4 Things To Do With Your Stocks Now - Don't Panic (Morningstar)

Improving Your Finances

A To-Do List for Volatile Markets

By Christine Benz | 02-11-16 | 06:00 AM | 

Rough market environments like the current one remind me of the old quote from value-investing legend Shelby Cullom Davis: "You make most of your money during a bear market; you just don't know it at the time."

Easy for him to say. Yes, great value investors like Davis make their money by buying when other investors are panicking. But there's always someone on the other side of those trades. Morningstar's investor-return data, which aim to reflect investors' actual gains and losses, show that many investors mistime their purchases and sales. Before stocks began to recover in early 2009, for example,investors were flocking to bond funds, and they kept right on buying them through much of stocks' recovery. Bonds weren't a terrible investment subsequently, but they sure did underperform stocks.

Many investors have heard that they should do nothing with their portfolios during bear markets, and sitting still is certainly better than selling out of stocks altogether, or making shifts based on fear rather than good investment sense. But doing nothing may not be psychologically appealing. Moreover, there are constructive actions investors can take to improve their portfolios and their total financial plans during periods of market turbulence.

Here are four to consider.

1) Scout around for tax-loss candidates.
One way to make a save during weak markets is to reap a tax loss by selling depreciated securities from your taxable account. You'll be able to use those losses to offset capital gains on your 2016 tax return, and if your losses exceed your gains, you can use them to offset up to $3,000 in income. Of course, the very securities in which you have the biggest losses may be poised to deliver the biggest gains when the market recovers, so you need to be careful that your tax-loss selling doesn't choke off your portfolio's future return potential. You can't sell something and rebuy it right away; doing so will effectively disallow the tax loss. But you can swap a losing security for another that helps you maintain similar economic exposure--for example, you could sell one losing master limited partnership and buy another, or buy an MLP ETF, instead. You may even be able to give your holdings an upgrade in the process--swapping a fund with a Morningstar Analyst Rating of Neutral for one with a Gold rating, for example, or supplanting a higher-cost index fund with one with a rock-bottom expense ratio.

Even if your taxable portfolio doesn't feature a lot of good tax-loss candidates, you can use the sell-off as an opportunity to give your taxable account a tax-efficient makeover. If one or more of your holdings has been kicking off a lot of taxable capital gains distributions and you'd like to swap into a more tax-efficient index fund or exchange-traded fund, declining market values mean that you'll owe less in capital gains taxes when you make the switch.

2) Consider IRA conversions and/or recharacterizations. Tax-loss selling from an IRA is usually not advisable for most--except perhaps investors with very small IRAs holding investments that have declined in value, as discussed here. But IRA investors can reap a benefit from a falling market, too. That's because the taxes you owe when converting a traditional IRA to Roth depends on how much of your traditional IRA hasn't been taxed yet--both your own pretax contributions as well as your investment gains. And if your traditional IRA has shrunk, as is inevitably the case when the market declines, the taxes due when you convert will be less than when markets are lofty. It won't usually make sense to convert a large IRA balance all in one go (unless you find yourself in an abnormally low tax year and have the cash on hand to pay the conversion-related tax bill--a rare confluence of events). Instead, most would-be converters would do well to convert bits of their IRAs from traditional to Roth over a period of years, to lessen the tax burden in a single year. The postretirement/pre-required-minimum-distribution years are often considered a "sweet spot" for conversions, in that most retirees at this life stage will have a greater ability to keep their income down than they will once RMDs commence.

Investors who set up traditional IRAs with an eye toward converting them into "backdoor Roth IRAs" but who haven't yet undertaken the conversion may also find it's an opportune time to convert, as their investments have likely slumped in value since they funded the accounts. That means their conversions will trigger little if any taxes (unless, that is, they have other traditional IRA assets apart from their backdoor IRA assets, as discussed here).

For investors who converted their IRAs when their balances were higher, "recharacterizing" back to a traditional IRA may be advisable. That's because the earlier conversion would trigger a higher tax bill than would be the case today, when the taxable IRA balance is likely lower. This series of FAQs from the IRSoutlines the specifics of recharacterization, including deadlines and time limits.

