Diversification- A Reason Against

 

Warning do not attempt this without knowing and understanding that this could be a zero sum game.

Almost everyone I know wants to get filthy stinking rich. They would do just about anything to get there except risk any of their money.

When it comes to getting rich the average investor sneaks up on it in the same way as they buy a lottery ticket. ‘Here’s a dollar, make me rich.’

In order to get rich in the stock market investors have to do the very opposite of what they have been taught to do. The single most important rule to ignore is using diversification as a method of money management.

Diversification, the cornerstone of investment planning, reduces risk and, most importantly, return. Yes, dear reader, diversification, the fundamental that every financial talking head tells people to do reduces return on investment. No one will ever make a bundle by diversifying.

Aggressive investors are better off to ignore diversified investment portfolios such as mutual funds and ETFs and concentrate on buying a handful or maybe just one or two stocks. Now before you light torches and march up my driveway for being a financial heretic allow me to explain.

Jack Bogle of Vanguard fame believes in diversification – sort of. He thinks you should own an equity fund for growth and a bond fund for age protection when markets go poof. You’ll never make a lot of money following Bogle but you won’t lose any sleep worrying about your investments either.

Warren Buffett who manages the huge Berkshire Hathaway with approximately $47 billion in assets has only 37 positions as of June, 2010. To put this in perspective the Fidelity Contra fund has over $55 billion dollars of investor money but it is spread over 482 issues. Obviously Warren Buffett doesn’t believe in diversification. Warren is all about maximizing return on his investor’s money. If a company stock is really compelling Warren will just buy the entire company. About 25% of Berkshire Hathaway money is invested in Coca Cola. Not a one of my clients has 25% of their money in one asset unless you count their homes.  (No, I am not telling you to buy Coke! But, you see my point about buying a company with a great franchise, a wide moat and owning it for a very long time.) It is also easier to monitor a few holdings versus a portfolio that resembles a weekend ‘honey-do’ list.

Jack Bogle does not manage investments, nor did he ever. Everything Jack tells us has a bias because of his role at Vanguard creating low cost index funds and the fact he is an investor just like you and me. Jack’s equity philosophy is to match index returns not to exceed them. Warren Buffett, on the other hand, is both an investor (he eats his own cooking) and portfolio manager. Over the years he has made his investors, and himself, a lot of money.

Warren is all about making as much money as possible while Jack is about preserving what you own. Warren is not a trader. Once he owns a stock he generally keeps it forever. He also does not buy anything he doesn’t understand. (Yes, he does sell what falls out of favor or reduces his holdings.)

Common sense tells us that if you are an active investor there can be only one investment that is the best performer for the moment. Every additional investment  decreases your total return.  The more you own the less your total return.

The average investor diversifies and allocates their portfolio into producing mediocre returns.

The truth is most of us are uncomfortable owning only one or two investments. The majority of investors are not trying to hit home runs but returns that are slightly better than inflation and taxes combined.  But for the ultra-few who are looking to hit four or five baggers owning one or a handful of stocks is just the ticket to either riches or the poor house.

One place for the uber-aggressive investor to start is the company 401k. In the past advisors cautioned against owning too much company stock because of the weakening economy and the rich valuations. Now with the economy getting traction and many stocks below their all time highs investors just may find rewards right where they work.

If you’re inclined here’s a few more ideas to get you started:

• Make sure you have enough years left to overcome any mistakes you make now.  Trust me – you will.
• Define who you are: Aggressive-Trader or Aggressive-long-term investor.
• Because you’re trying to get rich it’s okay to invest all your money into one stock. Remember: Buying more than one reduces your return .
• Cut losses quickly. Make a promise and keep it.
• Know when to sell and book your profit. If you’re trading pick a target number and stick to it.
• Don’t chase a hot stock.
• Don’t be afraid to lose money.
• Learn all you can about the what you want to buy, the overall market, technical side of investing, options and leverage.
• Study your stocks before you buy.
• Don’t buy on tips, because you have a gut feeling or you like the stock for some unexplainable reason. (It’s like betting on a horse because of the length of its tail.)
• If you buy and sell in your retirement account you lose valuable tax benefits.
• Buy what you know and only after doing your homework.
• Don’t try aggressive investing as a part-time hobby. Markets move quick and you have to be there to make decisions.
• Finally, if it seems like work then quit and buy some funds, kick back and let someone else manage your money.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.

