Decide to Be Rich (2008-04-07)

by David John Marotta

It used to be that becoming a millionaire was regarded as a huge achievement. In today's dollars, however, it is fairly trivial. According to the Department of Labor's inflation calculator, $1 million today was worth only $183,285 in 1970. But $1 million in 1970 had the same buying power as $5,456,005 today.

That's the new rich: over $5 million.

Depending on your lifestyle, if you have amassed $1 million at age 65, you may not even have enough to retire. At age 65, you can withdraw only 4.36% of your assets each year to ensure you don't deplete your savings before you die. So if you are just a millionaire, you must be able to live on an annual income of $43,600. And if your lifestyle demands twice that amount, you don't have enough money to retire yet.

Many of our parents and grandparents were fortunate enough to have pension plans that continued to pay their salary in retirement. Even though they never had a large investment account, those guaranteed benefit plans were extremely valuable. A pension paying $43,600 a year starting at age 65 is worth $1 million in the bank. Our parents and grandparents were truly millionaires, although they didn't know it!

But the days of defined benefit plans are over. Most employers today provide defined contribution plans. They define the amount they contribute to your retirement, usually in the form of matching dollars, and you are responsible for saving a sufficient amount and investing it wisely. Thus employees must amass $1 million for every $43,600 they'll need when they retire.

Want a higher lifestyle? Save $1.5 million and you can spend $65,400 each year. Save $2 million and you can spend $87,200. At $2.5 million you can spend $109,000. So don't think people with a big income don't have to worry about money. Those accustomed to a high lifestyle can find it very difficult to save enough to retire.

All this information leads us to the most important lesson about wealth. You can live rich or you can be rich. Many people live as though saving and investing wealth is wrong. Yet consider the alternative: Is spending every dime you earn virtuous? Isn't it better to produce more than you consume? Isn't it preferable to consume less and therefore have more wealth that you can invest and put to work creating jobs and producing goods? After all, the economic definition of capital is deferred consumption. Can you put off spending or decline to consume long enough to create investment capital that creates factories, businesses and jobs so others can benefit?

Consider two families with identical incomes. Family A lives rich, buying high-definition TVs, indulging in luxurious vacations, dining out frequently, and so on. Family B chooses to save and invest instead. Which family is wasteful and addicted to wealth, the family that is living rich or the one that is growing rich?

Family B may live simply and modestly below their means during their entire working careers. Amazingly, for every $100 a month they save and invest at 10%, they will have $1 million more when they retire. The two families may have the same income, but Family A spends $250 each month on a richer lifestyle and Family B retires with $2.5 million in assets. Interestingly, one of them we encourage, help and support and one we envy, tax and ridicule.

The members of Family A who have lived rich will have no assets at retirement and will further strain the Social Security and Medicare systems. We perceive them as the truly needy when in fact they have lived life as the truly greedy. They could have taken care of themselves, but instead they burdened society simply by ignoring their retirement.

To add insult to real societal injury, these same people often claim they just don't care about money. They are above amassing wealth and instead just live to enjoy themselves. If they truly were indifferent about money, however, they would be able to live on 15% less than their take-home pay and save and invest the difference.

A couple we know just retired with $2.5 million after working and earning quite modest salaries. They lived simply and practiced frugality. Nothing was wasted. They waited a few years before purchasing the latest technological gadgets and then bid for them on eBay. They made do or did without. They grew rich by shopping at sales and avoiding impulse buying on credit.

Now that they have managed to save $2.5 million, however, some of the presidential candidates have suggested increasing the tax on investment gains to 28%, rather than taxing the consumption of those living rich. That will mean if your investment assets earn an 8% return, you will be unable to make any progress toward your goals. Five percent of your return will just keep up with inflation, and you will owe 2.24% for a 28% capital gains tax. You would only be left with a 0.76% real return after taxes and inflation.

We won't be able to help the truly needy until a majority of Americans realize they are part of the problem. People's failure to save for their retirement stresses our governmental programs with those who ought to be multimillionaires. Saving just a few hundred dollars a month over your working career makes the difference.

No matter what your income, a similar family is living off half of your salary and still saving more than 15% of their take-home pay. Another family is earning twice what you earn and struggling to make ends meet. Nearly every family we work with wishes they had an extra $10,000 a year to make life easier.

Because of inflation, the gap between the rich and the poor is growing. If $5 million today is less than $1 million in 1970, the absolute dollar difference between the rich and the poor has to be at least five times greater. The poor always have zero.

Greg Mankiw, a professor of economics at Harvard, offers an interesting analysis (gregmankiw.blogspot.com): "If we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. Let's take the adjustments one step further. Richer households are larger--an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1."

That's the difference. The richest 20% in America live 2.1 times more extravagantly per person than the poorest 20%.

Another study by Steven Landsburg shows that leisure used to be evenly divided among the classes, but it isn't any longer. Although Americans as a whole have an extra four to eight hours of leisure per week (or about seven extra weeks of leisure per year), this extra leisure has not been gained evenly. About 10% have no more leisure than they did in 1965. These hard workers, it turns out, are highly educated and have had the largest gains in income. At the other extreme, about 10% have gained 14 hours a week or more (over 18 extra weeks of leisure per year). These excessive gains in leisure have gone, oddly enough, to those who are the least skilled, least educated and have the most stagnant incomes.

It used to be the leisure rich or the idle rich. Now it is the working rich and the idle poor.

Many believe it is OK to redistribute income but would consider it absurd to redistribute leisure. It turns out there really is little difference.

Decide to be rich. Your retirement, and the country's welfare, depends on it.

from http://www.emarotta.com/article.php?ID=278

Ignore Daily Financial Noise (2008-03-31)

by David John Marotta

Investors are fickle. Investing should not be.

Even with a brilliant investment plan, it takes diligence to overcome emotional biases and avoid making investing mistakes. Naturally you love it when your portfolio values go up. But when they go down, even slightly, you may be tempted to make poor choices. Here are some reminders to help you resist succumbing to the fallacies of behavioral economics.

Psychologists suggest we feel a loss about 2.5 times as much as an equivalent gain. This "loss aversion" phenomenon means that even we see an equal number of ups and downs, we still feel miserable. Daily market movements are nearly always noise. Only 52% of daily movements are positive. Because the negatives feel worse, your average day could feel 68% negative. Quarterly odds of satisfaction are 62% but still feel 13% negative. But if you discipline yourself to look at annual numbers, you get 77% odds of happiness, and when you analyze 3-year, 5-year, or since-inception returns on your reports, it will make you even happier.

You may believe you have a high risk tolerance when the markets were going up, only to regret being in when they go down. You also remember your uneasy feelings just before the markets dropped and forget you had the same ones just before the markets went up. All this leads to a false confidence in your own ability to predict what will actually happen and possibly a weakening confidence in your financial advisor's skills to see the obvious.

Research repeatedly shows that jumping in and out of the markets reduces returns. But some people persist in believing that if they just had enough information, they could predict what, in reality, only seems obvious after the fact.

Remember to ignore daily financial information. Most so-called news is just noise; we call it financial pornography, which includes everything from CNBC to the nightly news.

The markets are inherently volatile, but until recently they have been well behaved. Between 2004 and 2006, the S&P 500 moved up or down by more than 2% on only two days. Since mid-2007, we have had 27 days over 2% and market volatility has returned to historical averages. Between 2004 and 2006, the S&P 500 moved a daily average of only 0.51% compared with a historical average of 0.75%. Since mid-2007, volatility has been slightly above average at 0.99%. You must remember that such volatility is normal.

Every January 1, sometime during the year we will have a foot of snow in a week, 6 inches of rain in another week, and a 5% to 10% market drop in one month. It is almost beyond commonplace. But the snow always melts, the rain dries up, and the equity market resumes its great long-term uptrend.

The markets are inherently volatile but also inherently profitable. It is prudent to diversify for safety and stay invested for long-term growth. So although we don't know the markets won't go lower (no one does), don't let your short-term emotions trump an effective long-term strategy. Remember that strong long-term investment returns do help, but the best way to achieve your financial goals is to moderate spending and stay on track with savings.

