Category Archives: Investing

What Will 3D Printers Mean to Investing and Business?

In the first book of the Bible in Genesis we read a full account of God creating heavens and earth, all out of nothing (Genesis 1:1). From the first substances, God created everything else (Genesis 1:2-31). God created man and women in his image, and endowed them with amazing creative abilities. Technology has helped us expand our creativity, with 3D printers coming on the scene, the time from conception of an idea to the creation of an object, is now quicker than ever. This technology evolution will change they way we think, live, and invest, and will affect the business world in rapid ways. Change always brings challenges and opportunities.

Taking a reflective walk down memory lane about 3D printers, I find that it’s a short walk from my dentist to my laptop.  Several years, ago I had a cap glued onto a molar. It was created from several pictures relayed to a 3D laser that cast a duplicate of the missing top of my tooth from a raw piece of ceramic. This year I had it done again. With increasing frequency I’ve read articles about 3D printers and the amazing things they can do.

What really caught my eye lately is what Jay Leno is up to. No, not the fact that he was retiring from the Tonight Show, but what he was doing with car parts. This is boring to most people but not to me since I’m a car guy. Jay has several pieces of equipment, including a 3D part printer, a 3D scanner, and various computers, so that he can create parts right in his garage from raw blocks of material. I stumbled across the Popular Mechanics article. If you don’t know already, Jay has an amazing collection of cars; some are very rare, such as several steam-powered machines. Finding parts can be hard and it can take forever and cost a lot; even if you find them, they don’t always arrive in great condition. Jay solved this problem by being able to create them from scratch.

A few months ago the Wall Street Journal had an article about printers that could print candy, and Hershey’s was looking into them. I tweeted that the day will arrive in many of our lifetimes when we own food replicators in our home, much as we have Keurig coffee machines today. Previously they were science fantasy first seen on Star Trek’s Next Generation series in 1987.

Last month I walked into my local computer store, MicroCenter, and they had three 3D printers buzzing away creating trinkets and toys from blocks of plastic. For about $1,000 you can buy one and take it home.  You can design something on your computer, such as your invention for a better mouse-trap, or a gift for your children, and before you know it you are watching it being created in front of your eyes. It is quite interesting to view the machine work through the clear plastic printer case.

In the coming years, 3D printers could be as huge and common as personal computers, cell phones, home printers and microwave ovens are today. What this will mean to manufacturing, to the company you work for, and to your investment portfolio, no one knows. But I predict that it will be huge–big in terms of profits, shifting wealth, unemployment, individual investment growth (and losses), and entrepreneurship. Hold on to your rocket Boy Elroy; we will be in for quite a ride when this technology hits main stream. If you are interested to know more, check out the video at Motley Fool titled “The End of ‘Made-in-China’ Era. It is a little bit of hype but well done. Caution–be careful if you are thinking of investing in this industry; picking winners and losers is difficult, just as it was when the dot.com world was white-hot.

Great Articles from InvestSense

For a few years I have been following the blog InvestSense, written by a Christian who is a wealth adviser and attorney. I find his articles refreshingly frank, helpful, non-self promoting, educational and intelligent- cutting through much of the baloney the investment consumer stumbles upon in the media or from some firms. I either agree with him about 90% of the time, or he thoughtfully challenges my thinking.

Here are a few of his most recent articles, that I thought were spot on and very helpful:

Year End Benchmark Rates of Return

A couple of times per year I publish this benchmark return report for investment portfolios.  This is useful for those who use a buy and hold approach to holding their investments, in various common investment allocations of stocks and bonds. I provide this so that you can compare your investment returns to what the market was doing.

For this report I compare 5 models to help demonstrate different risk levels: very conservative ‘Volvo portfolio’, conservative ‘Lexus portfolio’, moderate ‘Acura portfolio’, aggressive ‘BMW portfolio’, and lastly the very aggressive ‘Porsche model portfolio’ – each investing in a different mixture of cash, bonds and stock, as well as different allocations of large, mid and small cap stock and foreign stocks.

The table below compares the GROSS rates of return that you would have earned in any of these portfolios if you invested in index funds that held investments identical to the index. Gross rates of return are before any expenses, such as: * Mutual fund management fees and expenses * Taxes * Commissions * Transaction costs * Financial planner’s management fee.

Historical Rates of Return as of 12/31/2012
Portfolio Model ‘Volvo’ ‘Lexus’ ‘Acura’ ‘BMW’ ‘Porsche’
Model Type Very Conservative Conservative Moderate Aggressive Very Aggressive
1 year 8.76 10.40 12.04 13.69 15.36
3 year 7.40 8.04 8.21 9.09 9.79
5 year 3.77 3.32 2.50 2.23 1.82
10 year 6.18 6.68 7.06 7.62 8.21
20 year 7.42 7.34 7.36 7.54 7.67
30 year 9.17 9.40 9.51 9.80 10.07

 

If you do your own investing, active or passive, or hire someone to invest for you, it is prudent to make sure that you are doing as good as the benchmark net of expenses. The benchmark is a minimum expectation of rate-of-return that you should be achieving. It is a way to hold yourself or your investment adviser accountable. It is important that you know why your investments are either not doing as well or are doing much better than the benchmark. Either could be cause for concern: it could be merely a timing issue or it could be because your adviser made a mistake or is not doing his/her job. It is important that you are in the know, asking the right questions, and getting the right answers.

