July 30, 2010

Retirement Killers

Retirement is the number one goal of investors. Yet, looking at the numbers, it's clear that many investors are undermining their good intentions with unfortunate actions.  Here are five mistakes to avoid if you want your retirement dreams to become a reality.

1.  Cracking your nest egg before retirement.  A study by Hewitt Associates found that 45% of workers cash in their 401(k)s when they switch jobs.  In other words, they take the money -- paying income taxes and a 10% penalty if they're not yet 59 1/2 years old -- rather than leave it in a retirement account.  That's no way to build the retirement of your dreams.  When you change jobs, you can transfer the money in your employer-sponsored retirement plan to an IRA.

2.  Spending your retirement savings too fast. If you've made it to retirement, congratulations.  You've amassed enough money to create your own portfolio-generated paycheck.  Excellent work.  But you can't take it too easy, because you'll receive a severe pay cut if you deplete your portfolio too fast.  How much can you take out each year and be almost certain that you won't outlive your savings?  Just 4% a year.  That's the withdrawal rate that would have sustained a mix of stocks and bonds over most 30-year historical periods. Sure, if you retire on the eve of the next bull market, you can take out more.  However, if you quit working right before the next bear market, then taking out more than 4% a year could have your portfolio beating you to the grave.

3.  Trying too hard to beat the market.  You basically have two choices: You can be a master stock-picker like Warren Buffett or Peter Lynch and try to find the next Wal-Mart.  Or you can broadly diversify your assets, mostly via low-cost index funds. This way, you enjoy hefty exposure to all the great companies.

4.  Paying too much for help.  There's nothing wrong with getting financial advice.  But I firmly, strongly, passionately believe that such help should be objective and affordable.  Paying too much for advice (especially if it's bad or at least conflicted) does a lot for your broker's retirement, not yours.  Paying just 1% a year on a $100,000 portfolio over 20 years could result in your forking over more than that amount in fees. That's a hundred grand that could have been in your pocket. Of course, if the advice you received had your portfolio performing better than what you could do on your own, then the price might be worth it.  But if you're paying 1% or 2% a year to lose to an index fund -- as most mutual fund managers do -- then you're better off taking control of your own investments.

5. Retiring permanently when you really just needed a break.  If you're in your 60s, you should plan on living at least another two decades.  Can you stand full-time leisure for 20 years?  Sure, it may sound good now, but many retirees find they get pretty bored after a while.  But by then, they have already severed many of their professional ties.  Before you decide to retire fully and permanently, discuss a phased or gradual retirement with your employer and/or business partners.  Or the possibility of working on a project basis, allowing you to take several months off each year.  Or maybe just a one-year sabbatical. Explore your options before you no longer have them.

July 26, 2010

Ten Stock Market Myths That Just Won't Die

Here is a great article I just saw online from the Wall Street Journal, I couldn't say it better myself.

At times like this, your broker or financial adviser may offer words of wisdom or advice. There are standard calming phrases you will hear over and over again. But how true are they? Here are 10 that need extra scrutiny.

1 "This is a good time to invest in the stock market."
Really? Ask your broker when he warned clients that it was a bad time to invest. October 2007? February 2000? A broken watch tells the right time twice a day, but that's no reason to wear one. Or as someone once said, asking a broker if this is a good time to invest in the stock market is like asking a barber if you need a haircut. "Certainly, sir — step this way!"

2 "Stocks on average make you about 10% a year."
Stop right there. This is based on some past history — stretching back to the 1800s — and it's full of holes.
About three of those percentage points were only from inflation. The other 7% may not be reliable either. The data from the 19th century are suspect; the global picture from the 20th century is complex. Experts suggest 5% may be more typical. And stocks only produce average returns if you buy them at average valuations. If you buy them when they're expensive, you do a lot worse.

3 "Our economists are forecasting..."
Hold it. Ask your broker if the firm's economist predicted the most recent recession — and if so, when.  The record for economic forecasts is not impressive. Even into 2008 many economists were still denying that a recession was on the way. The usual shtick is to predict "a slowdown, but not a recession." That way they have an escape clause, no matter what happens. Warren Buffett once said forecasters made fortune tellers look good.

4 "Investing in the stock market lets you participate in the growth of the economy."
Tell that to the Japanese. Since 1989 their economy has grown by more than a quarter, but the stock market is down more than three quarters. Or tell that to anyone who invested in Wall Street a decade ago. And such instances aren't as rare as you've been told. In 1969, the U.S. gross domestic product was about $1 trillion, and the Dow Jones Industrial Average was at about 1000. Thirteen years later, the U.S. economy had grown to $3.3 trillion. The Dow? About 1000.