You can resist the temptation to overgeneralize or to succumb to the random noise with these two simple rules. First, a diversified asset allocation with a fiduciary financial advisor sitting on your side of the table ensures the best chance of meeting your goals. And second, don't forget to relax and enjoy life at least 364 days out of each year.

from http://www.emarotta.com/article.php?ID=277

Gold Mining Companies Glitter More Than Bullion

Last week gold broke $1,000 an ounce. Gold advertisers and gold investment newsletters are touting their wares as though gold only goes up in value. Nothing could be further from the truth. Gold may glitter, but it is still better to own the mine.

Keep in mind that investing in hard asset stocks is not the same as investing directly in commodities. Buying gold bullion or a gold futures contract is an investment directly in raw commodities or their volatility, whereas buying a gold mining company is a hard asset stock investment.

Over time, dollars lose their buying power, and the goods and services we buy cost more. Commodities as an asset class generally maintain their buying power in terms of dollars. Stocks as an asset class, in contrast, generally appreciate over inflation after factoring in dividends. And recently, hard asset stocks such as precious metal mining companies have been appreciating nicely.

Jeremy Siegel, author of the book "Stocks for the Long Run," analyzes investments over the past 200 years. Gold, on average, maintains its value over time. If you bought a dollar's worth of gold 200 years ago, after adjusting for inflation, it would be worth $1.07 today. Because of inflation, a dollar today would only have had the buying power of about 7 cents back then! However, the stock market, on average, has been appreciating about 6.5% over the long-term rate of inflation. Hard asset stocks give you the best of both worlds: the stability of a real asset plus higher market returns.

The beauty of hard asset stocks is that they are not highly correlated to U.S. large-cap stocks as a whole. The correlation between the Goldman Sachs Natural Resources Index and the S&P 500 Index is only 0.49. Importantly, the correlation between the Goldman Sachs Natural Resources Index and the Lehman Aggregate Bond Index is even lower at –0.26. A negative correlation means that bonds and natural resources, as separate asset classes, are often moving in opposite directions. Balancing a bond portfolio with hard asset stocks can help hedge the risk that inflation poses to a bond portfolio.

Natural resource companies sell valuable tangible commodities. Thus their earnings are tied to inflation because their resources are worth more as the dollar declines in value. This situation can occur in times when the supply of money and credit is increased to fund government spending and budget deficits.

Consider a gold mining company in 2001 whose expenses and overhead allowed it to pull gold out of the ground for $290 per ounce and sell it for $300 per ounce, making the company a $10 per ounce profit. As the price of an ounce of gold rose 3.3% from $300 to $310, the company's profit doubled from $10 an ounce to $20 an ounce--a 100% jump--which caused the company's earnings and stock price to soar. Now that gold is more than $1,000 per ounce, the current price level of gold stocks is much higher than it was in 2001.

Therefore, we segment hard asset stocks into their own asset class because they have a unique set of characteristics. First, the movement of hard asset stocks generally correlates less with the movement of other asset classes such as bonds. Second, hard assets react in a unique (and positive) way to inflationary pressures. And third, in certain periods in the longer term economic cycle, including hard assets helps boost returns.

Direct investments in gold react a little differently, however. The correlation between the price of gold and the S&P 500 is nearly zero, lower than hard asset stocks at –0.02 instead of 0.49. But the correlation between the price of gold and the Lehman Aggregate Bond Index is also nearly zero at 0.09 instead of –0.26. In truth, the price of gold does not fluctuate with investments because it is simply holding its value.

But although it is true that gold generally holds its purchasing value, it still fluctuates wildly based on other factors of supply and demand. While it does so, the part of these movements that is not just random noise is simply an inverse reaction to the value of the dollar.

In January 1980, gold reached its high of $850 an ounce. The following year my wife and I became engaged and chose modest wedding rings that were still very expensive. Note that $850 in 1980 had the same buying power as $2,184 in today's dollars. Gold trading at $850 an ounce then was like gold trading at more than twice its current price. Those people who purchased gold in 1980 have lost over half their buying power during a 28-year investment.

In August 1998, gold reached its low of $356 an ounce. So those who had invested 18 years earlier at $850 an ounce had lost 79% of their purchasing power. By 1998, an ounce of gold should have been worth $1,682 just to keep up with inflation, but instead it had dropped dramatically.

A small percentage of your portfolio should be in precious metal mining companies. It provides a balance to your portfolio that you cannot gain by investing directly in gold.

Here are three mutual funds we have used for investing in precious metal mining companies. We look for a low expense ratio, a turnover ratio of under 50% and returns that capture the lion's share of the sector's returns.

Vanguard Precious Metals and Mining (VGPMX) earned 36.13% during 2007 and has had an annualized return of 35.28% for the past five years. It is up 12.74% for the first two months of 2008. It has an expense ratio of 0.35% and a turnover ratio of 24%. Although closed to new investors, VGPMX is probably one of the best funds.

U.S. Global Investors World Precious Minerals (UNWPX) earned 23.02% during 2007 and has had an annualized return of 36.66% for the past five years. It is up 15.05% for the first two months of 2008, with an expense ratio of 1.01% and a turnover ratio of 54%.

American Century Global Gold (BGEIX) earned 15.12% during 2007 and has had an annualized return of 20.53% for the past five years. Although it underperformed relative to other funds last year, it is up 16.52% for the first two months of 2008. It has an expense ratio of 0.67% and a turnover ratio of only 3%.

Because of the negative correlations, our firm uses these investments and others in this sector for a small percentage of a balanced portfolio. Diversified and negatively correlated investments can help your portfolio maintain its equilibrium when the U.S. markets are losing money.

from http://www.emarotta.com/article.php?ID=276

Life Insurance: Determining Your Need

You may have heard that "Life insurance is a gift of love." But if you bought a $100,000 whole-life policy because you wanted to build some cash value when you should have bought a million dollars of low-cost term insurance to meet the survival needs of your family, your well-intentioned effort was not an act of love.

Objective life insurance advice is hard to find. Prior to joining the National Association of Personal Financial Advisors (NAPFA), Bob Arms, CLU, ChFC, AIF®, coauthor of this week's column, sold life insurance for 26 years. He is currently licensed as a life insurance consultant, a fiduciary whose legal obligation is to represent the client first.

The first step toward representing your best interests entails an in-depth discussion of how much life insurance you might or might not need. The formula is Future Financial Needs minus Current Assets equals Your Current Risk. How much you want to provide for your loved ones should you predecease them (A) minus how much you have that could be used to provide for the survivors (B) equals your surplus or shortage (C).

To the extent that a gap exists between your financial needs and your current assets, life insurance is the most efficient product available to provide tax-free dollars exactly when you need them. As you go through the life changes of marriage, children, and career, you should recalculate your need and revisit the life insurance you own.

When members of a young family are making a decision about life insurance, six line items are significant.

1. Debts: The baggage of debt makes the journey toward financial success difficult. Avoid debt if possible, but if you have any, don't burden your family with it after you are gone. Being able to liquidate all credit card debt and car, home equity, and personal loans will give your surviving family the best chance at success in life.

2. Mortgage: Carrying a long-term fixed-rate mortgage keeps more money invested in the markets and qualifies you to enjoy a tax deduction on the interest. Leverage is a popular financial strategy of the rich. But if you would sleep better at night without a mortgage, sleep is more important. Either way, you need enough insurance or investments to pay off the mortgage.

3. Educational and child-care expenses: Depending on the age of your children, multiple expenses must be considered. If your children are preschoolers, the cost of child care may make it impractical for the surviving spouse to return to work. Consider the math. When the children are school age, will you want them to attend private school? Call the schools in your area and work the numbers. What percentage do you want to help with college? In-state tuition, room, board, books and transportation for college presently averages $6,185 annually. Private schools cost about $23,712 per year. Which do you want to fund?

4. Final expenses: Include a small amount for your funeral, approximately $10,000. The average funeral today costs $5,000 to $7,000, but expenses can exceed $10,000.

5. Family income: Estimating a young family's income needs is very challenging. To ease the mental strain, use seven times your adjusted gross income as a rule of thumb. A more accurate prediction requires either a financial calculator or a computer program.

