it also.

We're not in a recession, if you go by the book, as we've had two straight quarters of positive GDP growth. But I think there's more to it.

For one thing, the U.S. stock markets are showing the signs we don't want to see. The up days are not happening on high trading volume, and the down days are happening on higher volume. This indicates weakness.

For another, the jobs reports are bearing bad news. Most of the new jobs are from temporary government stimulus, or from very temporary Census-related hiring.

And another example is the terrible housing data we just got. Real estate is about location, location, location, but, overall, the U.S. housing market is not going the right direction. Might even be going the wrong direction.

Here's the last of the big warning signs I'm tuned-in to at the moment: the TED Spread is starting to widen. That's the difference between the LIBOR and short-term Treasuries. An increasing TED Spread often comes before a downturn in the U.S. economy, as it indicates liquidity is being withdrawn (investors are getting a better deal in Europe than the USA).

Now, here are some positive indicators and factors:
1) U.S. corporate profits are improving, and not just on the bottom-line (which can be affected by cost-cutting) but also on the top-line (sales).
2) There are trillions of dollars on the sidelines now, sitting in cash, belonging to both consumers/investors and businesses. If things do turn around, the stock market could actually boom.
3) Europe is starting to shift from stimulus spending to "austerity" measures, and while the USA isn't exactly jumping the gun on that matter, the stimulus-oriented Democrats are not as politically strong as they were a year, or even six months, ago, and so the USA might try another tack sooner than expected.

Advice: bond funds over bonds, short- and intermediate-term bonds over long-term bonds; high-quality stocks over speculative stocks; global/flexible mutual funds over "style-pure" mutual funds; and, by all means, get rid of credit card debt and/or build-up an emergency reserves fund in a cash acct or a very low-volatility and readily-liquid ETF or mutual fund.

Insurance: How Much Do You Need?

Make sure you have enough life insurance, everyone. $1mm of investible assets for every $50k you need to spend each year. If you need $50k per year of spending money to replace your wife's income if she dies (to be expected if she makes a salary of, say, $75k), you need $1mm nest egg. If you have $200k in your portfolio and savings plus her retirement plan, then you need $800k of life insurance coverage on your wife. Make sure you or your Trust is the beneficiary.

Also, makes sure you have Long-term Disability Insurance, and pay the premium yourself, even if your employer offers to pay it for you as a fringe benefit. Paying it yourself allows you to get the income tax-free; if your employer pays the premium, you will have to pay income taxes on your benefit.

Waste no time with this. Too many people need insurance before they get the right amount.

More On Interest Rates and Bond Investing

I'm preparing for rising rates. While I don't expect the Fed to raise 'em this year, or even in 2011, it is bound to happen some day. Rates are as low as they can go (the Fed Funds Rate is now 0-.25%).

There is also the market-forces factor. If the USA keeps needing to borrow money, our national credit rating could be at risk and that, along with the flood of additional bond issues to the global markets, could naturally force rates up, regardless of the Fed's action.

Well-managed bond "ladders" and bond mutual funds can mitigate the "interest rate risk" of owning bonds. Remember, bonds are usually less risky than stocks and are used for the more conservative and/or the income-oriented portion of an investor's portfolio. But rising rates hurt the market value of bonds, so portfolio values can decline when rates rise.

There are many ways to address these scenarios, and I have my ducks in a row. If we hit rough weather in the bond markets, we know where the lifejackets and life boats are, and how to use them.

Interest Rates and Bond Risk

The Federal Reserve is tasked with two primary objectives: maintain price stability, and maintain high employment.

Maintaining price stability means, simply, keeping inflation pretty low without pushing us into deflation.

Maintaining high employment... well, that means keeping unemployment low (not sure how else to explain that obvious objective).

In both cases, the most effective tool at the Fed's hand is raising or lowering the interest rates. Lower rates stimulate the economy because it makes it easier/more affordable for people and businesses to borrow money. Raising rates tames inflation by slowing down the economy.

But interest rates affect the value of bonds. Bonds, as I've posted here before, are thought to be the "safe" place to invest, but they do fluctuate in value. Rising interest rates force bond prices lower; falling rates lift bond prices.