What is asset allocation? You may want to read my article entitled The Asset Allocation Style of Investing, which highlighted this method of investing made popular from the study by Garry P. Brinson, Brian D. Singer, and Gilbert L. Beebower; they found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not from market timing or security selection.

Footnotes:

Asset allocation investors do not just invest in funds similar to the S&P 500 or the Dow (the most common benchmarks), therefore they should compare their results to aggregated benchmarks that include indices that closely match their allocations.

Timing: In order to have earned these rates of return, you would have had to invest at the same precise time of the time period represented. Fluctuations in the market can make a drastic difference in your actual rate of return, so if you invested a lump sum of money on a day that the market was down or up, or you invested each month (perhaps using dollar-cost-averaging), you may and will experience quite a bit different results from those illustrated here.

Historical Perspective of Indexing: Index fund investing (passive) has been popular because people hear in the media frequently that a majority of actively managed mutual funds do not consistently beat their respective index.

Actively managed mutual funds usually have higher expenses, thus making it more challenging for them to out-perform their passive brethren. However, investors may want to consider looking for mutual funds that beat the indexes (net of expenses); they might even find some that have a lower risk (volatility) than the index.

The preference to invest in index funds is a fairly recent phenomenon. Now you can even invest in ETFs (exchange traded funds), a hybrid of index investing that has emerged in the last several years. The charts below illustrate returns all the way back to 30 years; however, index funds and ETF’s didn’t exist  back that far for each of the indexes used to make these calculations.

The indexes used to compile the historical rates of return are below. Keep in mind there are dozens of different indices. Many feel that the ones used here most closely represent the benchmark for each category. There is some differing of opinion in the investment community as to the best indices that should be used for benchmarking. * Cash – Money Market (3-month CD * Intermediate Long Bond – Lehman Bros Aggregate Bond * Large Cap Value — S&P 500 * Mid Cap — Russell Mid-Cap Index * Small Cap – Russell 2000 * International Equity – MSCI EAFE Equity Index.

Past Performance an Indication of Future Performance? Anyone who as ever glanced at any financial product advertising or literature will see “Past results are not an indication of future performance” pasted all over the place. This sentence is required by the security industry’s regulating authorities and it is very true. However, in order to make intelligent decisions, historical information is very useful for comparison purposes, in addition to a lot of other financial information, including your own personal financial plan.

Should You Buy Gold?

The most commonly asked question I get is this: “Should I buy gold or some other precious metal like silver or platinum?” The main reasons for driving interest in gold are advertisements, the increased price of gold, and fear.

There are a lot of commercials on TV and the radio from companies that want to sell you gold. The main reason is that they are guaranteed to make a profit when they sell it to you, regardless of whether the price goes up or down. They are not selling it to you at the pure spot price because they have to mark it up to make a profit or else they charge you various fees. Their commercials prey on your fear that the economy is going to collapse and that money will be worthless. The secondary motivation they use is that they build the expectation that the price of gold will go up, benefiting you, the buyer. If you want to sell your gold, you can sell it back to the company you bought it from, or some other entity, but they won’t give you the full market value of it. That is because they have to make a profit when they subsequently sell it.

Are gold and other precious metals good investments? They are if you buy low and sell high. However, most people buy when the excitement is the greatest, when prices are at their highest, and then sell when it slumps. This is perhaps the riskiest time to buy gold and some other metals. The highest price gold ever reached was in September of 2011, when it hit $1,895 per ounce. This year the price per ounce has been bouncing pretty much between $1,600 – $1,800. 10 years ago it was only $400.

People that bought gold at $400 and sold it when it peaked at $1,895 earned about a 475% return on their money. That is really exciting, but now that it has been fluctuating within a couple hundred dollars of the peak, it is a nervous time to get into gold. Some might play it like a commodity–buy when it trickles down a little and sell when it pops up, or sell it short when prices get high, but even trained gold professionals don’t know when is the best time to speculate like that. Others may tell you to wait until it drops a lot, then buy in, but how do you know it might not drop more after you buy it? Or what if you bought gold 10 years ago and watched it do nothing for a few years, and then impatiently sold it before it started climbing when the recession hit.

I watch some of the recession indicators and post them every Friday here, on at Weekending Financial Scorecard. Some feel there are clear signs that we could go through another recession next year, and that would make gold prices go up, since recessions and inflation fears often are indicators. However, as we look back at many financial indicators over the last 10 years, some of the things financial experts always rely on haven’t always held true.

Some people remember when silver hit almost $50 an ounce in 1980, going from about $5 an ounce just a couple of years prior. It quickly dropped back to about $5 an ounce in a short time, and it held there for about 15 years. Those who invested in silver late and got out after it tumbled lost a lot of money. Now part of that run up was due to market manipulation, when the Hunt brothers tried to corner the market. I’m no expert or conspiracy guy, but various forces unknown to the average investor like you and me could cause the price of metals to fluctuate these days, making it more difficult to know when to buy and sell. If you have gold and are considering selling it, you may want to read an article I previously wrote on How to Sell Your Scrap Gold.