6. Emergency fund: No one can forecast the exact amount a surviving family will actually need, but this category does absorb a potential miscalculation. Most gaps are filled by using 10% of the total of the other five line items: debts, mortgage, education, final expenses and family income.

Now that you have an estimate of how much your family needs, compare the total with your current assets. Include only the assets the surviving spouse can use for expenses. So do not include your house because your spouse needs someplace to live; your car because transportation is essential; or your retirement assets, which the surviving spouse will need during retirement. Nor should you count any inheritance. The old adage is true: Don't count your chickens before they hatch. This category is the total of your current life insurance and all investment assets.

The easiest math remains: Your Total Future Financial Needs minus Your Current Assets equals The Current Risk you may want to insure against. To determine how much life insurance the other spouse should carry, trade places as the first to die and rerun the numbers. Clearly, if the bottom line is positive, you've done something right and either you have enough life insurance or you are self-insured. Congratulations. If the bottom line is negative, thankfully you still have time to take action.

Financial planning is a lifelong process that covers multiple areas, including investments, insurance and taxation. Reviewing all of your financial affairs periodically with a trustworthy advisor who sits on your side of the table will ensure that you achieve your financial goals.

For more information about life insurance--how to shop for it, what to buy, what to do with what you have or other questions--you are invited to attend the NAPFA Consumer Education Foundation meeting. Bob Arms, CLU, ChFC, AIF®, will present a talk, "Straight Talk about Life Insurance," on Saturday, March 22, noon to 1:30 p.m., at the Northside Library in the Albemarle Square shopping center.

For more information, call (434) 244-0000 or e-mail charlottesville@napfafoundation.org. To learn more about the NAPFA Foundation, visit http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm. All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=275

Remember to Fund Your Roth IRA (2008-03-10)

by David John Marotta

If you are eligible, make sure you fund your Roth IRA or your Roth 401(k) this year with the maximum contribution possible. It may be your last chance to pay a reasonable tax rate before the prevailing winds of class envy swamp your retirement sailboat.

Although a traditional IRA and a Roth IRA share some features, they differ significantly in the way they are taxed.

Money put in a traditional IRA comes out of your paycheck before paying taxes, so your contribution reduces your taxable income this year. Traditional IRA investments grow tax free. But you must pay ordinary income tax rates when you take the money out in retirement, on both what you contributed and on the growth in the account.

In contrast, the money you put in a Roth IRA comes out of your take-home pay after you have paid taxes. So your contribution does not reduce your taxable income this year. Like a traditional IRA, your Roth IRA investment grows tax free. But because you have already paid tax on the money, in retirement you won't be obligated to pay any additional taxes.

So you can pay now on what you contribute to a Roth IRA, or you can pay later on the value that has accrued in your traditional IRA.

The standard wisdom favored funding the traditional IRA. Assuming your tax bracket would be lower in retirement, it thus would be advantageous to avoid the higher tax rate now and pay at the lower rate later. But for many retirees, this advice has proven misguided.

Employees typically contribute to a traditional IRA or 401(k) from the day they start working. Of course their starting salary is relatively low compared with what they earn later in their career. Thus an increasing number of employees find themselves in a higher tax bracket during their retirement than they were when they were contributing to a traditional IRA or 401(k). This phenomenon has produced some strange economic results.

Some workers have lost money, but the government has gained. As people have contributed to their traditional IRAs and 401(k)s, the government has given up a little revenue. But workers have invested that small amount and grown their money, thanks to the magic of compounded returns. Now the government is anticipating a windfall of taxable income as the baby boomers withdraw these investments during retirement.

The good news for the government is that budget projections do not include any of these retirement withdrawals. Thus taxes on traditional IRA distributions should cover about a third of the existing federal deficit.

But it's not your job to help the government get out of debt. Tax rates today are at an all-time low, but the political climate makes tax hikes much more likely in the next administration. Kennedy lowered the top marginal rate from 90% to 70% in 1964. Then Reagan lowered it from 70% to 50% in 1981. And in 2003, Bush lowered the top rate from 39% to 35%. Historically, income taxes have not been this low since 1931. So pay as much tax now as you can and fund a Roth IRA rather than deferring your taxes until later when the rates are higher.

As long as you (or your spouse) receive a paycheck, you are eligible to open a Roth IRA. Account owners may contribute $4,000 per year in 2007. Contribution limits rise to $5,000 in 2008. All account owners age 50 and older are permitted an additional catchup contribution of $1,000 annually.

Unlike a traditional IRA, you are not obligated to begin required minimum distributions at age 70½. As a result, a Roth IRA can help fund the end of your retirement.

And if the tax benefits of a Roth IRA aren't enticing enough, the estate-planning benefits are amazing. Leaving a Roth to your heirs can be likened to setting up a lifetime tax-free stream of income. Because Uncle Sam has already taken his cut of the principal when you put the money in, withdrawals can be made tax free, either by you or by your beneficiaries.

With a traditional IRA, you must begin distributions at age 70½, whether you need the cash or not. But when you do this each year, you put the brakes on the snowball effect of compounding interest. Plus your required withdrawals deplete the account, making it difficult to control what you actually leave to your beneficiaries.

A Roth can help you keep more of your money by sheltering your investments from capital gains and from minimum distribution requirements during your lifetime. Spouses who inherit a Roth can also forgo taking distributions, preserving the account's ability to grow unchecked year after year.

Only when members of the next generation inherit a Roth IRA must they begin taking distributions, and then they are withdrawn based on the beneficiary's age. By taking the smallest required distribution each year, the beneficiary achieves the maximum tax-free growth of tax-free income.

No traditional IRA can offer that kind of benefit to your heirs. If they were to inherit a traditional IRA of equal value to a Roth, the former would run dry long before the latter. The required minimum distributions for a traditional IRA are based on the original owner's age, not the beneficiary's, so required withdrawals are larger in the next generation. Also, because taxes are due on withdrawals from a traditional IRA, larger amounts must be taken out to match the tax-free sums taken from the Roth. Those hefty withdrawals from the traditional IRA eventually drive it to zero. Meanwhile the Roth account would still be growing and withdrawals could continue to be made.

If you already own a regular IRA, you may have the option to convert it to a Roth. You pay taxes now so your beneficiaries won't pay later. Even if you inherited a traditional IRA from your spouse, it is still not too late to convert to a Roth.

Converting may be a smart move, especially if you plan on leaving more than $2 million to your heirs. Paying taxes for the conversion will mean you reduce the size of your estate and thus its tax liability. Your heirs will pay less estate tax, and they will inherit a tax-free income stream.

The option to convert to a Roth currently is limited to those with an AGI less than $100,000. If your income exceeds that number, current law does not allow Roth conversions to all Americans until 2010. By then, significant tax hikes may have been implemented.

A Roth in itself cannot provide a complete answer to your estate-planning needs. Seek the advice of a financial planning professional who can provide you with a comprehensive financial plan. To find a fee-only financial planner in your area, visit <a href="http://www.napfa.org" target=blank>www.napfa.org</a>.

from http://www.emarotta.com/article.php?ID=274

Loss Aversion (2008-03-03)

by David John Marotta

Even with a brilliant investment plan, it takes diligence to overcome our emotional biases and avoid making investing mistakes. Here is the wisdom that both advisors and investors need to bear in mind to avoid succumbing to the fallacies of behavioral economics.

It doesn't take extensive research to determine that we are much happier when our portfolio values go up. When they go down even slightly, however, we are tempted to make poor choices. To avoid these unfortunate choices, we need reassurance and a sense of how our instincts can deceive us.

The tendency to experience significantly more discomfort with slight losses than to experience happiness with large gains is called "loss aversion."

Psychologists suggest we feel a loss about 2.5 times as much as an equivalent gain. That means if you see an equal number of ups and downs, you feel miserable. You feel some pleasure when the markets move up and a great deal of pain when the markets move down. But most of the daily and weekly fluctuations in the markets are just random noise.

Therefore, the more frequently you look at the markets, such as daily or weekly, the more discouraged you get. And even if you have a well-crafted investment strategy, you may be tempted to make changes in order to alleviate your suffering. Every study shows that loss aversion actually causes greater than average losses.