 

 

That Was The Week That Was – 1st Week November

• Last Monday on election eve, markets soared and then petered out and barely closed positive. Nervous traders took money off the table not sure of the election and concerns over the Fed’s decision to print more money and buy Treasuries to lower interest rates and, hopefully, stimulate the economy.
• The government may reduce stake in GM (see chart last week’s blog) to 50% from 35%, a basically symbolic number. Stock price will be set November 17th and the sale will be on the 18th.  It’s expected that GM will sell 24% of all shares or about $10 billion.
• Commodities rule, according to Barrons.com. Corn, cotton and crude oil are moving higher and the Reuters CRB index has reached its highest level since July 2008.According to Barrons.com the prices are closing in on levels that 2 years ago were called speculative frenzy but that sentiment is nowhere to be found today. (Much more room to run.)
• Investors looking for winners in emerging markets should look to countries who have already hiked their interest rates, according to Andrew Freris an Asia investment strategist at BNP Paribas in Hong Kong.
• Markets closed up on election day.
• Home real estate markets are unsettling. Irwin Kelliner at MarketWatch.com wonders what buyers are waiting for when: real estate is at 1990 levels, mortgage interest is at 1950s levels and real estate commissions have fallen to 4% from 6% and in some cases into the category of negotiable. Falling car, computer and cell phone prices have not stopped people from buying those items but real estate has the experts baffled.
• The GM IPO seems too low, according to Barrons.com. The pre-sales is drawing lukewarm attention from institutional investors. WSJ estimates fair value of GM at $44 a share.
• GM could be free of taxes for years. In a doc filed with regulators the car maker won’t have to pay $45.5 billion in taxes on future profits.
• Bush tax cuts don’t appear to be rolled backed this year with the huge Republican win. Expect things to remain as is…for a while. (whew!)
• Autos had a grand month with Ford, Honda and Nissan each reporting sale increases in excess of 15% with Chrysler stating sales were up 37% from a year earlier. Toyota’s sales declined.
• ‘Another sign this recovery is real!’, according to Seeking Alpha pundit Calafia Beach, it’s the auto sales surging (still low by historic standards) but the upside is positive with increased confidence in the future.
• In India investors are being told to buy Indian securities rather than gold. Gold, as you know, is a huge commodity in India. However, according to Swapnil Pawar, chief investment officer of Karvy Private Wealth Management in Mumbai, ‘Gold has not been a high-return investment over the long term. (Indian) stocks,’ he says, ‘could deliver 15% per annum over the next few years.’  Dear reader, in the USA we call Indian stocks as emerging markets.
• The Fed plans on spending $600-$700 billion of bonds, mainly in the 5-6 year maturities. The purpose is to keep interest rates low, or lower, and a stronger economic environment to create an inflation of 2% per year. There is much debate whether this strategy will work, weaken the dollar even more or do anything to increase employment.
• On CNBC.com supposition on a stronger stock and commodities market going forward with QE2. From their lips…
• The most fun I’ve had in a long time Thursday last with markets soaring over 200 points I just wanted to walk around town asking, ‘Is it good for you?’ The Dow closed at its highest level since September 2008 just before the Lehman Brothers collapse.
• GM touting its IPO in preparation of Nov 18th.  Execs predict pre-tax profit (when markets at strongest) of $17-19 billion with 9%-10& profit margins.
• Food prices increasing and manufacturers and retail stores reluctant to pass higher costs on to consumers. But chains like Kroger and Safeway have said they’ll pass supplier increases on. Reason for increases is rising demand from emerging markets such as China and India. This with moderate inflation.
• Last week ended with a sigh as the markets took a nap for most of the day only to awake at the close to end slightly up. They ended the week at 2-year highs.  The Dow climbed 2.9% for the week while the S&P rose 3.6%. This all on better jobs report.
• Finally, the week ended with 143 banks closed beating last year’s 140.