3) Make 2015 IRA Contributions.
The admonition to buy more stocks when they're down can be psychologically difficult. But investors who haven't yet contributed to an IRA for 2015 find themselves coming up on a hard deadline: April 18, 2016, your tax-filing deadline, is also your deadline for making an IRA contribution for the 2015 tax year. Procrastinators got lucky this time: The fact that stocks have fallen in the past year makes now a better time to contribute than in early 2015. The 2015 contribution limits are $5,500 for investors under 50 and $6,500 for those 50-plus; this article discusses the income limits governing deductible traditional IRA and Roth IRA contributions.

4) See if changes to your (actual) asset allocation are in order. 
Before you make any changes to your portfolio--either adding to your equity holdings or subtracting from them--check your asset allocation relative to your target. (If you don't have an asset-allocation target, you can look to a good target-date fund like those from Vanguard and T. Rowe Price, Morningstar's Lifetime Allocation Indexes, or my model portfolios for some asset-allocation guideposts for various life stages and risk tolerances. This article can help you further refine your stock/bond mix based on your own situation.) With U.S. stocks down about 8% in the past year and some equity categories down much more than that, many investors may find that their equity holdings need topping up. But hands-off investors getting close to retirement may find that they're actually heavy on stocks given their life stage. For them, derisking may actually be in order, even if they've been exhorted to sit tight amid the volatility. This article discusses the problem of having a portfolio that's too equity-heavy as you get close to your retirement date.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Top Books on Investing (from Value Walk)

Top 10 Investing Books Executives and Portfolio Managers Suggest

valuewalk.com/2014/08/top-10-investing-books/

VW Staff

National Book Lovers Day on Saturday inspired Covestor’s portfolio managers and members of Covestor’s senior management team to share their recommendations for their favorite investing books (readers will likely be familiar with most of these books, although they may find some new names). Via PRWeb

Here are the top 10 investing books:

Investing Books #1: The Art of Asset Allocation

The Art of Asset Allocation: Principles and Investment Strategies for Any Market by David Darst. Selected by Charles Sizemore – CFA, RIA, and manager of Strategic Growth Allocation portfolio

A global leader and preeminent expert in asset allocation, David Darst delivers his masterwork on the topic. In a fully updated and expanded second edition of The Art of Asset Allocation, Morgan Stanley’s Chief Investment Strategist covers the historic market events, instruments, asset classes, and economic forces that investors need to be aware of as they create asset-building portfolios. He then explains how to use modern asset allocation concepts and tools to augment returns and control risks in a wide range of financial market environments. This completely revised edition shows how to achieve asset balance with the author’s proven methods, decades of expertise, relevant charts, practical tools, and astute analyses.

Investing Books #2: Active Portfolio Management

Active Portfolio Management: A Quantitative Approach for Producing Superior Returns and Controlling Risk by Richard Grinold and Ronald Kahn. Selected by Jane Edmondson – MBA, RIA CEO, and manager of Mid Cap Quant portfolio

“This new edition of Active Portfolio Management continues the standard of excellence established in the first edition, with new and clear insights to help investment professionals.”

-William E. Jacques, Partner and Chief Investment Officer, Martingale Asset Management.

“Active Portfolio Management offers investors an opportunity to better understand the balance between manager skill and portfolio risk. Both fundamental and quantitative investment managers will benefit from studying this updated edition by Grinold and Kahn.”

