Wednesday, September 29, 2010

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:

Monday, September 27, 2010

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).

Tuesday, September 14, 2010

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.

Saturday, September 4, 2010

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:

Cash = 25% vs 9%
US Stocks = 27% vs 39%
Foreign Stocks = 23% vs 39%
Bonds = 15% vs 13%
Alternatives = 10% vs >1%

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.