Investments 101

How to Choose a Financial Advisor

2010-05-27T23:38:00.000-07:00

A good financial advisor is worth his or her weight in gold. Even at current gold prices! However, a bad one can be detrimental to your long term wealth. There are a lot of choices and even the most educated fall prey to having a lousy advisor. So here are a couple of good questions to ask.

1. Do they own the product they are trying to sell you? For me this is a fundamental question because if they don't own it either they can't afford it or don't believe enough in it to put their own money into it. Both of these would be red flags.

2. Why are they still working? Often times advisors will show products or portfolios that have performed well above their benchmarks for 10 to 20 years. If they have done so well over the years they shouldn't have to work anymore. Chances are they haven't achieved the same returns as what they are pitching you. Which means they didn't invest in this product or bought and sold it at the wrong time.

3. How do they get paid? Most advisors are paid on a commission basis based on the product they sell. They might tell you that the commission is paid by the company, but you will pay it over time. The place to look is in the fee section of the prospectus. Also find out if they have a management fee. Try to keep it under 1% because this is usually in addition to the fund management fees and transaction costs.

4. What did they do in the last bear market? If they let their clients deviate from the agreed upon strategy you may want to find another manager. Unless they timed it correctly...but don't confuse luck with skill. Bear markets and corrections are normal when investing in the stock market. If they change their strategy based on market movements you will see a lot of trading, but won't have the results to show for it. It would be nice to avoid bear markets. However, if you capture most of the down and then miss the up you will never catch up to your benchmark.

5. What is the performance? This one is tricky because actual performance is usually different from the performance of the underlying funds. Why? Most managers back test data to find the best performing asset classes to construct your portfolio. So in essence they are cherry picking. However, the actual portfolio they were recommending a year or two ago was very different. So the returns they are showing you are not the actual returns their clients received. Also be careful if the returns are too good. Remember questions number 1 and 2.

So your ideal advisor might be someone who is financially secure, semi-retired, fee based, big picture focused and forward looking.

Portfolio Strategy Vs. Portfolio Tactics

2010-04-19T00:55:00.000-07:00

When managing your assets you have to consider your overall strategy as well as tactics. Hopefully by now you've overcome all the gloom and have re-equitized your accounts. If not you may want to read some of my previous posts. So what is the difference between strategy and tactics?

Portfolio Strategy
The primary determination of your longer term returns are tied to the asset allocation decision between stocks, bonds and cash. Many are overweight to bonds and cash right now. For those who want growth and a higher potential return, stocks are the way to go. Adding bonds lowers the volatility of your portfolio, but also lowers the potential return. John Bogle, founder and former CEO of the Vanguard Group, suggests "a bond percentage equal to your age". That's reasonable if you have enough money to retire. However, for people under 60 years old you may want to consider a portfolio of all equities. Why? You will probably live at least another 40 years and have a risk of running out of money. Yes, we will probably see more bear markets in the future. However, the inflation adjusted return on bonds is hard to live on and they also experience bear markets. Based on different studies this simple decision can account for upwards of 85-90% of your long term returns. Where do the rest of the 10-15% of the returns come from? It comes from portfolio tactics.

Portfolio Tactics
This is where your financial advisor, money manager, mutual fund, or hedge fund tries to add value above the market return. How successful are they? About 85% can't beat their respective benchmark (a non-managed index like the S&P 500) after their management fees of 1-2%. They will try to outperform by selecting growth vs. value, large cap vs. small cap, domestic vs. foreign, etc.

Lately, I've been wondering if there is a lasting trend of small cap outperforming large cap. Small cap tends to outperform at the beginning of bull markets and is outperforming so far this year. However, when venturing down this path one has to remember these trends can be short lived. One of the best illustrations of this is the Callan Periodic Table of Returns. These trends may last for one year or few years, but are short lived. So you have to make two good decisions in order to make it effective. The first is buying it at the right time and the second is switching out of it at the right time. Unfortunately, there are few professionals who can do this effectively. However, if you have this skill you are probably very wealthy. Congratulations! For the rest of us, a global index fund or low cost global mutual fund (<1% per year) would be the better investment.