Investing Books #3: Wall Street

Wall Street: How It Works and for Whom by Doug Henwood. Selected by Asheesh Advani – Oxford doctorate, and CEO at Covestor

A scathing dissection of the wheeling and dealing in the world’s greatest financial center. Spot rates, zero coupons, blue chips, futures, options on futures, indexes, options on indexes. The vocabulary of a financial market can seem arcane, even impenetrable. Yet despite its opacity, financial news and comment is ubiquitous. Major national newspapers devote pages of newsprint to the financial sector and television news invariably features a visit to the market for the latest prices. Does this prodigious flow of information have significance for anyone except the tiny percentage of people who have significant holdings of stocks or bonds? And if it does, can non-specialists ever hope to understand what the markets are up to? To these questions Wall Street answers an emphatic yes. Its author Doug Henwood is a notorious scourge of the stock exchange in the pages of his acerbic publication Left Business Observer. The Newsletter has received wide acclamation from J.K. Galbraith, among others, and occasional less favorable comment.

Investing Books #4: The Intelligent Investor

The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham. Selected by Aaron Pring – commercial construction VP, and manager of Buy and Hold portfolio
The greatest investment advisor of the twentieth century, Benjamin Graham, taught and inspired people worldwide. Graham’s philosophy of “value investing” — which shields investors from substantial error and teaches them to develop long-term strategies — has made The Intelligent Investor the stock market bible ever since its original publication in 1949.

Investing Books #5: One Up On Wall Street

One Up On Wall Street: How To Use What You Already Know To Make Money In The Market by Peter Lynch. Selected by Drew Steinman – CPA, and manager of Leveraged Value portfolio
More than one million copies have been sold of this seminal book on investing in which legendary mutual-fund manager Peter Lynch explains the advantages that average investors have over professionals and how they can use these advantages to achieve financial success.

America’s most successful money manager tells how average investors can beat the pros by using what they know. According to Lynch, investment opportunities are everywhere. From the supermarket to the workplace, we encounter products and services all day long. By paying attention to the best ones, we can find companies in which to invest before the professional analysts discover them. When investors get in early, they can find the “tenbaggers,” the stocks that appreciate tenfold from the initial investment. A few tenbaggers will turn an average stock portfolio into a star performer.

Investing Books #6: When Genius Failed

When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein. Selected by Sanjoy Ghosh – Wharton Ph.D., and Covestor Chief Investment Officer
In this business classic—now with a new Afterword in which the author draws parallels to the recent financial crisis—Roger Lowenstein captures the gripping roller-coaster ride of Long-Term Capital Management. Drawing on confidential internal memos and interviews with dozens of key players, Lowenstein explains not just how the fund made and lost its money but also how the personalities of Long-Term’s partners, the arrogance of their mathematical certainties, and the culture of Wall Street itself contributed to both their rise and their fall.

Investing Books #7: The 100 Best Stocks to Own in America

The 100 Best Stocks to Own in America (7th Edition) by Gene Walden. Selected by Robert Freedland – MD, optical surgeon, and manager of Healthcare portfolio
Savvy investors realize that blue chip investments are companies that are better capitalized and positioned to succeed in the changing marketplace where “bricks and clicks” alike are required. Among the best of the best, companies chosen by Walden for the previous edition have led the market indicators: the average return of his top five picks was 30.4% compared to -7.2% for the Dow Jones Industrial Average over the same one-year period.
The 100 Best Stocks to Own in America goes far beyond impressive figures for one year. Since its first edition in 1989, Walden’s guide to stocks poised for superior long-term growth has not let investors down. In fact, hundreds of thousands of investors have used this information to create powerful portfolios. Many buy each edition of the book to see how the lists of companies have changed over time. What hasn’t changed are the rigorous criteria for inclusion: only the strongest companies make the grade. Companies are selected on the basis of: earnings growth, stock growth, dividend growth, dividend yield, consistency, shareholder perks.

Investing Books #8: The Big Short

The Big Short: Inside the Doomsday Machine by Michael Lewis. Selected by Bhargav Shivarthy, Covestor Director of Client Relations

The real story of the crash began in bizarre feeder markets where the sun doesn’t shine and the SEC doesn’t dare, or bother, to tread: the bond and real estate derivative markets where geeks invent impenetrable securities to profit from the misery of lower–and middle–class Americans who can’t pay their debts. The smart people who understood what was or might be happening were paralyzed by hope and fear; in any case, they weren’t talking.