If you own various mutual funds, check out their statement of additional information for lists of the underlying stocks and bonds they hold. You may find that they are investing in the precious metal industry. Already you may be investing in gold and silver or other metals and not even know it. If you direct more of your money into precious metals, you could be increasing your exposure and your risk.

If you have comments or questions, please comment below. Was this article helpful? If so, please like it on Facebook, Tweet about it on Twitter, or mention it on LinkedIn. The links at the top of the article are there for you to do it easily.

How to Withdraw Needed Funds from and IRA or Inactive 401(k)

Question: I lost my job several months ago, and have exhausted my savings. However, I have some money in a 401(k) Plan from an old employer. I need to get to some of it to pay my rent, but I don’t want to pay tax on the entire amount in the Plan. What is the best way for me to get to a portion of it? I am under the age of 59 1/2 and would be faced with the 10% withdrawal penalty in addition to income tax.

Answer: The first thing you should do is to make sure that you are living on a minimalist budget, so that you take out only the small amount that you really need. Next, contact your investment professional and ask him/her to open an IRA account for you, and to execute a trustee-to-trustee transfer of your funds into the new IRA. Tell the investment person you need to have some money sent to you right away after the funds clear and are deposited into your IRA. Doing it this way will ensure that their is no automatic tax withholding to your 401(k) Plan, as there would be if you asked your Plan’s provider to just send your money to you in check form. Also, this way gives you control of when to take money out, and how much to take–just based on your needs. Also, as the year end approaches, this gives you a way to spread the tax due over a couple of tax years.

Question:  How should I invest the money?

Answer:  If you are having financial difficulty and are not sure if you will need more of the money, then you don’t want to invest the money for the long-term nor pay any sales charges to invest or contingent deferred sales charges (CDSC) to pull the money out. Short term investments such as savings accounts or FDIC-money market accounts are suitable because the principal is guaranteed by the FDIC not to lose any value. Avoid annuities or mutual funds until your situation is more stable, you have adequate savings, and you can resume planning for the future.

Question: Is there any way around paying the 10% pre-age 591/2 penalty?

Answer: Some expenses of your family may be deemed to be immediate and heavy, including certain medical expenses, costs relating to the purchase of a principal residence, tuition and related educational fees and expenses, payments necessary to prevent eviction from or foreclosure on a principal residence, burial or funeral expenses, and certain expenses for the repair of damage to your principal residence.  For more information, go to IRS.gov.

Question: What are some other issues to be aware of?

Answer: There are too many to cover in this article; however, be sure to ask your financial professional about all of the issues that pertain to you, including the tax issues. Be sure to plan for the extra tax that you will owe on the IRA or 401(k) distribution. If you need the money very quickly, you might ask the current 401(k) Plan to send you some money now, but to execute the trustee-to-trustee rollover on the balance.

As Stocks Head Higher So Do Risks

The stock market is up 16.4% this year, as reported in the Wall Street Journal today’s article “As stocks head higher so do risks.” Therefore, there might be some rationale for reducing one’s portfolio exposure to stocks, contends Daniel Roe of Budros, Ruhlin and Roe, the largest financial planning firm in my hometown (Columbus, Ohio).

The Journal article is excellent reading for investors, not only because of the insight it gives about re-positioning portfolios given market conditions, but also because it gives a look at some of the mutual funds used in portfolios for clients. Most financial planning firms don’t use individual stocks and bonds, but they use mutual funds that they select after doing intensive research of a fund’s return, management, expenses, risk and investment style and philosophy.

What is rare, though, is that most financial planning firms don’t make public some of the funds they select, nor do they publish them in the newspaper. This article makes good reading for those researching possible funds to consider.

How Does Inflation Affect Savings?

People are aware of inflation, since it is talked about all the time on the news and they see gasoline prices increasing astronomically and erratically. You may have heard someone talk about loss of purchasing power, but what does that mean?

As a quick review, when you invest or save money, and you pull it out later, it should be worth more. This is because it either pays interest (e.g., bank pass-book savings, money market account, certificate of deposit [CD], bond), or earns dividends (e.g., stocks), or appreciates in value (e.g., stock, real estate).

If you invested in a savings account, CD or money market account, you are typically going to earn 0 – 1.5% annually.

Inflation (increase in the cost of goods), on the other hand, averages about 3.5% over time. If the money you deposit in an interest earning account earns less than the rate of inflation, you won’t be able to buy the same amount of goods when you take your money out to buy something as you could have bought before you invested the money. You have lost what is called purchasing power.

If you buried the money in a coffee can in the back yard or hid it in your mattress, it would not appreciate in value at all. Each year you left it in the ground or in your mattress, it would actually go down in value an average of 3.5% per year, since you can’t buy the same amount of goods with it when you take it out as you could have bought with it when you buried it or hid it.

Some people are very risk averse, meaning they are afraid stocks or bonds may lose value. However, as you can now see, even by taking no risk, your money can go down in value if not invested wisely.

 

How to Sell Your Scrap Gold

The price of gold is climbing again to about $1,800 per ounce, close to its all time high of $1,895 on 9/6/11, so many people are thinking about selling their old gold jewelry they have lying around. If you are interested in selling yours, here are a few tips to help you get the most for it.