Questions call Paul@ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.

Inflation Is A Coming & What You Should Do

I’ve written about this before and I know you know this but sometimes singing to the choir twice is not as silly as it sounds. What I don’t want to happen down the road is have clients adamant in not becoming proactive in moving to assets that will benefit them from inflation and a cheaper dollar. I understand why people don’t like change because I don’t like change anymore than anyone else. ‘Why, should I get rid of a  bond mutual fund that made me money for so many years just to go and buy an exchange traded fund that shorts Treasuries?  Life is getting complicated when all I want is simple. Yes, I know this and so do you but things change and owning Amalgamated Buggy Whips is not what you want in a world of Google.

First we have to understand what is going on and the game the Fed is playing. Our government is determined to reduce the purchasing power of our dollar and the result is having countries who buy our  bonds screaming bloody murder. Those countries who bought our yesterday debt at yesterday prices are rewarded to see the Fed go about devaluing those very dollars they bought just a few short weeks ago. And with QE2 this is only the beginning of the Fed plan. Over the next 6-9 months the Federal Reserve will be doing their best to get the dollar down even more, inflation up and interest rates less than they are right now. And when they decide enough is enough what? No one, including the Fed, seems to have the answer. That is why smart investors are buying emerging market funds, investing in blue chip global companies that pay solid dividends and moving money into commodities. The signal is that there is little faith in today’s dollar and probably a lot less in tomorrows.

Fed chief Bernanke has said that inflation is low and for us not to expect it to increase exponentially any time soon. ‘Well, Mr. Chairman, I don’t know when the last time you filled your tank with gas or bought food at the grocery store but those items have increased dramatically and will continue to go up as you go about buying more and more of of our debt.’ 

Already we’ve seen cotton prices surge and copper is moving higher as emerging markets are coming of age and using this metal for their infrastructure. Agricultural prices will soar even more as more countries demand better food and nutrition. Morocco is becoming one of the most wealthy countries with huge deposits of potash, a fertilizer additive that is becoming more dear in the rest of the world. In the last few months we have seen extraordinary interest in potash producing companies as companies position themselves in a world where food becomes more expensive.

But the sharpest investor of all China is moving over half their Treasury purchases to hard assets because they simply know what they need in a few short years.

The Chinese buying spree will not abate in 2011 from hard assets, namely commodities. Their shift from U.S. Bonds is telling. Obviously our government is not and will not be pleased with the Chinese buying but you and I can take a lesson as the Chinese load up on iron, oil, potash lumber and copper (according to November 6th Barrons.com).

The Chinese are now the world’s largest consumer of copper, tin, steel, coal, aluminum, iron ore and second largest consumer of oil.

Taking a lesson the American investor should now be placing a portion of their assets into commodity funds simply to protect their dollar’s from inflation.  Most investors only know of the metals markets and completely ignore the rest of the commodity index which includes agriculture, metals and oil.

The inflationary stage in our markets will not simply pop up one day. It will be a slow and insidious growth, eating away at our portfolios and paychecks until realization of what we have to do is too late. At that point owning cash, unlike 2008, would be one of the worst things an investor could do.

Over the next few months investors should review what they own and look to make room to own commodity funds either through ETFs or mutual funds. As always, if you have questions or need more information do not hesitate to call.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.

Sometimes It Makes Sense Not To Rollover Your 401(k)

Many financial prestidigitators will have you believe that everyone who leaves an employer must rollover their IRA. This is not true. There are many instances, especially in today’s economic times, that leaving the 401k at the employer makes sound financial sense.

I should explain that there are many more good reasons why someone should roll over their 401k and keep their money close to them.  A few of those reasons are: In most cases there are greater investment choices, lower costs, estate planning considerations and eliminates the corporate uncertainty of plan and investment menu changes.