Consider that over the past decade, the daily movement in the markets was positive only 52% of the time. That means if you watched the markets every day, you were content on 190 days and despondent on 175 days. Because you grieve the down days 2.5 times as much as you celebrate the positive ones, on the average day you're glum, and instead of remembering the reality that the markets dip 48% of the time, you feel as if they go down 70% of the time.

If you only look each week your odds of happiness rise slightly to 54%, but your misery remains low, still feeling like they go down 68% of the time. The monthly odds of happiness are 62%, but you still like they go down 64% of the time. Quarterly returns go up 68% of the time, but your average emotions tell you they only go up 55% of the time.

Even though the vast majority of calendar quarters in the market are positive, it is the shortest time period in which, on average, we won't be disappointed. Only if you can refrain from looking at the markets for an entire year, will you be more likely to feel satisfied. Annually you get happy news 77% of the time, although you only perceive it as 62%.

These are the best case scenarios, assuming you have an outstanding investment plan. You may feel much worse whether you have a poorly designed portfolio or a well-designed one. Here’s why.

A poorly designed portfolio is typically laden with fees and commissions, putting a drag on your returns. It may also be inadequately diversified and oscillating with an even higher noise-to-performance ratio than necessary. In this case, your odds of happiness are slim indeed.

But even if you have a well-designed portfolio, your may feel unsettled. Being diversified means always having something to complain about. You must recognize the difference between a poorly designed portfolio and a well designed portfolio. You must know when to heed the warning signs and when to ignore the noise.

If you own a handful of mutual funds that are commission-based A, B or C shares, you probably have a reason to be discouraged. If that is the case, first set a diversified asset allocation that has the best chance of meeting your goals with a fiduciary financial advisor who sits on your side of the table. And second, relax and enjoy life 364 days out of each year.

from http://www.emarotta.com/article.php?ID=273

by David John Marotta

I've decided to run a mock campaign for president again as a forum to talk about public policy. Every four years I look for a candidate who understands economics, only to find politicians instead. My political bias, like many economists, leans toward freedom. The unintended consequences of much of our legislation result in great harm to the economy and to people's livelihood. If elected, I promise to do less harm.

Lots of polls are out there supposedly to help us choose a candidate. I hate them all. They inevitably ask a battery of two dozen questions dealing with issues I don't care about and only vague questions about the ones I do. As a result, these polls are as useful as recommending I vote for a candidate because we like the same flavor of ice cream.

From helping people from all walks of life with their family finances, I've discovered that the most successful people recognize that their financial future mostly depends on actions under their own control. The best way for people to achieve their financial goals is to moderate spending and stay on track with a savings plan.

The issues I consider of primary importance are those that interfere with everyday families becoming self-sufficient. Unfortunately, these are not the issues that voters seem most passionate about. But they should be. Issues such as the capital gains rate determine if we will be able to save toward retirement or not.

Saving and investing just a dollar a day over your working career produces $400,000 at retirement. Saving $2.50 a day produces $1 million at 11% after 45 years. Obviously, most families don't save at all. They are struggling because of the choices they make. Financial planners encounter this problem so often, it's been dubbed "the latte effect." People spend $2.50 a day on lattes rather than becoming millionaires.

Being a good citizen means first and most importantly to produce more than you consume. This will ensure you can take care of yourself. It will also mean you can be charitable and give to the truly needy. You, however, are not the truly needy. Odds are there are people getting by just fine earning half of what you bring home. Don't succumb to envying those who make more than you. At the same time, embrace the virtue of compassion for those who make less.

The previous few generations did not accrue much in savings, but they did have defined pension plans for their retirement. A pension paying $75,000 a year is equivalent to having a $1.7 million portfolio for your retirement. As we all know, however, the days of defined benefit plans are largely over. We need to grow our savings to more than $1 million simply to fund a modest retirement. The government can help us reach that goal by eliminating the capital gains tax.

Every economist worth his PhD agrees that the correct rate for the capital gains tax is zero, zip, nada. Some have even suggested the optimum tax rate for capital gains is negative! Unfortunately, all the 2008 presidential hopefuls (except for me) who would reduce or eliminate the capital gains tax have dropped out of the race.

Certain proposals regarding the capital gains tax are totally unrealistic. Some would like to impose ordinary income tax rates on capital gains; others want to raise the rate to 28%. Many people divide the nation between those who have an adjusted gross income over $75,000 and those who do not. All of the suggestions just described will dissuade Americans from saving and investing, the very activity we should be encouraging.

Under these rules, if your investment assets earn an 8% return, you will be unable to make any progress toward your goals. Five percent of your return will just keep up with inflation, and you will owe 2.24% for a 28% capital gains tax. You would only be left with a 0.76% real return after taxes and inflation. And at ordinary income tax rates, your return would be even more dismal. At these rates, everyone with taxable investments in the market would do better to pull their money out and buy municipal bonds and Treasuries.

Hopefully there isn't a chance these policies would be implemented, but I use a candidate's views on economic matters to judge his or her competence. I find this year's choices particularly discouraging.

We need an incentive to save and invest in order to create an economic environment that encourages the hard work and risk taking that pays everyone's salary. Investment is simply capital, and capital is simply deferred consumption. Why defer consumption if you are penalized for it?

Investment is what builds the factories, businesses and entrepreneurial endeavors that actually make money. Investment stimulates the economy, and as the economy grows, jobs are created and real wealth is produced.

The prospects for our Social Security system look bleak. There won't be enough money to support the number of retirees. Chances are only the worst off will receive anything significant from current funding. Now the political winds are blowing to make saving and investing for your own retirement much more difficult. It seems as though "fair" is being redefined as everyone being impoverished and reliant on the government.

Without incentives, we may as well all go have another latte.

from http://www.emarotta.com/article.php?ID=272

Last week we discussed the many ways you can save money as you learn to live on your own. Our suggestions included sharing housing costs, buying a previously owned car with cash, preparing meals instead of eating out, and eliminating the frills from services that are deducted automatically each month from your checking account. Here we offer some sound advice on how to put that money you've saved to work for you.

First, look carefully at your company's benefits plan. Disability insurance is probably the most neglected insurance. Consider signing up through a work plan. More employers are implementing health savings accounts, which allow you to pay for your medical expenses with pretax dollars. They are coupled with a high-deductible health insurance plan. If you are young and healthy, these provide you with disaster insurance as well as health-care insurance savings. If your employer has one, put the maximum away annually, and invest it if possible.

All the pundits say, "Save as much as you can," which is fine advice but not specific enough. You need to take a substantial chunk of change out of your discretionary money each month, some before it even makes it to your checking account and most of it after you deposit it. The amount, about half your take-home pay, may seem excessive at first, but remember, you are trying to grow rich, not live rich.

As your first priority, get the benefit from your company's 401(k), which usually amounts to contributing 5% of your salary while your employer matches with another 4%. This is the portion we mentioned that's deducted before you ever see a paycheck. If your employer has a health savings account, the money you contribute will also come out before your collect your paycheck.

After these deductions, you probably have the remainder of your paycheck deposited automatically into your checking account. You should then automate a transfer out of your checking account into an investment account to meet many of your long-term financial goals. Money in your investment account will appreciate. Always keep your goals in mind and stay on track.

For example, make a list of all the big-ticket items you will need to pay for over the next several years. You need to pay your car insurance. Transfer the appropriate monthly amount to your investment account. You should be saving for your next car. Transfer the appropriate monthly amount to your investment account. All of these significant purchases may comprise around 10% of your take-home pay.

You should be fully funding your Roth IRA while you are young and in a relatively low tax bracket. For 2008, to meet the $5,000 limit for your Roth IRA, you need to save $416 a month. Put this money into your investment account and then transfer it once a year to a Roth IRA account.

Save 5% of your take-home pay in a taxable account allocated for your retirement. This is after fully funding your 401(k) match and your Roth IRA. There are times in life when you will need taxable savings, and you should be saving and investing 5% of your take-home pay.

Save and invest 10% of your take-home pay for charitable giving. As your investments earn money for you, you will give appreciated assets to the charity and replace the same dollar amount from your take-home pay. Donating appreciated assets provides an additional 15% tax savings.