  • 24 carat gold is 99.9% pure gold, and the price fluctuates everyday
  • 99.9% 24 carat gold is very soft; most jewelry is either 10, 12, 14, or 18 carats, but it can be other grades as well
  • Coins and bars might be pure gold
  • Jewelry stores and gold buyers have to buy your gold at a discount, either because the market price may go down tomorrow or they need to make a profit when they sell it
  • 10 carat gold is 41.7%, 14 carat is 58.3%, and 18 carat is 75% gold
  • Your scrap gold is weighed in grams, and it is purchased from you at the buyer’s per gram quote offer, depending upon your gold’s carat rating
  • There are approximately 28 grams in an ounce
  • An Example: If gold is selling at $1,700 per ounce and you have 14 grams (1/2 ounce) of 14 carat gold, the current market value of your gold equals 50% of $1,700 ($850), and then 58.3% of $850 (to account for the amount of gold in your item), or $495. Go to Wikihow for additional information before selling.

When you decide to sell your scrap gold, first have a reputable jeweler grade your gold (with a little acid and stone test), and weigh it. Next ask their purchase price per gram for each item, and then ask for the total amount they will give you for your items. Then call or visit some other gold buyers for their prices per gram for your carat weight. Make sure each item is tested and weighed separately, since each one could be a different carat. Don’t ever mail your gold to any gold buying firm.

Take each item, such as old gold teeth, bars, coins and scrap jewelry, in a separate ziplock bag, and take your time. Some buyers talk fast and the process can be intimidating. A few days ago, a relative took 4.7 grams of 14 carat gold to 2 places. Assuming a $1,750 per ounce (solid gold), or $62.50 per gram. If 14 carat would be 58% of that, or $36.25 per gram. The retail price is $170.35. They were offered $40 from a coin shop (23% of the value) and the attendant didn’t weigh it. The second offer was from a jewerly store was for $90 (52% of the value). Don’t be hurried, understand what you have, if you don’t do your homework and visit 2 or more reputable buyers, you might get ripped off.

Do It Yourself Investing Options

You have some money to invest, and you are not sure where to turn.  I get asked all the time by people that have some money to invest and they don’t know where to turn.  If they have several hundred thousand dollars or more, they can command more attention and higher levels of service, but what if someone only has a more modest sum to invest, say $30,000 from the 401(k) left an a previous employer’s plan? Maybe they inherited $70,000 or accumulated $50,000 in addition to a full-funded emergency fund of 6 months of income–where should they turn? Here are some of the options people have today:

  • Day trade:  buying and selling securities on a daily basis is often an option that appeals to many people; however, most people lose a lot of money doing this, even though some books, websites, commercials and seminars tout the millions you can make with the Day Trade option.
  • Hire an adviser:  some professional money managers will help people invest modest sums. Typically they will be investment sales people at a bank or an insurance company, or a professional with less experience–but not always. Most of the investment products will pay a commission to the adviser. This doesn’t mean that you should be suspect of the adviser’s recommendations, but it does mean you should be cautious about the products sold. Annuities are common in this situation, but they are controversial; you should read up on them before investing. Most professional money managers don’t like them. I, however, do like some of the features for the right client, but I think buyers should be careful since most complaints I hear as well as the industry reports are from annuity sales.
  • Become an expert: if you like reading many financial books and taking courses, and you are able to comprehend  sophisticated information, then take your time and delve into it, but at the end of the day, having someone who does it full-time help you may make a lot of sense.
  • Index investing: with little experience you can be a passive investor in various stock and bond markets, and buy no or low cost index funds. If you decide to explore this very common route, be sure to take your time to learn about asset allocation, different index options, and a host of other things related to investing. This is definitely not as intense as trying to become an expert, but there is a learning curve.
  • Do-it-yourself but with help: Many of the investment firms offer various levels of online and telephonic help. You can do various types of research, educate yourself, and talk to trained people online, but just as with index investing, I recommend people take time to read a few good books on investing first. Also, it seems as if every other day, new services are offered online. For example, FutureAdvisor.com provides some nice online services for the do-it-yourselfer. The options continue to be expanded online as investment and financial technology firms go after the vast underserved low and middle market investors.

Mid Year Benchmark Rates of Return

My article entitled The Asset Allocation Style of Investing, highlighted this method of investing made popular from the study by Garry P. Brinson, Brian D. Singer, and Gilbert L. Beebower that found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not market timing or security selection.

In that article I compared 5 fictitious model portfolios to help demonstrate different risk levels: very conservative ‘Volvo portfolio’, conservative ‘Lexus portfolio’, moderate ‘Acura portfolio’, aggressive ‘BMW portfolio’, and lastly the very aggressive ‘Porsche’ model portfolios – each investing in a different mixture of cash, bonds and stock, as well as different allocations of large, mid and small cap stock and foreign stocks.

Benchmarking The mid-year chart below provides historical rates of return for each asset allocation model from the article, based upon the respective indices. Investors should take into consideration expenses and timing and have a healthy historical perspective.

The Expense Factor

The table below compares the GROSS rates of return that you would have earned in any of these portfolios if you invested in index funds that held investments identical to the index. Gross rates of return are before any expenses, such as: * Mutual fund management fees and expenses * Taxes * Commissions * Transaction costs * Financial planner’s management fee

Timing

In order to have earned these rates of return, you would have had to invest at the same precise time of the time period represented. Fluctuations in the market can make a drastic difference in your actual rate of return, so if you invested a lump sum of money on a day that the market was down or up, or you invested each month (perhaps using dollar-cost-averaging), you may and will experience quite a bit different results than illustrated here.