The two prime reasons why someone should not roll their 401k over are (1) Early Retirement Income withdrawals available in most plans at age 55 with no 10% penalty and (2) the ability to borrow from a 401k plan up to 50% of the assets and payback over 5 years.

Anyone who needs income or access to cash prior to age 59 1/2 may be better off keeping their plan at their previous employer.

Once someone rolls their 401k into an IRA they are unable to take a systematic income out of their plan without paying a 10% penalty if they are under the age of 59 1/2 unless they are disabled or if they construct a 72(t) plan. There are no borrowing choices available in an Individual Retirement Plan.

It is always a bad idea to dip into retirement plan money before retirement. However, having the ability to start systematic income without a penalty or being able to borrow funds and payback when things get better makes sense.

While most plans do have early retirement and loan features it is essential to confirm this. Of course there are a different set of significant problems once someone starts taking early retirement income or a loan and then wants to rollover their 401k plan. Investors should only do this after getting all the facts from the plan administrator and personal financial advisor.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.

 

That Was The Week That Was –4th Week in October

• Monday last the markets extended their winning streak. According to Wayne Whaley of futures firm Witter & Lester who reported that this continued rally does not have doom written all over it as some would think. Whenever the markets advanced at least 10% without at least a 2% pullback only once in 22 times was the market down a month later. (From your lips, Wayne.)
• Balancing the budget officials are looking at eliminating deductions on mortgage interest, the child tax credit and the ability of employees to pay their portion of their health-insurance tab with pre-tax dollars. (I have no idea what these idiots are drinking but they’re as serious as cancer about this. Can you say, This is another sure way to kill housing forever.)
• The Government latest TIPS auction went well as the Treasury sold $10 billon of the inflation-protected bonds with a ‘negative’ yield. If inflation heats up to 5% over the next 5 years those TIPS will bring an averaged yield of 4.45% and if the CPI declines to 2% investors will get 1.45%. In either case investors win.
• Financial advisors still prefer American Funds and Blackrock, Inc. However, Franklin Templeton has doubled in preference from a year ago.
• Opps on Tuesday as trading flattened. Coach, Ford and Bank of America gained while DuPont fell. At the closing bell DJIA, S&P and Nasdaq finished slightly up.
• Some of America’s money managers, in Sunday’s Barrons.com, say stocks are cheap and the economy will keep growing. They’re bullish on tech and bearish on Congress. The chart reflects their thoughts.
• IBM buying back $10 billion of its stock. Quick- what does that generally mean for a bellwether stock like IBM? (You are right, dear reader.)
• Due to a stronger yen Toyota plans to increase price on several of its models in 2011. Ford aims to decrease debt to zero. Shares have doubled in the last 12 months.
• BarronsTake was bullish on Ford in June and is still bullish at current levels in excess of $14 a share.
• Someone manipulating the price of silver? Seems one regulator at the Commodity Futures Trading Commission is putting pressure for an investigation. Four market players own in excess of 24% of all net bearish bets in the silver market. These include HSBC and J.P. Morgan. Zounds! Retro Nelson Bunker Hunt and his brother who tried to corral the same market.
• As long as we’re into alliteration –zoom, zoom – as the Fed gears up to start buying Treasuries this week, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, said that the monetary policy was a ‘bargain with the devil.’ The Fed’s aim is to push down yields and drive up prices on bonds in order to spur more investment and spending.
• GM gearing up (get it?) for IPO road show. Banks are pressuring Treasury to maximize number of shares to offer at IPO. While not disclosing details some money managers report they would be leery of GM stock at levels being discussed. Expect shares to be offered around Thanksgiving.
• 
• Speaking of IPOs there are some hot ones in the pipeline: Harrah’s Entertainment, HCA, Inc., Nielsen Holdings, Skype.
• Bill Gross of PIMCO declares the death of the Bond Bull market by the Federal Reserve. Yes, indeed, Bill, the Fed wants bonds to be pushed down to levels where the only other direction will be up.
  • Unemployment numbers decreased unexpectedly last Thursday. That’s a lot of un’s in one sentence. Here’s the deal- no second recession or double dip. Equities will outperform bonds going forward and the economy will get slowly better and better and better.  Don’t be sitting in cash is the object lesson here.
• Stocks ended mixed Wednesday as investors considered the Fed easing as being ‘not enough’.
• Microsoft edged up on great news as it posted a 52% profit. According to MSFT general manager of investor relations Bill Koefoed, ‘Businesses are spending money.’ MSFT is still under April 2010 highs.
• Consumer uncertainty is still in driver’s seat as Sketchers USA, Jones Apparel Group and Whirlpool all were disappointed with sales of their products last week. Inventories are causing fourth quarter concern.
• Kohls, on the other hand, and according to Bloomberg BusinessWeek, plans on hiring 40,000 part-time employees for the holiday season.
• In the same Bloomberg’s BW issue prediction of a strong 2011 with a projected 3% GDP by the 4th quarter up 50% from this quarter of 2%.
• China plans on more than halving the number of state-owned businesses by 2015. Expect more IPOs & investment opportunities. Industrial & Commercial Bank of China, Ltd., the world’s largest bank and 70% owned by the Chinese government just bought Prime Dealer Services a U.S. broker/dealer with only 75 customers from Fortis Securities, a French firm.
• So who did what for the month? The S&P was up 3.7% as was gold. The dollar fell 3.6% and the Nasdaq was up 5.9%.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares.