Finally, as a margin of safety, save and invest 10% of your take-home pay to help cover the cost of unknown unknowns. If your first response to this suggestion is to ask, "Like what?" the answer is "Exactly." Most people who run up credit card debit keep their regular spending within 100% of their take-home pay until some unexpected expense causes them to deficit spend. You can't anticipate unknown unknowns, so the best you can do is set aside some money to cover them when they arise

All of these expenses can easily comprise half of your take-home pay. Even if you've landed a good paying job straight out of school, don't spend over half of your take-home pay on daily expenses. Transfer half of your pay directly to an investment account and let it start growing. Cash in the bank is the best financial security. Cash doubling in an investment account is the best financial future. By the time you need money from your investment account for some of those long-range purchases, ideally it will have already started earning a nice return.

Saving and investing should be automatic. You won't miss what you don't see. Have half your take-home pay transferred out of your checking account and into an investment account each month.

Live simply. Avoid buying items you have to store, repair and maintain. Produce twice what you consume. Be generous. Avoid liabilities you have to pay each month. Invest in assets that pay you instead. Do these things and you will have a peace of mind that your contemporaries may never find.

from http://www.emarotta.com/article.php?ID=271

Learning to Live on Your Own, Part 1 (2008-02-11)

by David John Marotta

If you're like most of today's college graduates, you may find yourself ill prepared for the real world of financial responsibility. You never saw how your parents lived when they were first married and struggling. Consequently, you may be basing your after-school expectations on an upper-middle-class lifestyle. Here is my financial advice for those of you learning to live on your own.

My own financial education began when I was very young. My parents shared openly with us about the cost of running the household. I learned our home mortgage was $12,500, or about half the value of the house, and the interest rate on the loan was 4.5%. I knew my father's annual salary ($7,500) and that a week's worth of groceries cost $20 for a family of five.

Although you have to count on spending about 6.58 times more than that today, the principles of proportional living I learned are still the same: You can look like you are rich or you can actually become rich by saving and investing. Wealth is what you save, not what you spend. So be rich. Live frugally, and learn to save and invest.

The people who are struggling financially buy things and clutter their homes with them. The middle class buy liabilities such as boats and vacation homes and must spend money every month to maintain them. The rich, in contrast, buy investments. An investment is anything that pays you money.

Now that you are learning to live on your own, learn to live like the rich. The frugal millionaire enjoys both financial security and peace of mind. Living well within your means is a skill you may not have picked up from your parents or in school. Rather than learning from the so-called school of hard knocks, consider the following suggestions.

Rent is probably your biggest expense, but keep it well under 20% of your take-home pay. To lessen the impact, share your living quarters with roommates. If you learned nothing else in college, you at least found out how to share a room. Later on, when you get married and want your own place, you'll need the money you can save and invest now.

Whoever actually signs the rental agreement or lease and pledges to pay the rent on time each month deserves a better financial deal. That person should be able to charge his or her roommates more and also get first pick of the rooming options.

If you decide to live in a house or apartment and sublet, make sure to factor in the possibility that a roommate may leave without notice, owing you rent. Insist on a sublet agreement that requires the first and last month's rent to lessen the impact.

Your car ranks as your number-two expense. Again, keep total costs well under 18% of your take-home pay. With the salary at your first job after college, you probably can afford to make the payments on a trendy new car. Don't. Expensive cars increase both your insurance and your maintenance costs.

Be practical. Your car is a means of transportation, not a lifestyle. Buy a reliable car that has low maintenance costs. One that is at least a few years old will have already depreciated the most.

Only buy a car you can pay for with cash. Shun easy credit. The only decision that's worse than buying a depreciating asset is buying that depreciating asset on credit. Paying interest on an asset that's going down in value may buy you a ticket to the poorhouse. Instead, start saving some of your monthly salary immediately for your next car.

After rent and transportation comes buying food. The average family spends 10% of their take-home pay on food. If you don't eat out, you should spend about 6%. When your earnings increase substantially, perhaps you'll be able to justify saving food preparation time and eating out. But until then, the time you spend cooking is well worth it. The calories you purchase at restaurants are about 2.5 times as expensive as those you prepare at home.

For example, if you brown bag your lunch all week, you can easily save $5.40 a day. Saving $27 each week adds up to $1,458 per year. After factoring in the rising costs of eating out and investing your savings in the stock market where they will grow and multiply, the difference to your net worth is amazing. Investing $27 each week will produce $100,000 in 20 years and $1 million in 40 years. Bring your lunch from home starting at age 20, and you'll have an extra million dollars at age 60!

Eating at home isn't the only way to save money. To extend your savings to the grocery store, here are a few commonsense rules that will lead to uncommon cents savings.

For dinners, master a dozen easy-to-prepare meals. If you can read, you can cook. Keep staples on hand to make these meals. Consider a bread machine and a slow cooker as essential purchases.

Plan your meals when you are hungry, but shop right after you have eaten. Shopping on a full stomach will help you limit impulse purchases. Make a shopping list. Buy staples in bulk at super discount stores.

Avoid convenience packaging and expensive processed foods. Try buying the generic store brand. If you don't like it as well as the leading advertised brand, many stores will refund your money. Actually compare the prices. Most stores make the bulk of their profit from products placed at eye level.

You don't have any extra in your budget for monthly services. You have only about 6% more to spend, and the remainder you should be saving and investing. You may tend to ignore the services that are billed automatically each month, but they will be the most serious drain on your finances. So consider getting the least expensive package of features or doing without entirely. These electronic transfers include phone service options, cable or satellite TV, high-speed Internet, and health club dues.

Next week, in the second part of this series on learning how to live on your own, we discuss how best to manage the money you're saving by living frugally.

from http://www.emarotta.com/article.php?ID=270

For Now, Avoid Real Estate Investment Trusts (2008-02-04)

by David John Marotta

I received my county real estate tax bill recently, and for the first time in several years, my property tax assessment went down by about 2.8%. The drop is very small, but the trend is significant. Commercial real estate investments fell sharply during 2007 and may underperform other investment choices during 2008.

Investors commonly purchase real estate through a real estate investment trust (REIT) that buys and manages properties. These are publicly priced and traded, and collections of REITs are available in mutual funds and exchange-traded funds.

Just over two years ago, we warned our readers that real estate prices might be peaking and ready to correct. We wrote, "A bubble is never known until after it has burst. What can be suggested is that the housing prices boom shows signs of weakness, and that they may correct or at least underperform for the next few years. Higher interest rates will slow housing growth in 2005, but the bubble, if it is a bubble, could pop as late as 2006 or 2007."

But getting out of real estate two years ago would have been a year early. It wasn't until 2007 that the Cohen & Steers Realty Majors Index turned negative, losing 18.03%. In fact, the three-year average is still positive, averaging 9.69%, and the five-year average is a whopping 19.79%. In the foreseeable future, however, we are very unlikely to see as much appreciation as the last five-year average.

Most real estate property sectors declined last year. Sectors with longer leases did the best. Health-care leases had a positive total return of 2.5%. The industrial sector of REITs was also positive. Apartments suffered one of the largest declines, down 25.4%. The office sector was also down 19.0%.

Since 2000, U.S. markets have experienced the ripple effects of the tech sector's correction. The latest waves were the slow decline of the housing market and the weakening of the commercial real estate market.

As a result of the 2001 recession, the Federal Reserve lowered interest rates to help stimulate the economy. These new rates created an unprecedented increase in lending activity in everything from refinancing for mortgage equity withdrawals to commercial real estate loans.

Lower interest rates also boosted available credit and the speed at which dollars were moving through our economy, in essence expanding our money supply. Lower interest rates for mortgages drove housing prices up. As interest rates hit historic lows, home buyers could now afford houses that previously were out of their price range. For example, in March 2000, a family with a 30-year fixed-rate mortgage at 8.4% could borrow $131,000 with a $1,000 monthly payment. By the time the interest rates had dropped to 5.4% in June 2003, that $1,000 monthly payment would service a $178,000 mortgage.

Housing prices soon skyrocketed in absolute dollars, but they were not rising as much in terms of monthly payments. Lower mortgage rates, along with a devaluation of the dollar and the resulting higher prices for all hard assets, explain the rise in housing prices over the past several years.