Historical Perspective of Indexing

Index fund investing (passive) has been popular because people hear in the media frequently that a majority of actively managed mutual funds do not consistently beat their respective index.

Actively managed mutual funds usually have higher expenses, thus making it more challenging for them to out perform their passive brethren. However, investors may want to consider looking for mutual funds that beat the indexes (net of expenses), they might even find some that have a lower risk (volatility) than their index.

The preference to invest in index funds is a fairly recent phenomenon. Now you can even invest in ETFs or exchange traded funds, a hybrid of index investing that has emerged in the last several years. The charts below illustrate returns all the way back to 30 years, however index funds and ETF’s didn’t exist for each of the indexes used to make these calculations back that far.

Past Performance an Indication of Future Performance?

Anyone who as ever glanced at any financial product advertising or literature will see “Past results are not an indication of future performance” pasted all over the place. This sentence is required by the security industry’s regulating authorities and it is very true. However in order to make intelligent decisions, historical information is very useful for comparison purposes, in addition to a lot of other financial information including your own personal financial plan.

The Indexes

The indexes used to compile the historical rates of return are below. Keep in mind there are dozens of different indices. These ones many feel most closely represent the benchmark for each category. There is some differing of opinion in the investment community as to the best indices that should be used for benchmarking. * Cash – Money Market (3-month CD * Intermediate Long Bond – Lehman Bros Aggregate Bond * Large Cap Value — S&P 500 * Mid Cap — Russell Mid-Cap Index * Small Cap – Russell 2000 * International Equity – MSCI EAFE Equity Index.

Historical Rates of Return as of 6/30/2012
Portfolio Model ‘Volvo’ ‘Lexus’ ‘Acura’ ‘BMW’ ‘Porsche’
Model Type Very Conservative Conservative Moderate Aggressive Very Aggressive
1 year 3.9 2.91 1.44 .83 -.27
3 year 9.91 11.11 11.63 13.17 14.44
5 year 3.43 2.61 1.43 .79 -.01
10 year 5.55 5.72 5.71 5.96 6.20
20 year 5.88 5.77 5.65 5.8 6.01
30 year 9.41 9.83 10.08 10.57 11.00

If you do your own investing – active or passive or hire someone to invest for you, it is prudent to make sure that you are doing as good as the benchmark. The benchmark is a minimum expectation of rate-of-return that you should be achieving. It is a way to hold yourself or your investment advisor accountable. It is important that you know why your investments are either not doing as well or much better than the benchmark. Either could be cause of concern: it could be merely a timing issue or it could be because your advisor made a mistake or is not doing their job. It is important that you are in the know and asking the right questions, and getting the right answers.

Asset allocation investors do not just invest in funds similar to the S&P 500 or the DOW (the most common benchmarks), therefore they should compare their results to aggregated benchmarks that include indices that closely match their allocations.

Why did the Facebook IPO Fail?

The much followed initial public offering (IPO) of Facebook failed to be a runaway opening day success, by they way I warned you to be very cautious about IPOs like this on my February 1 2012 post. The first day of trading Friday May 18th, shares opened up at $42.50 about 11% higher than the initial public offering price of $38, closing today at $31, representing almost a 30% drop in value within a few days. This is a failed IPO, not a good start for this new public company, but one they will recover from.

Why did it fail to meet the wild expectations? Here are a few of my guesses…

  • Technology where the stock was being sold, the National Association of Securities Dealers Automated Quotations or NASDAQ, was unable to handle the demand
  • A few days before the IPO a few large companies announced that they thought the advertising value of Facebook was overrated
  • The expectations were set too high by the media and investment talking heads
  • Too many shares were issued

This IPO is looking to be controversial from the start…

  • Two top regulators said the IPO should be reviewed (source Reuters)
  • Regulators looking into Morgan Stanley’s sharing of analyst’s negative reports with some institutional investors but not others (think retail buyers)
  • There could be lawsuits involving Facebook, NASDAQ and shareholders involving the fumbled IPO, considering the 30 billion dollar loss in shareholder equity
  • Today the Securities and Exchange Commission Chairman said they will examine “issues”

What can we learn from this, so that our personal financial management is wise?

  • Stay away from most IPOs, especially hyped ones
  • Be extra careful about industries that don’t have a proven track record of profitability
  • Media investment people are often wrong, so we should take their advice with many grains of salt

What can Facebook and other new hot up-and-coming social media companies learn from this? Perhaps they are not as smart as it seems they are perceived to be. Be wary of the advice of investment bankers and market makers involved in your IPO and get many second opinions. Maybe do a better job of employing social media to help you assess value, plan and market your IPO.

What does the JP Morgan Chase loss mean to you?

There has been constant chatter about JP Morgan Chase’s $2 billion loss on the news, but what does it really mean to you with your personal finances?  How will it affect you?