Most folks buy bonds in order to get predictable income streams, not capital gains. Hold a bond to maturity, in fact, and you get your original money back. Your benefit was the income the bond paid while you owned it.

So, if interest rates are so low, aren't bonds scary now--won't they be likely to go down in value? Yes. If and when the Fed starts raising interest rates.

But that should only happen when the economy starts growing too fast again. We're just hoping it's really even starting to grow now. Some experts think it won't be for another year or two that the Fed will start raising rates.

So, this is potentially good for bond investors who need income or who seek relative safety compared to the volatile stock market. Alas, other forces could work against interest rate stability. If the USA's spending remains in deep deficit mode, we might need to offer higher rates on our more risky Treasury bonds when we sell more to fund our ongoing deficits.

The key is to know what you have and to have an exit plan. Most individuals should not tinker with individual bonds right now. It would be better to have a private portfolio manager run things, or to use a reputable and successful bond mutual fund.

What To Do With Your Old 401(k)?

Do not roll it over into the 401(k) of your new employer. That's usually the best advice for the vast majority of people. Unless...

...you want your heirs to have worse tax treatment after you die

...or you prefer to have a very limited selection of investments available

...or you want no financial advisor to help you

...or, if you're a do-it-yourselfer, you'd rather have mediocre customer service instead of the excellent service provided by Schwab, Fidelity, TD Ameritrade, etc.

If it's somehow all about low-cost, the 401(k) might make sense. Except using exchange-traded funds at Fidelity or Schwab almost certainly eclipses that in terms of cost-savings, and it absolutely eclipses your 401(k) in terms of investment selection, even if you are limited to just some ETFs.

Now, if you think you'll ever need to borrow against your retirement plan assets, then DO combine your old 401(k) plans into your current one. But then take a serious look at your budget and figure out why you needed to borrow from your 401(k) in the first place. This is a huge red flag. Try not to go there.

Imports, Exports and Empties: Positive Economic Signals

Good economic news!

Six straight months of increasing port activity in Long Beach (the huge port near Los Angeles). Imports up 27%, exports up 15%, "empties" up up 35%. Empties are ships going back over to Asia to bring more stuff back here. This doesn't mean we're out of the woods, but it's a positive sign.

Terminology To Offend Or Titilate

"Dead Cat Bounce"

"Sucker's Rally"

"Bull Trap"

These terms all apply to market upswings that have little or no fundamental economic or financial support. The stock market moves on valuation and sentiment, and sometimes one weighs more heavily than the other, sometimes at the wrong time.

Cat fans don't like the imagery of the first term, and most folks don't like to be thought of as fools, and investors who play to win hate to be caught on the losing end. But a ton of investors have bought in during a Dead Cat Bounce, a Sucker's Rally, or a Bull Trap. Especially in recent years.

Make long-term investments with money you can afford to go without for many years, and buy shares of companies you think are solid financially and will either share their profits, grow their business, or both.

Make short-term trades with money you can afford to lose forever. Buy shares of stocks you think will go up. Period. And try to avoid buying during an uptick that turns out to be a Dead Cat Bounce.

Predicting Economic Crisis: "What" Is Easy, "When" Is the Trick

Here is outstandingly keen insight from economist Professor Ken Rogoff, from an interview by Ezra Klein:

Start with a really important point: It’s very hard to call the timing of a crisis. You can see that an economy is vulnerable, and maybe even fairly reliably say you’ll have a crisis in 5 to10 years, but until it’s upon you, it’s hard to narrow the window down with any precision. Many of the people who say they predicted the crisis in a precise way had actually been predicting a crisis for years. There’s irreducible uncertainty coming from fragile confidence and political factors. The analogy is someone who’s vulnerable to a heart attack. You can go to the doctor and they can see your cholesterol is high and you have a number of risk factors, but you might go on for 20 years without anything happening. Or it might be 20 hours.

Because the timing is hard to call, policymakers have trouble getting seized by it. Why worry if it is not going to hit on my watch? And if you’re an investor and you’re making great money for five more years and then you have a bad year, you still have a good decade. But policymakers, especially, need to have a longer vision because of the human cost of financial crises, particularly in the hugely elevated level of long-term unemployment.