The rising real estate market boosted consumer spending in three ways. First, homeowners--because of rising home values--enjoyed a higher net worth and therefore spent more money. Second, low rates encouraged a huge turnover of houses, resulting in intensified levels of consumer spending as the new owners refurnished and remodeled homes and rentals. And finally, homeowners refinanced or set up equity lines of credit, turning their houses into virtual ATM machines.

As a result of Americans using their homes to finance bigger spending habits, their home equity began to dwindle. Many mortgages grew to exceed 80% of the home's value. Then the Federal Reserve started to raise rates.

Homeowners with adjustable-rate mortgages saw their monthly payments jump. Many found it impossible to stay in their homes. The rate of late payments and foreclosures increased, resulting in some of the lenders themselves declaring bankruptcy. Rising interest rates caused housing prices to fall.

Studies suggest that for every 1% drop in housing prices, the gross domestic product (GDP) could drop by 0.2%. Looking ahead, if falling home prices continue along with a slowing economy, the situation could result in a recession. Declining prices in housing would have a direct effect on company earnings and thus stock prices. If the real estate market does experience a downturn, the effects will continue to ripple through the economy.

More recently, Fed rate cuts have still kept mortgage rates near their low end. But if you haven't refinanced your home with a 30-year fixed rate, this is your last chance. As rates rise, home prices will continue to decline.

Short-term trends are difficult to predict accurately, but with foresight and a sound investment approach, you can still profit from some long-term trends. Diversifying your portfolio across noncorrelated asset classes is the best way to earn steady long-term returns while managing risk.

Investments in REITs are grouped in the hard asset stocks category, but C&S Realty's correlation with the GSSI Natural Resources Index is low at 0.23. Correlations change over time, but they haven't gone above 0.43 in the past three years.

Investing in REITs during normal markets makes a lot of sense, but we suggest you continue to steer clear of them for the coming year. The beta of REITs versus the S&P 500 is currently about 1.68, which means REITs are about 1.68 times more volatile than the movements in the S&P 500.

Perhaps 90% of wealth management is avoiding the financial products and mistakes that surround us and compete for our attention. Real estate may seem attractive with today's choppy U.S. markets, but we suggest you keep your money invested elsewhere until the Fed is done raising interest rates.

from http://www.emarotta.com/article.php?ID=269

Ever since communism collapsed in the early 1990s, stock markets around the world have been booming. This phenomenon is especially true in the former communist states of Russia and China. We also see it in countries that had been following the socialist model, such as India, and in former high-tariff countries like Brazil.

As students of stock markets and world economic trends, we try to determine which countries will benefit from various trends. For example, those countries with the greatest economic freedom and the highest level of gender equality also tend to exhibit superior performance in the stock market.

The World Economic Forum (WEF) conducted a study in 2005. It reported that the 10 best gender-equal countries are Sweden, Norway, Iceland, Denmark, Finland, New Zealand, Canada, the United Kingdom, Germany and Austria. These countries also scored high on the Heritage Foundation's measurement of economic freedom.

In 2006 when the Dow Jones world stock market index went up by only 19%, the stock markets of these 10 countries advanced 31.4%. Furthermore, in the Nordic countries, stocks went up 38%, twice the world average. In contrast, the United States advanced by only 19%.

In the WEF study, the United States did not fare too well in gender equality, coming in at number 17. Ranked 11 through 16 were Latvia, Lithuania, France, the Netherlands, Estonia and Ireland. The health factor dragged down the U.S. showing. Negative factors included the high number of teen pregnancies, only 12 weeks of unpaid maternity leave, high child mortality rates and the lack of quality child care.

Tax rates affect gender equality. Because of the marriage penalty in the U.S. tax code, a financially successful husband and wife are taxed as though they represent one very high income taxpayer. They must pay more for their combined income than they would if they were unmarried and just living together.

This tax disadvantage doesn't often affect the decision to get married. But it certainly may impact a wife's willingness to work. The incentive is to spend time shopping and preparing elaborate meals even if the wife's abilities could support much higher aspirations.

By combining their incomes, the couple pushes each other into the top marginal tax bracket. So for every dollar the wife earns, she could be taxed at over 50%, including federal, state and local taxes. In contrast, when the woman doesn't earn an income, every dollar the couple saves makes them a dollar richer.

Here's the bottom line. The flatter the tax system, the less it matters whether couples combine their incomes or not. That is, if every dollar of income was taxed the same and there were no deductions or credits, whether a husband and wife combined their incomes would be irrelevant.

The WEF study also rated other items related to women. These included their economic participation in society, economic opportunity, political empowerment, educational attainment and health and well-being. Americans are proud of the relatively high number of women serving in the U.S. Congress (85). But that participation rate is still 1% below the world average as measured in a WEF study of 58 countries. And it is well below the top-10 countries in the study. In fact, in the Nordic countries, 41% of the officials elected to the parliament are women.

Japan scored particularly poorly in the 128-country study, ranking 91. It suffered a 4.23% loss for 2007 and pulled the foreign EAFE index down to only 11.17% for the year. Japan has only averaged 4.48% over the past decade. It has struggled internally with both gender inequality and government regulatory intervention in the free markets.

In less developed countries, women have difficulty securing credit to start or expand businesses. You need a little money to make money. Often very small loans allow women to become entrepreneurs and pull themselves out of poverty. To facilitate this, many organizations have started giving small loans, called "micro loans," aimed at women-owned start-up businesses in developing countries.

It has been observed that loans to women more often benefit the entire family than loans to men do. Also, women are a better risk for micro loans, and providing them credit changes their societal status and offers them greater economic freedom.

A number of the countries ranked high in gender equality have exchange-traded funds (ETFs) that track their market indexes. They provide an easy and inexpensive way to invest there. ETFs combine the liquidity of individual stocks with the diversification of an index fund. They also typically have lower expense ratios than most mutual funds.

Democratic countries provide equal incentives for both men and women. As a result, women are able to participate as fully as possible in the economy. When women can pursue and achieve their own financial well-being, we see rich rewards in their country's economy and consequently the performance of their stock markets.

from http://www.emarotta.com/article.php?ID=267

by David John Marotta

A valuable exercise this time of year is to review your investment returns to analyze what occurred in the broader asset classes. First, check to see if your specific investments are capturing a majority of the potential market return of their asset class. Second, evaluate whether your asset allocation is optimized to balance risk and return.

The fourth quarter took away many of the gains in the U.S. markets. The S&P 500 broke a record on October 9 and then fell about 7% to end the year up 5.49%. The Dow and NASDAQ showed similar trends.

The S&P 500 ended the year up 5.49% and the Lehman Aggregate Bond Index up 6.97%. U.S. bonds beat U.S. stocks. Average investors often have a majority of their assets in U.S. large-cap stocks such as the S&P 500 with a small helping of U.S. bonds, even though these categories represent only two of the six asset classes they should be using.

Evaluate your specific investment choices against the index returns. For example, the Vanguard 500 Index Fund (VFINX) had a return of 5.39%, losing only 0.10% of potential market return, even though it has an expense ratio of 0.18%. An even better selection was the iShares S&P 500 Index Fund (IVV), which had a return of 5.43%, losing only 0.06% of the potential market return even though it has an expense ratio of 0.09%. Both of these funds performed slightly better than the S&P 500 Index before expenses and slightly worse than the index after expenses.

Compare the return of each of your funds with the return of an appropriate asset class index to see how much market return you lost to poor fund choices and how much you lost to high expense ratios. Every fraction of a percentage does make a difference.

Then evaluate your asset allocation against the entire domain of potential asset classes. Asset allocation is the most significant investment decision you will make. It is  even more important than selecting the best managed funds within an asset class.

Steady returns are an essential part of meeting your financial goals. Imagine two investment choices. Choice A returns 30% the first year and nothing the second year, for a total return of 30% over two years. Choice B returns nothing the first year and 30% the second year for the same 30% over two years. It seems as though no static asset allocation can do better than 30% over two years. But this isn't true.