If you own their stock, you have experienced at 12% reduction in value, but it will probably recover in time. If you bank at Chase, will your savings rates go down, or borrowing rates go up? Probably not. Is your money still secure? Yes reports say the bank is financially secure, and has been one of the stronger banks throughout the great recession. If Chase is your investment manager, should you be concerned? Probably not, unless you are an institutional investor and Chase helps to manage your multi-million dollar portfolio, you may want to have some long conversations to make sure they are not applying the same investment methodology. So in my estimation, JP Morgan Chase’s loss means very little to the average person’s personal finances. Perhaps the only take away for us is for their loss to serve as a reminder that “If you don’t understand it, don’t invest in it.”  It seems that the derivatives employed by Chase were too complex even at their level of sophistication to use wisely.

Benchmarking Asset Allocation Investment Performance Results Using Indices

My article entitled The Asset Allocation Style of Investing, highlighted this method of investing made popular from the study by Garry P. Brinson, Brian D. Singer, and Gilbert L. Beebower that found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not market timing or security selection.

In that article I compared 5 fictitious model portfolios to help demonstrate different risk levels: very conservative ‘Volvo portfolio’, conservative ‘Lexus portfolio’, moderate ‘Acura portfolio’, aggressive ‘BMW portfolio’, and lastly the very aggressive ‘Porsche’ model portfolios – each investing in a different mixture of cash, bonds and stock, as well as different allocations of large, mid and small cap stock and foreign stocks.

Benchmarking
The chart below provides historical rates of return for each asset allocation model from the article, based upon the respective indices. Investors should take into consideration expenses and timing and have a healthy historical perspective.

The Expense Factor

The table below compares the GROSS rates of return that you would have earned in any of these portfolios if you invested in index funds that held investments identical to the index. Gross rates of return are before any expenses, such as:
* Mutual fund management fees and expenses
* Taxes
* Commissions
* Transaction costs
* Financial planner’s management fee

Timing

In order to have earned these rates of return, you would have had to invest at the same precise time of the time period represented. Fluctuations in the market can make a drastic difference in your actual rate of return, so if you invested a lump sum of money on a day that the market was down or up, or you invested each month (perhaps using dollar-cost-averaging), you may and will experience quite a bit different results than illustrated here.

Historical Perspective of Indexing

Index fund investing (passive) has been popular because people hear in the media frequently that a majority of actively managed mutual funds do not consistently beat their respective index.

Actively managed mutual funds usually have higher expenses, thus making it more challenging for them to out perform their passive brethren. However, investors may want to consider looking for mutual funds that beat the indexes (net of expenses), they might even find some that have a lower risk (volatility) than their index.

The preference to invest in index funds is a fairly recent phenomenon. Now you can even invest in ETFs or exchange traded funds, a hybrid of index investing that has emerged in the last several years. The charts below illustrate returns all the way back to 30 years, however index funds and ETF’s didn’t exist for each of the indexes used to make these calculations back that far.

Past Performance an Indication of Future Performance?

Anyone who as ever glanced at any financial product advertising or literature will see “Past results are not an indication of future performance” pasted all over the place. This sentence is required by the security industry’s regulating authorities and it is very true. However in order to make intelligent decisions, historical information is very useful for comparison purposes, in addition to a lot of other financial information including your own personal financial plan.

The Indexes

The indexes used to compile the historical rates of return are below. Keep in mind there are dozens of different indices. These ones many feel most closely represent the benchmark for each category. There is some differing of opinion in the investment community as to the best indices that should be used for benchmarking.
* Cash – Money Market (3-month CD
* Intermediate Long Bond – Lehman Bros Aggregate Bond
* Large Cap Value — S&P 500
* Mid Cap — Russell Mid-Cap Index
* Small Cap – Russell 2000
* International Equity – MSCI EAFE Equity Index.

Historical Rates of Return as of 2/29/2012
Portfolio Model ‘Volvo’ ‘Lexus’ ‘Acura’ ‘BMW’ ‘Porsche’
Model Type Very Conservative Conservative Moderate Aggressive Very Aggressive
1 year 4.97 4.18 2.75 2.29 1.44
3 year 14.40 16.86 18.53 21.38 24.00
5 year 3.78 3.14 2.09 1.66 1.05
10 year 5.26 5.31 5.13 5.30 5.46
20 year 6.97 7.11 7.05 7.46 7.74
30 year 9.48 9.81 9.86 10.32 10.68

If you do your own investing – active or passive or hire someone to invest for you, it is prudent to make sure that you are doing as good as the benchmark. The benchmark is a minimum expectation of rate-of-return that you should be achieving. It is a way to hold yourself or your investment advisor accountable. It is important that you know why your investments are either not doing as well or much better than the benchmark. Either could be cause of concern: it could be merely a timing issue or it could be because your advisor made a mistake or is not doing their job. It is important that you are in the know and asking the right questions, and getting the right answers.

Asset allocation investors do not just invest in funds similar to the S&P 500 or the DOW (the most common benchmarks), therefore they should compare their results to aggregated benchmarks that include indices that closely match their allocations.

The Asset Allocation Style of Investing

There are four ways to invest money, and the most boring way works best for most people: Asset Allocation.

The other three ways to invest: strategic asset allocation, market timing or picking stocks are more sexy. Next time investing comes up at a cocktail party you will be sure to hear someone touting their get rich quick hot stock. When interest rates soar, or stocks drop you may even hear someone brag about how they got in or out at just the right time, or used some type of ‘option’ strategy and made a bundle. You will see people interested in these types of conversations, because many people’s investment portfolios have not performed well.