5 "If you want to earn higher returns, you have to take more risk."
This must come as a surprise to Mr. Buffett, who prefers investing in boring companies and boring industries. Over the last quarter century, the FactSet Research utilities index has even outperformed the exciting, "risky" Nasdaq Composite index. The only way to earn higher returns is to buy stocks cheap in relation to their future cash flows. As for "risk," your broker probably thinks that's "volatility," which typically just means price ups and downs. But you and your Aunt Sally know that risk is really the possibility of losing principal.

6 "The market's really cheap right now. The P/E is only about 13."
The widely quoted price/earnings (PE) ratio, which compares share prices to annual after-tax earnings, can be misleading. That's because earnings are so volatile — they're elevated in a boom, and depressed in a bust.
Ask your broker about other valuation metrics, like the dividend yield, which looks at the dividends you get for each dollar of investment; or the cyclically adjusted PE ratio, which compares share prices to earnings over the past 10 years; or "Tobin's q," which compares share prices to the actual replacement cost of company assets. No metric is perfect, but these three have good track records. Right now all three say the stock market's pretty expensive, not cheap.

7 "You can't time the market."
This hoary old chestnut keeps the clients fully invested. Certainly it's a fool's errand to try to catch the market's twists and turns. But that doesn't mean you have to suspend judgment about overall valuations.
If you invest in shares when they're cheap compared to cash flows and assets — typically this happens when everyone else is gloomy — you will usually do very well.  If you invest when shares are very expensive — such as when everyone else is absurdly bullish — you will probably do badly.

8 "We recommend a diversified portfolio of mutual funds."
If your broker means you should diversify across things like cash, bonds, stocks, alternative strategies, commodities and precious metals, then that's good advice.  But too many brokers mean mutual funds with different names and "styles" like large-cap value, small-cap growth, midcap blend, international small-cap value, and so on. These are marketing gimmicks. There is, for example, no such thing as "midcap blend." These funds are typically 100% invested all the time, and all in stocks. In this global economy even "international" offers less diversification than it did, because everything's getting tied together.

9 "This is a stock picker's market."
What? Every market seems to be defined as a "stock picker's market," yet for most people the lion's share of investment returns — for good or ill — has typically come from the asset classes (see No. 8, above) they've chosen rather than the individual investments. And even if this does turn out to be a stock picker's market, what makes you think your broker is the stock picker in question?

10 "Stocks outperform over the long term."
Define the long term? If you can be down for 10 or more years, exactly how much help is that? As John Maynard Keynes, the economist, once said: "In the long run we are all dead."

And I would add given the above ten myths, that a person shouldn't even really consider investing period unless they have paid off their house!

July 20, 2010

Analysts Are Not Important to Investors

Analysts are not important to you as an investor. Don’t get me wrong, analysts are important to the financial markets, just not to you as a longer term investor.

Analysts typically work for brokerage firms and express opinions and write reports on the public companies that they follow. They offer different ratings such as buy, hold and sell.

The analysts you regularly see on TV work for brokerage firms (sell side) or investment firms (buy side).  They will often times mention their price target for a particular stock and sometimes more vaguely will issue a statement on how a particular stock will perform compared to the market as a whole which is quite weak to say the least.  Talk about riding the fence.

Up until recently, analysts did not disclose that they held those stocks in their personal portfolio nor did they have to mention if the firm they work for had received some investment banking fees from that same company they are supposedly impartially reporting on!

You will no doubt have seen an analyst upgrade or downgrade a particular stock due to some important event.  What is not widely recognized is that the analyst’s record does not reflect that day’s price action and therefore their record is entirely bogus and unreliable.

Studies show that during the height of the technology bubble in 1999-2000 that over 90% of brokerage firm analysts had buy or strong buy ratings on the stocks they covered at the peak or top of the market.

As a stockbroker, I often times wondered if analyst buy ratings were so the firm could sell inventory to clients?  I and you will never know.

Just remember this.  There isn’t really any correlation between what happens on Wall Street this morning and your long term investments so ignore the analysts and all the other noise and remain focused on the long term.

July 2, 2010

The Market Is Like a Yo Yo (and thats good)

Ok, its now July and the first half of the year is in the books and the stock market is down over 7%.  Thats not so great.  Its worse if you paid some financial 'professional' some percentage or fee for those same results.

The stock market is like a yo yo and very long term, its like a yo yo you are holding while going up stairs.  No one likes the downturns but they are necessary for you to make money (as long as you have been dollar cost averaging).

Just keep picturing yourself closer to retirement closer to the top of the stairs having reaped the benefits of long term investing, not being sucked in to short term trading scams or get rich quick schemes.

Stay focused and you will get there.