Vanguard is one of the best low cost mutual fund providers you can find. They have many index funds and some low cost actively managed funds. Their global index fund is called the Vanguard Total World Stock Index Fund (VTWSX). It has an expense ratio of .50% as of 10/31/09. If you would like an actively managed global mutual fund, the Vanguard Global Equity Fund (VHGEX) has an expense ratio of .47% as of 9/30/09 and a solid track record versus it's benchmark.

Lehman Brothers Files for Bankruptcy on September 15, 2008

2010-03-26T00:13:00.000-07:00

This event sent shockwaves through the financial world and the global markets crashed. Swings of 5-10% in the global markets could be seen by the hour. It was chaos, despair and panic. Many sold their stock holdings and fled to Treasuries for safety in preparation for the Great Depression. Was it a good decision?
It depends on your long term goals. If you have plenty of money and don't need any growth then you are a bit ahead of where you would be had you held on. The S&P 500 closed at 1192.69 on September 15, 2008 and closed at 1165.73 on March 25, 2010. If you held on to the index you would only be down 2.26%.

If you are still in bonds unfortunately you have joined the masses of people who sold and missed out on one of the biggest stock market rallies in history. As described in a recent article on Bloomberg, "Americans Say They Missed 73% Rise in S&P 500 As Economy Surged." Unfortunately many sold at lower levels than on September 15th. Which means unless they got back in the stock market they are most likely worse off than if they just held on.

The worst case senario is if you sold in the middle of March of 2009 Since then the global markets are up over 70% and the Pimco Total Return Fund which now has over $200 billion in assets is up about 10%. That means the stock market now has a 60% spread on those individuals. This is the primary reason most investors don't achieve the average annual return of 10% over time and why most individual investors would be better off just buying and holding an index fund.

Good news! It's not too late to get back into the stock market. Maybe you will believe Bill Gross, the world's premier bond manager, who warned that the almost three decade fixed income rally may catch individual investors off guard as they invested $89 billion into bond funds this year. He said, "bonds have seen their best days." Source: Bill Gross Warning May Catch Bond Investors Off Guard, Bloomberg

Try to block out poor stock market forecasters like Robert Kiyosaki, author of the Rich Dad, Poor Dad series. He recently made a stock market forecast on February 22, 2010 called, "Doing the Deat Cat Bounce". He doesn't manage any money professionally, has never come clean with his total net worth, and his analysis is too simplistic. For a more critical critique of this "financial expert" please visit John T. Reed's web site here.

Happy Chinese New Year! What stocks should I buy in the Year of the Tiger?

2010-02-16T12:40:00.000-08:00

We are now into the Year of the Tiger and after surviving the "Great Recession" many are wondering what is next for stocks. PIMCO argues that we are going into the "New Normal". Hard to argue with their thesis, but you may receive an inflation adjusted 0 percent return if you invest in their Total Return Fund (All Bonds) for the next few years.

So where to invest? The MSCI All World Index (Ticker: ACWI) is a good place to start, but most people like to pick individual stocks. So the following will give you some ideas on where to find good stocks.

The first place to look is to find your favorite money manager and "cherry pick" some of his or her stocks. The way to do this is to look up the top 10 holdings then see what you like. One of the best small company funds is Longleaf. Their Longleaf Small Cap Fund (LLSCX) was closed in 1989 and has consistently been one of the top performing small cap value funds in the world. As of 12/31/09 its annualized performance is as follows:

1 Year 49.3%, 5 Year 3.1%, 10 Year 8.2%, 15 Year 11.6%

Here is how the Russell 2000 Index has done over the same period of time:

1 Year 27.2%, 5 Year 0.5%, 10 Year 3.5%, 15 Year 7.7%

Some clear outperformance through their stock selection process. Even though we can't buy into their fund anymore we can still "cherry pick" some of their stocks. Here are there top ten stock holdings as of 12/31/09 and their respective weighting in the fund:

1. TW Telecom 10.1%
2. Fairfax Financial Holdings 9.1%
3. Pioneer Natural Resources 7.7%
4. Dillard's 6.7%
5. Fair Isaac 6.2%
6. Washington Post 5.9%
7. Service Corp International 4.8%
8. Wendy's/Arby's 4.7%
9. Everest Re Group 4.6%
10. Olympus 4.4%

Now let's see how these have performed over the last year. What you are looking for is not the ones that have gone up the most, but the ones that haven't. Those have the most potential based on their market research. Of course they aren't always perfect, but have shown to be above average stock pickers over time.

Best place to get his information is Google Finance. Sorry Yahoo. Their site is better.

1 Year Performance from Google Finance as of 2/16/09:

1. TW Telecom (TWTC) Up 73%
2. Fairfax Financial Holdings (FFH) Down 8.25%
3. Pioneer Natural Resources (PXD) Up 182.7%
4. Dillard's (DDS) Up 287%
5. Fair Issac (FICO) Down 5.15%
6. Washington Post (WPO) Down .06%
7. Service Corp International (SCI) Up 85.92%
8. Wendy's/Arby's (WEN) Down 10%
9. Everest RE (RE) Up 14.61%
10. Olympus (OCPNY) Up 119.62%

So based on this you might want to consider FFH, FICO, WPO and WEN. You can do this for other managers as well to get more ideas.

Just a couple of quick tips before you dive in...

Don't risk what you can't afford to lose. It's a good lesson that we have learned after the last two bear markets and housing market crash.
Don't follow short term advisors. Jim Cramer is one of them. He will pick a stock and a few weeks later he will change his mind. He talks about doing your homework. Your first assignment is to turn him off.
Don't follow your friend's hot tip. They are usually wrong and no smarter than you are. Don't confuse a lucky trade with skill. Remember the house always wins. They house is your Stock Broker.

Good Luck! Happy Chinese New Year!

2009 Average Annual Returns for the S&P 500

2010-01-20T19:29:00.000-08:00

Happy New Year! To start out the new year I was curious what the annualized returns where for the S&P 500. It has been a rough decade for stocks so I wanted to see the numbers.

My methodology was to take all of the returns of the S&P 500 going back to 1926. Then I calculated the average annual returns for 3, 5, 10, 20 and 30 years. The chart below shows 2009 compared to the best, worst and average annual returns for the respective time periods.

So while it is one of the worst decades since 1926. It's a far cry from the Great Depression where the 3 year average annual return was (-26.96%) and five year average annual return was (-12.47%). The other thing to note is while the 20 year average return is trailing the long term average, investors who stayed invested for the last 30 years still averaged 8.21%. That's inclusive of the last two bear markets. Interestingly enough, investors who weathered the storm for the last 30 years are right in line with the historical average of 11.27%.

Only time will tell what will happen, but most of us might want to extend our time horizon out further when looking at our investments. If history holds true the next 10 years should be much better than the last.

Where do you find good financial information?

2009-12-13T23:55:00.000-08:00

As you look to 2010 you may be trying to figure out where to position your portfolio. There are a lot of gurus out there. Some good, but mostly bad.

For a ranking of gurus check out CXO Advisory: http://cxoadvisory.com/gurus/. The best one is currently at 63%. That means out of 10 forecasts the best guru tracked is wrong 4 times. So are these gurus lousy? No, they are very good.

What if you want to try and do better yourself? Where do you look? Below are some places you can find good information about the markets to make your own decisions. Of course, they are not 100% objective, but they are some of the best in the business.

Stocks
Ken Fisher has a global approach and a tilt towards equities (stocks). It's understandable given the historical data. Since the 30s stocks have outperformed bonds 98% of the time in rolling twenty year periods. Will they continue to outperform in the future? Who knows, but he has a monthly column in Forbes (http://www.forbes.com/) and has his own web site MarketMinder (http://www.marketminder.com/).