Jobs vs. Unemployment

The latest jobs numbers are in and the USA gained over 400,000 in May. But only about 40,000 were from the private sector, as hundreds of thousands of temporary workers are being hired by the government to conduct the Census.

The USA's economy needs around 150,000 new jobs a month just to keep the unemployment rate from going up.

If we're looking to cut the unemployment rate from around 10% to a more desirable 5%, we need a lot more than 40,000 private sector jobs each month.

The "Death Tax"

Americans who die in 2010 will pay no federal tax on their estate, thanks to the "sunset provision" of the "Bush Tax Cuts". For 2009, any amount over $3.5 million was taxed at over 40%. Prior to that, the threshold was even lower and the rate was even higher.

But starting in 2011, the federal estate tax (aka the "Death Tax", to those who lament the matter) returns--any amount of one's estate over $1 million will be taxed at 55%, unless the law is changed by Congress and signed by the president.

So, the heirs of someone with a net worth of $3 million will have to come up with $1.1mm cash to pay the federal government. That, after the "benefactor" has paid a lifetime of income, capital gains, dividend and interest taxes while building-up the $3mm net worth; and we should remember that the companies that paid-out the dividends did so after being taxed on their earnings already.

Food for thought.

The "real" Price of Gold?

Gold may have a lot of upside price potential, even with the major run-up it's had in recent years. It is about 30% below its all-time high price, if you adjust for inflation, and demand is likely to increase. A lot.

Gold prices historically have risen in times of fear and of inflation. And then there is good-old supply-and-demand.

There is already fear. The world's major economies are struggling, obviously.

There could well be inflation. The loose fiscal and monetary policies governments are using to fight-off recession and depression usually result in inflation.

And then there are China and Japan... China has just 1.6% of its currency reserves in gold, and Japan just 2.5%. The USA has 70% and Germany, another major developed economy, has 66%. In a world where the value of currencies is dubious at best right now, gold is probably going to be coveted.

What could this mean? Well, if China and Japan were to increase gold reserves to just 10% (nowhere near the 70% of the USA), the increase in demand for gold would be 3.5 times annual mine production. That would drive prices up, both for the gold itself and, presumably, for the stocks of gold mining companies.

Counterintuitive Is Not Just A Cool-Sounding Word.

It is the way to describe many of our best investment choices right now. With stock markets in volatile moods and economies on the ropes, investors are wondering where to invest. Bonds. That's usually the call when stocks get too scary.

But bonds are not always safe. The better-quality bonds do pay you back your money, with interest, but if you need your money back before the bond matures, you can make or lose money. Sometimes a lot.

When interest rates sink, such as during a recession when central banks want it to be easier for businesses and individuals to borrow money (to hopefully stimulate the economy), the price of bonds you hold will go up if the interest rate you have is better than what newly-issued bonds would offer. The reverse is true when things are going perhaps too well economically and the central banks decide to slow things down a bit.

Well, rates also rise by accident, when things are bad--not just when they're too good. If a usually economically-sound country keeps issuing bonds to pay for government services that are not funded well enough by tax revenue, that indicates to investors that the country might be facing difficulty. Between that and an increased supply of new bond issues, the demand/supply ratio is affected. When there are not enough buyers, sellers either lower their prices or sweeten the pot. Offering higher yields is the sweetening the pot, and selling for less than face-value (the earlier scenario) is the lowering of the price.

If the USA is taking on massive amounts more debt, there's a leveraging of the increase in yield it must offer to attract investors. That pushes down the value of the bonds one might already hold... and that's the kind of nest egg damage a lot of folks seek to avoid when they go into bonds in the first place.

So, what to do?

Interview with A Fund Manager: Matt McLennan, First Eagle Global Fund

Here is an interview with one of the two co-managers of one of the best global/flexible mutual funds on the planet. The fund tries to deliver good returns in good markets while protecting against the downside during bad markets. It is quite effective.

*down only 21% in 2008 (the foreign stock market was down 41%, the US down 37%)

*up 23% in 2009 (vs. up 27% for both Foreign and US).

*up over 7% per year for the past 5 years (the foreign market was up just 1% per year, the US market was almost exactly break-even).