<table border=1><tr><td align=center valign=top>Investment</td><td align=center valign=top>Year 1</td><td align=center valign=top>Year 2</td><td align=center valign=top>Total Return</td></tr><tr><td align=center valign=top>Choice A</td><td align=center valign=top>30%</td><td align=center valign=top>0%</td><td align=center valign=top>30%</td></tr><tr><td align=center valign=top>Choice B</td><td align=center valign=top>0%</td><td align=center valign=top>30%</td><td align=center valign=top>30%</td></tr><tr><td align=center valign=top>A + B</td><td align=center valign=top>15%</td><td align=center valign=top>15%</td><td align=center valign=top>32.5%</td></tr></table>

If you split your investment evenly between A and B, you will earn 15% the first year and 15% the second year. By compounding 15% the first year with 15% the second year, you will have a total gain of 32.5% over two years. You'll profit from the magic of compounding when you rebalance your investments after the first year and take some of the profit from A and move it to B. An even asset allocation between these two choices not only smooths returns, it actually boosts them. Particularly in volatile markets, periodic rebalancing can help.

The S&P 500 5.49% and the Lehman Aggregate Bond Index at 6.97% did not appear to provide much difference in potential returns in 2007. Most investors' asset allocation is built from these two categories, but they represent only one and a half of the six asset classes we recommend.

Economists are wary about a U.S. recession, and thus it makes sense not to invest exclusively in the market of a single country. But predicted recessions often fail to materialize. It is unwise to get out of the markets entirely. The markets are inherently risky, and unless you can time them within six weeks of a top or bottom, it is usually better to stay fully invested. But staying invested does not mean staying invested exclusively in U.S. large-cap stocks.

Including a healthy allocation to foreign stocks would easily have boosted your returns in 2007. The international EAFE index gained 11.17%. Freed from Japan's 4.23% loss, the 10 countries with the most economic freedom soared 19.97% for the year. And emerging markets produced a 39.39% return.

Investing in the S&P 500 index primarily represents large-cap growth stocks in the industries that did well last year. Broader indexes include more mid- and small-cap stocks.

Stocks with a smaller capitalization typically have better returns than large-cap stocks. Large-cap stocks have a capitalization greater than $8.5B. Small-cap stocks have a capitalization under $1.4B. Mid-cap stocks fall in between.

Small cap and value usually have better returns, but they didn't last year when small and value fared worse than large and growth, with small-cap value losing 8.15% compared with the 12.34% appreciation of large-cap growth. But over the past five years small-cap value is still ahead, averaging 16.43% annually versus large-cap growth's 10%.

We recommend leaning toward small and value even though large and growth did better this past year. Generally speaking, large and growth outperform small and value at the end of a bull market. Coupled with a slowing U.S. economy, this is another warning of a possible recession. Value stocks on the whole do better during market downturns, so we recommend staying invested in them.

Although U.S. bonds did well, foreign bonds did better as the value of the U.S. dollar continued to diminish. Having at least half of your assets outside the reach of a falling dollar protects you against currency devaluation. Unhedged foreign bonds, foreign stocks and hard asset stocks offer you some protection against a falling dollar.

Finally, hard asset stocks continued their growth, gaining 4.64% in the fourth quarter alone. The GSSI Natural Resources Index ended the year up 34.44%. Energy funds were up 38.77%, and industrial materials funds, which include precious metal mining companies, were up 40.94%.

Hard assets are not highly correlated to U.S. large-cap stocks as a whole, a distinct advantage. The correlation between the Goldman Sachs Natural Resources Index and the S&P 500 Index is only 0.38. Importantly, the correlation between the Goldman Sachs Natural Resources Index and the Lehman Aggregate Bond Index is even lower at -0.21. A negative correlation means that bonds and natural resources, as separate asset classes, are often moving in opposite directions. Balancing a bond portfolio with hard asset stocks can help hedge the risk that inflation poses to a bond portfolio.

Investments with low correlation mean lower volatility and better compounded returns. Your asset allocation should use all six asset classes: three for stability (money market, U.S. bonds and foreign bonds) and three for appreciation (U.S. stocks, foreign stocks and hard asset stocks). Then make sure to select the best specific investments in each class, those with low expense ratios that capture the majority of the return of their asset class.

You owe it to meeting your financial goals to review these aspects of your investments at least once a year.

from http://www.emarotta.com/article.php?ID=266

by David John Marotta

The first U.S. money market fund was created by Bruce Bent in 1970. The Reserve Fund, as it was called, offered investors a way to preserve their cash liquidity and still earn a small rate of return. Today 22% of all mutual fund assets are invested in nearly 900 money market funds.

Money market funds are a type of mutual fund that usually sells and redeems their shares for $1. The value to the consumer is the interest earnings plus the stability of getting their principal back. Unlike other mutual funds, money market funds are restricted to investing only in the highest quality debt with average maturities less than 90 days.

While money market funds typically are very stable, it's important to note that money market funds are neither insured nor guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Money market funds seek to keep their share price at exactly $1.00, but this is not guaranteed. It is possible to lose money by investing in these funds.

Protecting the consumer, several rules govern those who offer money market funds. They must invest at least 95% of their assets in securities that get the highest credit rating. Money market funds cannot have more than 5% of the portfolio invested in debt from the same issuer, except for the federal government debt. They can invest in Asset Backed Commercial Paper (ABCP) which is backed by a pool of assets that can include credit card debt, car loans, regular mortgages and subprime mortgages. Money market funds can invest up to 5% of their assets in securities with the second highest rating, but cannot put more than 1% with any one issuer. When an issuer's credit rating drops from the best credit rating to the second best credit rating, a money market fund will be on alert to sell the position quickly in order to satisfy SEC rules.

Some money market funds have lent money to what are called structured investment vehicles (SIV). Since they promise to pay the money back within a short period of time, SIVs can qualify as legitimate money market investment. The SIVs then take the money and invest it in high-yielding risky investments such as subprime mortgage debt. The SIVs then repay their debt by bundling and selling this mortgage debt and making their repayment deadline. They make money by collecting much more in interest and the sale of the loans than the cost of borrowing the money in the first place.

The difficulty is that it has become much more difficult for SIVs to sell their subprime mortgages. When there is a rise of foreclosures and defaults, companies devalue the bundle of mortgages which increases the likelihood of SIVs being unable to repay their loans from the money market funds. The ratings on some of this commercial paper have dropped with the increasing defaults on subprime mortgages.

Because of the rules that govern money market funds and their diversification requirements, the credit risk problems of subprime defaults are limited. A good manager should be diversified enough to weather these storms without showing losses in the money market.

Money market funds have several purposes in an investment portfolio.

They provide a liquid stable place to park free cash. They provide a place to keep money for rebalancing your portfolio in case of a market run up or a market correction. And they provide a place to collect interest and dividend payments.

Money market funds can also serve as an investment class by itself. In the decade of the 1970's with its rampant inflation, money market was the investment category with the highest returns at the end of the decade.

When interest rates are falling, longer term bonds with higher fixed interest rates will appreciate in value. But if interest rates are rising, these same long term bonds will lose the most value. In a period of rising interest rates, your money market investments will adjust quickly and simply pay a higher rate of interest.

Some money market fund investors are worried about losing their money. If a money market fund holds bad debt, the money market fund's value could drop below $1.00 and "break the buck". A money market fund has broken the buck when you go to get your money out of your account, and they return less than you put in.

So far, only one money market fund "broke the buck." They paid their investors only $0.96 per share. Although only one fund has dropped below a dollar, there have been a number of cases where the banks have bailed out their money market fund by pumping in more capital in order to show a positive return.

Any brokerage firm that showed a loss on a money market fund would ruin their reputation and their future business. Brokers would rather spend a fraction of their marketing budget supplementing their returns than face the public relations nightmare of their money market losing money.

It is not impossible that a money market fund would lose money, but if it did, it would probably take down the company running it as well. As a result, I would expect the company running the fund to take the hit themselves and supplement the fund's return if it were at all possible. Large companies with highly visible reputations and expensive marketing budgets are the most likely to bail out a money market rather than break the buck.