Exchange Traded Funds

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One of the most popular investments, to the tune of $820 billion, and least understood is the exchange traded fund. While I have written about them in past blogs I have not defined their value to the average investor.

Exchange Traded Funds have been around in the United States since 1993 and in Europe since 1999. Unlike mutual funds an investor cannot buy an ETF direct but has to purchase one or more of the thousand plus ETFs that are available from a brokerage firm. How much it costs an investor in commission is dependent on the services and the firm. A few discount brokers offer free trades on a select few ETFs but not all. ETFs are also available in some 401k plans and in fee managed accounts.

Don’t confuse ETFs with ETNs. ETNs are Exchange Traded Notes and the difference is one of credit risk. ETNs are structured products and if the organizer of the investment goes bankrupt the possibility exists that the investor in the ETN may not be made whole.

ETFs, or exchange traded funds, have their own mystique and I’ve gotten calls from clients who want to invest in an ETF because they heard you can get filthy rich by doing so. The fact is ETFs can either make or lose money just as any other investment.

Exchange Traded Funds combine the features of a mutual fund (diversification) with the liquidity of a stock where it can be bought and sold throughout the business day. The price of the ETF during the trading day is not exact but more or less close to its net asset price. The actual price isn’t calculated until at the end of the business day.

Commissions are charged just like a stock both on the buy and the sell. There is also an expense fee, just like in a mutual fund, that compensates the ETF manager and organizer. This expense fee varies from one fund to the other. There are 64 exchange traded funds that mimic the S&P 500 index. It not only gets confusing but an investor does need to know what he or she is doing before investing. For example, ETFs are not systematic investment friendly like mutual funds. The commission charged on small purchases will severely reduce potential growth on investment.

The mechanics of an ETF are pretty much simple and straightforward. Just like a stock an investor can short an ETF or even buy an ETF that shorts an index or sector all by itself. There are ETFs that are double and even triple leveraged both on the long and short side of a trade. In other words if you feel small caps will fall you could invest in a triple leveraged ETF that shorts the small cap index. There are commodity ETFs that invest in gold, silver, metals and oil. You can buy ETFs that invest in agriculture. In a previous blog I have written about ETF risk which in some ETFs is called contango where investors can almost be assured of not keeping up with the actual representative commodity because the ETF manager is buying and selling options rather then the actual commodity. (There is a new ETF that says it has solved the contango problem but I have not examined it as yet.)