Cut/paste the link below here to see the interview (I'll try figure out how to post links soon):

http://www.executiveinterviews.net/players/mini/default.asp?order=U13259

Double-dip Recession, or Just a Market Correction?

The Bad News...

European banks are starting to not lend to each other... reminds us a lot of the USA in late-2008.

The spread between junk bonds and treasuries has jumped 200 basis-points, indicating possible "contagion" here from Europe's troubles.

The stock markets are tanking lately.


The Good News...

The rising dollar has pushed down energy prices, which is a boost to the U.S. economy. It's like getting a decent-sized tax cut, some have pointed out.

Interest rates remain low, which helps troubled homeowners and lending banks that need time.

This is probably just a "correction", and so we can buy some good stocks "on sale" this week.


What We Think...

We hate to be pessimistic, but our long-term view is just that. We think the governments of the developed economies will fight-off disaster (another "Great Recession") but the tools used will be impediments to growth.

Avoiding that double-dip would inspire markets, though. Interest rates are so low and there's a ton of cash on the sidelines. Stocks have a lot of potential in the short term. But be flexible.

Thinking Out of the Box, Literally: What About the Style Boxes?

In our last post, we met the Style Boxes. If you missed it, please read that and then come back here.

2008 was an unfortunate but inevitable example of how sticking with strategic allocation to a variety of style boxes can sometimes be of little help in avoiding portfolio declines during a "crash". And 2009 similarly showed us how sticking with our selected style boxes can keep us out of the best performing areas of the market in an big "up" year.

Portfolios that utilize a global/flexible approach, though, can offer much better returns. Or much bigger losses. It really depends on whether the manager of a global/flexible fund, the advisor running a client's portfolio, or an individual investor picks the "right" style boxes to emphasize and avoid.

This tactical allocation is more art than science, whereas the strategic allocation is more science than art. It is clear, though, that managers with long-term track records of "success" using global/flexible or tactical methods have significantly out-performed "the market" and portfolios using just strategic asset allocation.

Some examples:

A global/flexible mutual fund we love uses both strategic and tactical methods at the same time. It is usually about 60-40 stocks-bonds, and 60-40 domestic-foreign. Within the stock allocation, though, it can go anywhere it wants, and same within the bond allocation. For example, if 36% of the portfolio is to be in U.S. stocks, but the manager is wary of small-cap growth stocks and strongly favors large-cap value, he can direct the entire 36% to that style box. This fund was down only 21% in 2008 (the US market was down 37% and the foreign-developed stock market was down 43%), and it averaged over 7% per year over the past decade while the U.S. market has been at about -1% per year. This fund has a 21 year track record and has always delivered like this. Clearly, they know better than most where to be and when.

Another global/flexible mutual fund we love can go anywhere and invest in just about anything. At the worst of the 2008 crash, it was only 15% in stocks and had taken large positions in cash, gold and bonds. During the big run-up in 2009 it was around 80% in stocks. It was only down 26% in 2008, and it's 10-year track record is over 10% per year.

Still another fund we love was only down 8% in 2009, and it's averaging almost 9% per year for the last decade. This one doesn't move around the style boxes so much as it invests significantly in areas outside of the normal style boxes.

These global/flexible funds are the exception; most who try don't succeed at beating the market for very long. But they are out there, folks. You just need to know how to get 'em. Or you need an advisor to find them for you.

Thinking Out of the Box, Literally: Introducing the Style Boxes

In an earlier post, I said investors and their advisors should be thinking out of the box right now, and I meant it literally. But it was industry insider lingo, so I'll explain it more in this post and the next one over the weekend. For now, let's meet the "style boxes".

Each investment style box represents a particular slice of the investment marketplace. Picture a tic-tac-toe board. The top boxes, if we're talking about stocks, are for the large companies. The top-left box is for large "value" companies. Top-right is for large "growth" companies. The top-middle box is for large "blend" companies.

The middle row is for the mid-size companies, the bottom row for small companies. And a similar board full of style boxes can be made for companies outside the U.S., in either "developed" markets or "emerging" markets.