Money market investments are clearly not the safest place to hide all your savings, but they are a reasonable and strategic place to allocate a portion of them in a well balanced and actively managed portfolio.

from http://www.emarotta.com/article.php?ID=264

by David John Marotta

We all want to be slim, eat healthy and get our financial house in order, but few of us are disciplined enough to accomplish all that without help. After the indulgences of the holidays, both gustatory and financial, inevitably you'll probably resolve once again to make some changes in all these areas. You owe it to yourself and your family to make certain you keep your financial New Year's resolutions this year.

I won't presume to offer help on your diet and exercise program, but I do know that with the help of a personal financial advisor, you can make your financial life more manageable and successful. Every six years you delay saving and investing, you cut in half the lifestyle you will have in retirement.

First, financial advisors listen to your personal goals and tailor their recommendations to your situation. Just the act of sharing what you hope to accomplish makes it a lot more likely it will translate from inside your head onto paper and then to taking action. And don't delay seeking a coach until you've worked out the details. A professional helps you ask the right questions and stays the course with you until you've found the answers.

Second, a coach works with you to make those goals concrete and then documents them. For example, your savings goals should be a specific annual percentage of your adjusted gross income (AGI), ideally at least 10% of your AGI in tax-free retirement accounts and another 5% toward retirement in taxable investments. If you are older and just getting started on a savings program, your advisor may recommend you save even more to catch up to where you should be.

Don't stop reading here with the idea that you are too rich or too poor to need a coach. Even financial advisors themselves seek professional help with their portfolios. Whether you live on $200,000 or $20,000 a year, you'll need to save enough to retire and keep that same standard of living. It will not be any easier to cut back on expenses when you're no longer working (if you think it will be easy, do it now and save and invest the difference!).

Relying on an objective advisor provides both a powerful catalyst for action and real peace of mind. You will have specific annual savings goals written down that you know will meet your goals, one for your retirement accounts and a second for retirement savings that will go into a taxable account.

Third, an advisor offers the best strategies to implement your goals, including prioritizing the appropriate retirement vehicles. You want to put your money into accounts that have the greatest number of asset allocation choices and the lowest fees. Many investors are frustrated by company 401(k) accounts that have high fees and poor choices and need help to sort out their choices.

For example, first invest just enough to get the entire match your company's 401(k) plan offers. Arrange for your contributions to get the full match in the company's Roth 401(k) if your company provides the option, next funding your Roth IRA accounts. After these two, make certain you have enough retirement savings in taxable accounts. There are strategic actions you can take as you enter retirement that require sufficient assets in taxable accounts.

Fourth, an advisor can also help you automate your savings. Making your contribution to an employer-defined contribution plan is simple enough, but few take the time to automate a taxable savings plan. Most brokers offer an automatic money link between your investment account and your checking account and also a monthly automatic transfer between the two accounts.

Say your paycheck is deposited on the first day of the month. Ask your broker to transfer money from your checking account into your investment account on the second day of the month. Then automate your investing. For example, if $600 is being deposited into your brokerage account each month, designate an asset allocation that purchases $100 or more of five or six funds. Most brokerage firms make this process both easy to set up and to change.

Once a year, rebalance your portfolio. Doing so after your June 30 statement is a convenient time, and your advisor can make that part of his or her ongoing recommendations.

You can get much more sophisticated than what's been described here, but a great way to start off this new year is to hire a financial advisor to help you realize the benefit of saving and investing with a minimal amount of work. Call the National Association of Personal Financial Advisors (NAPFA) at 1-888-FEE-ONLY (1-888-333-6659) to get a list of members in your area or visit their website at <a href="www.napfa.org" target=_blank>www.napfa.org</a>.

from http://www.emarotta.com/article.php?ID=263

Scrooge's Former Boss Fezziwig Is a Nester (2007-12-24)

by David John Marotta

One of my favorite Christmas movies is the version of Dickens's "A Christmas Carol" starring George C. Scott as Ebenezer Scrooge. I must confess that I understand Scrooge's character.

Scrooge -- a denizen of early Victorian London -- is a solitary and miserly businessman. He spends his days tracking in giant ledgers all the money he doesn't spend. He spends his nights alone in a huge drafty house he's too cheap to heat adequately. He isn't in debt, lives well within his means and makes shrewd investments. In fact, Scrooge is such a consistent and understandable character, sometimes it almost seems tragic that he has a change of heart at the end of the story.

Of all the colorful characters in "A Christmas Carol," I like Fezziwig the best. In Scrooge's youth, Fezziwig and his wife opened their doors wide to friends and family, spending three or four pounds to provide a fiddler, some foolishness and an unforgettable feast.

Financial advisor Bert Whitehead would describe Fezziwig as a "nester." In his description of financial personalities in his book "Why Smart People Do Stupid Things with Money," Whitehead describes nesters as family-oriented people whose homes are their greatest investment. And to Fezziwig, his employees are like family.

Fezziwig has achieved that wonderful balance between work and play, responsibility and frivolity. On Christmas Eve he and his staff work until seven the evening of the party, but once the guests arrive, the fun begins in earnest.

Like Scrooge, nesters like Fezziwig lean more toward saving than spending. Scrooge likely learned his propensity to save while working under Fezziwig. Because of this shared frugality, Fezziwig's willingness to spend a few pounds on holiday cheer moves Ebenezer's stony heart.

The greatest joys of the holiday season cannot be bought in a store and do not increase our credit card debt. Many parents spend more than they can afford out of a sense of guilt. But the satisfaction of putting a big-ticket item under the tree, unfortunately, is both short lived and shortsighted. There is a better way to celebrate that builds long-lasting family ties.

Holiday joy comes from taking time to celebrate values that don’t show up in your net worth statement, and Fezziwig certainly sets a great example. He hires a fiddler for the occasion. He opens his home to the six young admirers of his three lovely daughters. He invites all the young men and women who work for him. He extends his largesse to the cook, the milkman and even an apprenticed boy whose master doesn't feed him well enough.

They dance. And the Fezziwigs know how to dance: "advance and retire, both hands to your partner, bow and curtsey, corkscrew, thread-the-needle, and back again to your place . . . Fezziwig cut -- cut so deftly, that he appeared to wink with his legs, and came upon his feet again without a stagger" and "Mrs. Fezziwig was worthy to be his partner in every sense of the term."

And they feast. "There was cake, and there was negus [drink made from wine, hot water, lemon juice, sugar and nutmeg], and there was a great piece of Cold Roast, and there was a great piece of Cold Boiled, and there were mince-pies, and plenty of beer."

Scrooge's heart and soul are in the scene as he remembers and enjoys and joins his younger self in praising everything about the evening.

"A small matter," mocks the Ghost of Christmas Past, "to make these silly folks so full of gratitude. He has spent but a few pounds of your mortal money: three or four perhaps. Is that so much that he deserves this praise?"

Scrooge, defending the spirit of Fezziwig's Christmas party, replies, "Fezziwig had the power to render us happy or unhappy; to make our service light or burdensome; a pleasure or a toil. Say that his power lay in words and looks; in things so slight and insignificant that it is impossible to add and count them up: what then? The happiness he gave was quite as great as if it cost a fortune."

There is great financial wisdom to be learned from these two characters. Scrooge's riches did not make him happy. Fezziwig's celebration did not impoverish him.

Start by talking to your family about their fondest holiday memories. Make a list of all you have done right in past years so you can establish some annual family traditions. Add a few new ideas each year. The best holiday traditions don't cost a lot of money and aren't wrapped and put under the Christmas tree.

Some traditions are as simple as playing radio stations with Christmas music, reading favorite Christmas stories, or watching a Christmas movie. Your list won't be complete without a description of everyone's favorite holiday food. One tradition might involve holiday church services that reflect your family's spiritual values. Another might be as simple as a family game night. One family plants an evergreen sapling on their property every Arbor Day to have a supply of their own Christmas trees every December. Another family uses the children's school photos to make new ornaments for the tree.

When complete, your list should include a hundred ways to enjoy the holidays without going into debt. Like Fezziwig, the happiness these traditions bring you will be quite as great as if it cost a fortune.

Take Fezziwig's advice to heart: "When happiness shows up, always give it a comfortable seat." Merry Christmas to you and your family! And as Tiny Tim would say, "God Bless Us, Every One!"

from http://www.emarotta.com/article.php?ID=262