The true value of an ETF is for an investor to be able to buy and trade a diversified index or sector anytime throughout the day. This ability to be in and out provides mutual fund and institutional managers a convenient option to hedge or diversify a position. It also gives the average investor an opportunity of buying investments that they normally would not have available to them. I am writing specifically about precious metals and commodities. Finally it gives investors the liquidity to sell during the day instead of waiting until 4PM which they have to do with their mutual funds. When markets go south some investors want to get out quickly and not wait for their holdings to possibly fall farther. The ETF gives investors that liquidity. Investors may also set stops on their ETF holdings, decreasing their loss limits.

The positive value of the ETF is for an investor to be able to buy into a position when markets news makes an specific investment very attractive. The ETF also removes the guesswork out of which specific stock to buy  because of its sector or index diversification.

Until 2008 all ETFs were indexed or not actively managed. The SEC authorized the creation of actively managed ETFs that year and today there are several. However, because there has not been sufficient time these actively managed ETFs cannot be historically reviewed, compared and analyzed.

The most critical disadvantage of using ETFs in a portfolio are the unknown, untested indexes used by many ETFs.

Still many of my clients can benefit from buying ETFs because:

• Lower cost than mutual funds.
• Buying & selling flexibility.
• Low to no capital gains because of their low portfolio turnover.
• Market specific exposure and diversification.
• Complete transparency of portfolios.

Because of the wide breadth of products now available clients and others should call their advisor or this office to discuss specific ETF needs and solutions.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.

 

Investing Trick or Treat: What Works What Doesn’t

  Every time you turn around there is another investing rule. You cannot turn on the car radio without some self-styled expert pontificating about why managed accounts are better than buying no-loads or Roth IRA conversions make sense or buying mutual fund 529 plans is smart college planning. A body just wants to tear their hair out whenever every Tom, Dick & Suzie is tossing in their two bits on what you should do with your money. Okay so here are a few of mine. You can embrace or reject and you won’t hurt my feelings.

• There are worse things than paying taxes. Don’t sweat the possible increase on dividend taxes- you probably won’t even notice the difference. Chasing tax efficient investments is usually a waste of time for most of us.
• Rebalancing is simply selling high and buying low. It’s dumb. Warren Buffett holds winners and sells losers and so should you. (Don’t believe me? Check the S&P 500 index for the past decade versus the long-term bond index. Bonds posted an average annual return of 8.70% while the S&P 500 index lost o.54% per year.) How would rebalancing work with stocks and a bond allocation? Rather than compounding your winners you’d be minimizing your upside while feeding the loser. Like I said – dumb.
• Dollar cost averaging is a great way to get costs down as long as you do it with mutual funds and not stocks. It’s the one rule every investor should tape to the mirror or computer and read every day.
• Forget 529 plans for college education savings and buy the state of Michigan guaranteed plan. It’s called Michigan Education Trust. Don’t live in Michigan, lots of states have similar plans. No matter what happens you’ll guarantee the kid’s education. College costs escalate at double digit rates and no investment can keep up. Buying a 529 and investing in guaranteed dollars is just tossing money away.
• Not everyone needs a Trust to complete their estate plan. Simply designate beneficiaries on any account. It saves money and is just as efficient. What you should have is a Will along with Power of Attorney. There are lots of exceptions and you should talk to your advisor.
• Buying stocks and think you missed the boat on that one special company? Check the stock chart and see if and where it gapped in price. The stock usually comes back to fill that gap – sooner and sometimes later.
• Buy long-term care insurance. Cannot afford the full coverage than buy partial because something is always better then nothing.
• Don’t buy or invest in anything you don’t understand or cannot explain to someone else and have them understand what you said.
• Don’t invest with someone you don’t know or simply calls you on the phone from out of town.
• Ask what the ‘advisor’ is buying and if not what he or she is recommending find out why. 
• Naturally, my favorite is just keep things simple. The less moving parts the less chance of something going awry. (I dislike things going awry!)

Questions call Paul @ 586 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.