Same story for bonds, but the categories are different: high, medium and low quality... short, intermediate, and long duration... government (aka sovereign), municipal, and corporate... domestic, developed-foreign, and emerging markets...

Okay, so what?

Well, a typical mutual fund or private portfolio manager invests pretty much in just one style box, or maybe a few very closely-related style boxes. Since different investment styles do better or worse at different times, it is important to either allocate your portfolio to the right long-term strategic mix of style-boxes or to be able to move out of the style boxes that are going to have difficulty and into to the ones that will do well, and then back again when conditions dictate.

In 2008, all but a few style boxes were bad places to be invested. Almost everything was going down, a lot. Even the best strategic asset allocations got hammered. There is Nobel Prize-winning research showing us how much to put in and keep in which style boxes for the long-haul, and it's valid. But it was very painful in 2008 to have stayed with a strategic asset allocation because you were deliberately staying put in style boxes that were plummeting.

It could be painful like that again sooner or later, given the fundamental economic difficulties much of the developed-world economies have right now.

So, next we'll talk about ways to think and move out of "the box(es)". It might be helpful.

A Volatile Market

So, the stock markets were up today on pretty heavy volume. That's as good news today as it closing down on heavy volume was bad news yesterday.

There are a ton of competing indicators, so it's very tough to know what to expect. One thing is certain, though: the financial health of many of the economically developed countries is in jeopardy from unhealthy balance sheets (translation: the big, strong countries are in trouble because they're spending much more than they're bringing in, and the solutions are to cut services to people who need them and raise taxes on the people who are most productive in the first place).

This is not inherently a positive long-term situation for the stock markets, and it also jeopardizes the bond markets.

Investors and their advisors should probably be flexible and thinking out of the box. More on that later.

Happy Friday, and a great weekend to you!

Pullback, Correction, Bear Market, Crash???

Lots of market lingo gets tossed around. Here's my effort to clarify it for you:

A "pullback" is when a securities market declines up to 10% from its recent high-water mark. It may happen in a few days or even a few weeks. It's usually because the market was going up faster/higher than it should, but it usually does not signal any major problems. Long-term and opportunistic investors enjoy a pullback once in a while, as their Buy List securities are effectively "on sale".

A "correction" is when the market experiences an extended pullback, ending up 10% or more below the most recent high-water mark. This is where things get worrisome--perhaps there are real problems and the market is starting to price accordingly.

A "bear market" is much worse. It usually happens when a pullback or a correction turns out to have been due to economic fundamentals instead of just market action. 20% down from the recent high is the threshold. Long-term and opportunistic investors still like bear markets, though, as they feel great bargains are available.

A "crash" is when we speed right through pullback and correction status and into bear market range much faster than usual. A crash can be short-lived, like in the fall of 1987 or the fall of 2008, after which a sharp recovery can take place. A crash also can be the start of a long, drawn-out period of terrible market conditions like during the "Great Depression" of the 1930s.


We are in a correction right now. Many experts predict it's a bear market in the making. Those experts are often wrong, but they are also often right. Sometimes the market does not do what we think it should.

Diversify Your Portfolio, But How?

We are wise to not put all our investment eggs in one basket. Enron went bankrupt nearly a decade ago. It had been one of the very most highly-regarded businesses and stocks on the planet, until it suddenly wasn't.

Mutual funds, Separately Managed Accounts, Exchange-Traded Funds, and Unit Investment Trusts all offer convenient ways for investors to diversify their portfolios and avoid Enron-like debacles. They also offer the chance to make use of professional portfolio managers who can/should know a lot more about how to invest than the average person.

In addition to choosing which type of product to use, though, a prudent investor must determine which of the sometimes thousands of choices within a product category are worth using. Owning a mutual fund might offer more diversification than you would get for yourself, but it should also be "better" diversification.

It is a good idea to hire a trusted and knowledgeable advisor to help you decide what products to use, and especially to find the best providers of the chosen product type. You can do it yourself, of course, but make sure you have the time and tools and discipline to do it well.

All That Gold Isn't Always Glitter

Gold. Popular now. Likely to rise in coming years as currencies devalue, inflation returns, and instability spreads.

BUT GOLD IS NOT INHERENTLY SAFE. Gold is a volatile commodity. It's way up from where it was years ago, but that was way down from where it had been.