Most people are not good at picking stocks, even with the internet and greater access to information than ever, there are too many stocks and too little information about each one – and it gets outdated quickly. People are emotional. Even if they pick good ones, they often sell them at the wrong time, because their fears overtake their ability to objectively make decisions.

Market timing always becomes popular when the stock market drops, and people see their account values dropping as they are now. No one has consistently shown the ability to predict markets or securities. To win you have to have 60% accuracy just to cover the losses caused by mistakes of the other 40% – because of transaction fees and taxes. You have to be correct in all four decisions: what/when to buy and when/what to sell.

In the last decade of poor stocked market returns, some investment advisers have questioned the validity of asset allocation, and have come out with hybrids of it, or some kind of strategic approach using various computer driven modeling tracking numerous factors. Some of these approaches look promising, and they should be looked at, but they don’t yet have long term track records.

You are sure to put a damper on a party conversation by mentioning ‘asset allocation.’

What is asset allocation? It is the method of investing based on the study by Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower in 1991. They found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not market timing or security selection. This traditional buy and hold method is boring – but it works.

When you asset allocate you invest a portion of your money into each of the major asset classes: Cash, Bonds, and Stocks. When it comes to your stock portion you split or allocate it into Large Cap, Mid Cap, Small Cap and Foreign Stock.

If you are conservative you allocate a greater percentage into cash and bonds and large cap stock. If you are aggressive your allocation has less cash and bond and more mid, small and foreign stock. Aggressive allocations will probably have a better rate of return over time than going conservative, but will be the most volatile, meaning your values will fluctuate up and down more. You can pick a model like the ones below or take a quiz utilizing software to help identify your tolerance for handling risk.

I have designed 5 fictitious model portfolios to help demonstrate different risk levels. I call the most conservative the ‘Volvo portfolio’. The ‘Volvo portfolio’ fits you because you want something solid (good rate of return) and protection from market risk. The ‘Lexus portfolio’ is for those you are conservative but want more speed (little better rate of return), but you still like a smooth ride. The ‘Acura portfolio’ fits those who want a little more sport (higher rate of return), and are willing to encounter a little more risk. Riskier investors may choose the ‘BMW portfolio’, to get great performance (higher rate of return), and because they can tolerate tricky roads (a lot of market fluctuation). Lastly, the ‘Porsche is for those who want maximum performance, and whose nerves can tolerate the riskiest of roads. This fictitious demonstration was done with premium cars, because investing with asset allocation over the very long term will hopefully position you to be able to eventually afford one. In conclusion, neither of these asset allocation models would be considered at the upper end of the high risk continuum. As you progress from conservative to aggressive asset allocation models, you increase your probability for volatility and rate of return, but not by wide margins over the long term.

Stock Act Signed Into Law, Finally!

The Stop Trading On Congressional Knowledge, or Stock act was signed into law yesterday April 4th, 2012 by President Obama, prohibiting members of congress from buying and selling stock based upon inside information. It is about time that this was passed, given the 6 years the bill has been worked on and the opportunity for corruption it created for decades. The bill definitely stalled, but was recently given new life when 60 minutes featured it.

The law preventing everyone from investing based upon inside information has existed for decades, but congressman strangely were conveniently exempt from the law. This was political hypocrisy at the highest level, when members of congress had exempted themselves from law that effected everyone else, just so that it would provide them the opportunity to obtain wealth.

Before this law many congressman and women became millionaires trading on information that only they and few others had knowledge of, sometimes because of private committees that they were a part of. Some of these congressman and women probably crafted law and based their votes on the law knowing that it would provide them the opportunity to profit directly in their own investment portfolios. The corruption went further, when you consider there have been reports that some of the inside information was leaked to hedge funds. Many hedge fund’s investment minimums are so large that only the wealthy can invest in them. These are examples of congressman, their hedge fund friends and clients, and businesses that benefited, colluding using their political power to become wealthy or to add to their wealth. The gulf between the rich and the poor has expanded in recent years, is it any wonder that it has when you consider the special advantages afforded to a select few. Hopefully this is not the end of the story, I would love to see a reporter with courage to dig into the corruption further to trace who benefited from insider trading; the truth would be embarrassing to both political parties.

Diamonds the New Gold?

There is a commercial running now advertising investing in diamonds instead of gold, touting “diamonds the new gold.”. Many people have lost interest investing in gold, since the price has dropped to around $1,600 per ounce from a high of a $1,895 in September of 2011. Unlike gold, for the average consumer there isn’t a readily available market for pricing and selling diamonds. The pricing is set by a few large companies like De Beers. Jewelry grade are those that are finished and polished or rough stones, however they don’t have the attributes of other desirable investments, since they lack liquidity and fungibility. Fungibility is important, using gold for an example, gold of the same carat weight is gold, but with diamonds there will be great diversity of size, color, clarity and cut- no two diamonds are identical.  If you invested in diamonds and wanted to sell them quickly, you have to find a willing buyer, which is hard to do. Jewelers won’t buy them from you unless than can mark them up and make a profit, and the company that bought them from you may guarantee that they will buy them back, but will not guarantee the price. Investors should stay away from direct investments in diamonds, but if they have an interest may want to investigate companies that mine or supply them.