Bonds
Bill Gross manages the Pimco Total Return Bond Fund which is about to become the biggest mutual fund ever with over $200 billion in assets. You can read his monthly thoughts at http://www.pimco.com/. They are insightful and humorous, however, remember he is tilted towards bonds. Unfortunately, if the stock market continues upwards he will see some huge outflows out of his fund, but that won't happen till the next peak which may take a few more years.

Mutual Funds
There are a lot of mutual funds out there, but one of the best low cost providers is Vanguard (http://www.vanguard.com/). Warren Buffett has said the average investor may be better off just buying an index fund and holding it. Actually, the average professional might be better off also. Studies show that most actively managed funds underperform the indexes over time due to the fees they charge. For research you can check out Morningstar (http://www.morningstar.com/). They have a system for ranking funds, but it relies on past performance. Remember the key disclaimer: "Past performance is not indicative of future performance."

ETFs
Exchange Traded Funds have exploded on the scene and there are so many kinds its hard to keep track. Some even move in the other direction and some move 2x or 3x the underlying investment. For good information on ETFs go to http://www.ishares.com/. They have some nice tools for you to filter out the best and worst performing over different time periods. A word of caution. Try not to chase performance. The current hot sector is usually the next to collapse. Just think back to the .com crash or housing market before investing in the next hot sector.

Other
Bloomberg (http://www.bloomberg.com/) is a farily objective source for current information on the global markets. Google Finance (www.google.com/finance) has some really nice charting features.

Happy Holidays! Good luck in 2010.

Should I invest in gold?

2009-11-04T00:02:00.000-08:00

Wow, the SPDR Gold Trust ETF (NYSE: GLD) is up 23% year to date. The dollar is weak and inflation may rear it's ugly head. India just bought a 200 tons of gold! Should you follow? If you consider the approximate total supply of gold is 125,000 tons. They just bought two tenths of one percent. A lot, but hardly enough to move the market.

There are some that think gold is an anti-dollar play. The correlation since the early 70s is -.27. That means they move in opposite directions about 27% of the time. That means you would be wrong 73% of the time with this relationship.

What about gold as an inflation hedge? The correlation is 10%. Even worse!

So my prediction is that gold continues up for a little while longer and maybe reaches as high as $1,200 per ounce before crashing down to where it should be, around $800 per ounce. So if you are buying it now, get ready to get out! You are nearing the crest of the wave, try not to get crushed by it.

Still not convinced? Supply and demand are the key to pricing. In order to support the current prices you need to have limited supply and a great deal of demand. Right now we have the opposite. Supply is ample and demand is low. Jewelry fabrication, which is 60-70% of the gold market demand, is at a 20 year low.

So what's driving up the prices? Speculation. Try not to get caught up in it.

Source: Jon Nader, Kitco Metals, Metals Market Analyst

Is now a good time to invest in the stock market?

2009-10-12T00:44:00.000-07:00

Yes! Now is a great time to invest. The global economy is recovering and even though stocks have staged a strong recovery they are still undervalued by 20-30%. However, it will not be a straight line up. Expect a lot of volatility and a few 10% corrections in the developed markets (US, UK, Japan) from time to time. The emerging markets (China, Brazil, Russia) will experience 20-30% corrections. I expect the S&P 500 to be at 1300 by the end of 2010.

Not convinced? Still afraid? Use your fear to your advantage! Think back to the last time you were excited about an investment. Maybe it was your favorite dot com in 2000 or the second home which you were going to flip for a quick profit. How did those investments pan out? Yes, they lost money.

But it's different this time. Yes, its always different, but many of the companies are trading well below where they should be. The analysts have been overly bearish. The Second Great Depression is not upon us. Lift your head out of the sand and put some money to work.

So what should I buy? Buy the MSCI All World Index through IShares (Ticker: ACWI). With one purchase you will own the world. That way you don't have to figure out which country is going to do the best. As of the closing price on 10/9/09 it was trading at $41.39 per share. It wouldn't be a surprise if it was up over $50 by the end of 2010.