Invest in gold if you think it's going up. Do not invest in gold as an alternative to cash.

Cost vs. Cost-Justification

Most of us want to save money wherever we can, but blindly pursuing low-cost investments, such as index mutual funds or exchange-traded funds, can be costly. As with many of life's matters, investments should be more about cost-justification than simply cost.

To be sure, most investors are better-off using index funds or "ETFs" instead of actively-managed funds, since most of the latter underperform their benchmarks over the long-haul, and the benchmarks can be "had" via an index fund or an ETF.

However, savvy investors, or investors aided by diligent financial advisors or brokers, can find the mutual funds that have consistently and significantly outperformed their benchmarks on a risk-adjusted and cost-justified basis.

In short, if you can find a fund that does 3% per year better than your index fund, only charges 1% more per year, and has about the same risk measurements, wouldn't you rather have that extra 2% per year of growth?

Index Funds, If You Must

"I am in an index fund, so I'm just fine," you may think. But you may be wrong!

See, there are Domestic, Foreign and Emerging Markets stocks, and among them are Large, Medium, and Small companies, and each is likely of either the "growth" or "value" variety. On top of that, there are more than a dozen types of bonds. But each "index fund" usually only picks ONE of all those categories.

Investors should use a variety of index funds in order to balance risk and reward. But which index funds, and how much to put into each, are questions usually best answered by a professional. So, before you rest easy about your index fund, you should talk to a pro.

"Broker" vs. "Advisor"

An investment advisor has a fiduciary obligation to its clients to act in their best interests, and that obligation remains active throughout the advisor-client relationship. A broker simply needs to make suitable recommendations at the time of purchase or sale of investments.


If you know what you want to invest in and just need a professional to facilitate the transactions, a broker is a good choice. If you have time to enter the transactions and conduct your own due diligence, then an online or discount broker is an even better choice.


If you are not sure what to invest in, or how to evaluate the types of investments you want, or if you want personal financial advice to complement or guide your investments, an investment advisor is a good choice.


(UPDATE February 2015, in light of President Obama's push to bring "brokers" up from the "suitability" standard to the "fiduciary" standard)...


As the owner and sole employee of a Registered Investment Advisor-type firm, I am always serving in the advisory capacity with a fiduciary responsibility to my clients.  When I was a "financial advisor" at Morgan Stanley and then A.G. Edwards/Wachovia Securities/Wells Fargo Advisors, I was serving in a broker capacity with merely a suitability requirement, unless I was using the firms' "advisory" products that required me to adhere to the fiduciary standard.  I did the latter most of the time, and some clients understood that while others did not (even when I tried to explain the difference), and that is hopefully the real issue the Administration is now trying to address.  I hope they are not simply going after financial professionals in general.


An example of how the brokerage and advisory roles differ, and how different financial services professionals could/may/do operate, here's a little story from my early years (spoiler alert:  I did the right thing but got paid a lot less)...


A client came looking to invest $600k in an annuity, which is a complicated insurance product with investment features.  Morgan Stanley, my employer at the time and where I was serving in a brokerage capacity, offered variable annuities and fixed annuities, the latter having more guarantees, the former having more upside potential.  Either one was suitable for the client, but the fixed annuity was the better fit.  Morgan Stanley presumably made more money on the variable annuity products, as they paid us 40% of the commission on those, compared to just 10% of the commission on the fixed annuity products.


The client liked both ideas and left it up to me.  With either product, the commission was NOT taken out of the investment directly--the client's $600k would all be in the account on Day Two.  In a way, my choice was $9600 paycheck or $2400 paycheck.  Based on the suitability standard governing brokerage employees like me, I could have sold the variable annuity and made more money.  But I believed the fixed annuity was a better fit for the client.  So that is what I recommended and sold, and I left $7200 on the table despite no requirement to do so...


If the government is trying to make it so more financial professionals have a higher standard to uphold, I can live with that.  If new regulations are going to make it harder for "advisors" already subject to the fiduciary standards to find and keep clients, I will be unhappy--for myself and the mass-affluent and emerging-affluent Americans who really need my kind of help.