Stock Act Gaining Momentum

I previously wrote about the federal lawmakers exemption from insider trading laws, allowing them the ability to buy and sell stocks, bonds and real estate using inside information. The lawmakers have access to privileged information that helped many of them to become multimillionaires, peddle influence, and secretly make the information available to hedge-fund managers that only the very wealthy can invest in.  If anyone else traded on inside information, it is a felony which brings possible fines and imprisonment.

The Stop Trading on Congressional Knowledge Act, also known as the Stock Act has been floating around for several years, would make this practice illegal, has passed the Senate, and is moving to the House, and could be voted on as early as next week. Lets hope that this bill gets passed and becomes law.

Wondering If You Should Invest in Facebook’s IPO

The media chatter seems to be full of information about Facebook’s and Groupon’s initial public offering (IPO) of stock. Many people wonder if IPOs make good investments.

It is very difficult to determine the value of a stock that has been around a while, let alone a new one with little information to go on. Sometimes the initial public offering price is good, because it may be priced low such that if the underwriter has to buy unsold shares. However often most shares of the IPO are pre-sold to institutional investors or other qualified buyers. If the general public wants to buy the shares, they may be buying them after the market may have driven the cost up. For example LinkedIn went public last year with an initial price of $45, but sold $83 the same day. So if you bought it, you may be buying it at the higher cost. This is not to say and IPO may continue to appreciate, however most advisors think that investing in IPOs can be aggressive. If someone fits the model of a long-term investor, using mutual fund type accounts for professional security picking and diversification, then buying individual stocks isn’t really a fit for them, unless only done so with a small percentage of their portfolio.

Talk to your investment advisor about opportunities and risk of investing in IPOs and other alternatives: you might not want to miss an opportunity to get a nice little profit, however be careful to do so only if it really fits your overall goals, risk level and investment style.

Consider too Ecclesiastes 5:13-15 “There is another serious problem I have seen under the sun. Hoarding riches harms the saver. 14 Money is put into risky investments that turn sour, and everything is lost. In the end, there is nothing left to pass on to one’s children. 15 We all come to the end of our lives as naked and empty-handed as on the day we were born. We can’t take our riches with us.”

A Review of Monte Carlo Simulation

Conventional retirement projections in most retirement financial planning software packages and calculators looks at everything the moment you enter it, such as your goals, assets, benefits, and expenses coupled with assumptions for taxes, rates-of-return and inflation. Since this is just a calculation it doesn’t measure probability of all of the many variables that could possibly help or hinder your goal achievement. Therefore financial plans require ongoing updates.

Within the last decade most financial planning software programs have added Monte Carol Simulation as one way to visualize and examine the effect of unpredictable financial market volatility and other factors on your retirement plan.

Monte Carlo Simulation introduces random uncertainty into the assumptions and then runs the model a large number of times. Observing results from all these changing results can offer a view of trends, patterns and potential ranges of future outcomes illustrated by the randomly changing simulation conditions. While Monte Carlo Simulation cannot and does not predict your financial future, it may help illustrate for you some of the many different possible hypothetical outcomes.

Ten thousand full financial plan calculations are performed utilizing the volatile annual rates of return in our software program (eFinPLAN.com). The result is ten thousand new hypothetical financial plan results illustrating possible future financial market environments. By the use of random rates from a statistically appropriate collection of annual returns and repetition of the process thousands of times, the resulting collection can be viewed as a representative set of potential future results. The tendencies within the group of Monte Carlo Simulation results—the highs, lows and averages—offer insight into potential plan performance that may occur under various combinations of broad market conditions.

Most Monte Carlo Simulation reports, and those of eFinPLAN provide a:

  • Bold Line
  • Percentage of Monte Carlo Results Above Zero at Selected Ages
  • Monte Carlo Simulation Minimum, Average and Maximum Dollar Results

The Bold Line

The bold line in the Monte Carlo Simulation Results graph tracks the value of assets over the length of the illustration if all rates of return are held stable at the assumed rates of return. The estimate uses annual expected portfolio rates of return and inflation rates to model the growth and use of assets as indicated under Assumptions.

Percentage of Monte Carlo Results Above Zero at Selected Ages

These results represent the percentage of Monte Carlo simulation outcomes that show positive retirement asset value remaining at different ages. A percentage above 70 at last life expectancy is an indication that the underlying retirement plan offers a substantial probability of success even under volatile market conditions. Additional ages shown give the percentage of simulation outcomes with positive asset amounts at various ages.

Monte Carlo Simulation Minimum, Average and Maximum Dollar Results

These values indicate the best, worst and average dollar results at the end of the five thousand Monte Carlo Simulations. These show the range of results (high and low) and the average of all Monte Carlo results. All values are based on results at the life expectancy of the last to die.

Conclusion

Monte Carlo Simulation is a great tool; however, the most important thing to remember that is that financial planning is a process, and part art and part science. Regularly monitor your plan while seeking help from trusted professional advisors. Simulation results demonstrate effects of volatility on rate of return assumptions for education and discussion purposes only. The projections or other information generated by the plan regarding the likelihood of various investment outcomes are hypothetical in nature; they do not reflect actual investment results and are not guarantees of future results. Each Monte Carlo Simulation is unique; results vary with each use and over time.