Investing Books #9: I Am Right You Are Wrong

I am Right You are Wrong: From This to the New Renaissance: From Rock Logic to Water Logic by Edward de Bono. Selected by Bimal Shah, Covestor Chief Technology Officer

In this book, Dr Edward de Bono, who is well-known worldwide for his origination of lateral thinking, puts forward a direct challenge to what he calls the ‘rock logic’ of Western thought. Rock logic is based on rigid categories, absolutes, argument and adversarial point scoring. Edward de Bono believes that this thinking cannot solve our problems. Instead of rock logic, he proposes the water logic of perception. Drawing on our understanding of the brain as a self-organizing information system, Dr de Bono shows that perception is the key to more constructive thinking and creativity. Here, in this brilliantly argued assault on outmoded thought patterns, he calls for nothing less than a New Renaissance.

Investing Books #10: The Little Book of Behavioral Investing

The Little Book of Behavioral Investing: How not to be your own worst enemy by James Montier. Selected by John Spence – MarketWatch reporting alum, and Covestor Head of Content

Bias, emotion, and overconfidence are just three of the many behavioral traits that can lead investors to lose money or achieve lower returns. Behavioral finance, which recognizes that there is a psychological element to all investor decision-making, can help you overcome this obstacle.

In The Little Book of Behavioral Investing, expert James Montier takes you through some of the most important behavioral challenges faced by investors. Montier reveals the most common psychological barriers, clearly showing how emotion, overconfidence, and a multitude of other behavioral traits, can affect investment decision-making.

Quantitative Easing: Greed Kicks In (Bloomberg News)

Stocks Beat Junk by Most Since 1999 Amid Fund Flight
By Bryan Keogh and Lynn Thomasson - Nov 15, 2010

U.S. stocks are returning more than junk bonds after trailing them for a decade, valuations have fallen to a record low compared with credit -- and investors are pulling more money than ever out of equity funds.

The Standard & Poor’s 500 Index rose 17 percent including dividends since June, compared with 10 percent for the Barclays Capital U.S. Corporate High Yield Index. The equity gauge is on pace for its biggest six-month gain against the bond index since 1999, data compiled by Bloomberg show. At the same time, the more than 120 percent rally in junk bonds since 1998 has left them more expensive than ever versus stocks, based on earnings yields measuring annual profits as a percentage of price.

“People have pushed the trade too far,” said Peter Sorrentino, who helps oversee $13.8 billion at Huntington Asset Advisors in Cincinnati. “The next step is to move from fixed instruments into stocks.
Junk bonds have so little premium right now. It’s like the last chapter where people are finally going to capitulate.” Individuals are ignoring the advice, pulling $55.3 billion from stock mutual funds since the end of June after $11 trillion was erased from U.S. equity values between October 2007 and March 2009. Third-quarter withdrawals came as the S&P 500 rose 11 percent, the first time a three-month advance failed to spur investments, according to LPL Financial Corp. in Boston.

Favoring Stocks
Huntington, PNC Wealth Management and Goldman Sachs Group Inc. say stocks will beat speculative-grade debt as the economy improves. S&P 500 per-share earnings are poised to rise 37 percent in 2010, the biggest increase in 22 years, estimates from more than 10,000 analysts tracked by Bloomberg show.

Futures on the S&P 500 expiring in December rose 0.1 percent to 1,196.4 at 9:37 a.m. today in London.

The benchmark index for American equities fell 2.2 percent to 1,199.21 last week as profits from Cisco Systems Inc. in San Jose, California, and Burbank, California-based Walt Disney Co. trailed analysts’ estimates. S&P 500 earnings that beat forecasts more than 70 percent of the time have helped push the gauge up 7.5 percent this year, data compiled by Bloomberg show.

Stocks remain cheap compared with bonds even after the rally. Debt rated below Baa3 by Moody’s Investors Service and BBB- by S&P pays an average yield of 7.25 percent, compared with an earnings yield of 6.64 percent for the S&P 500, data compiled by Bloomberg show. That’s the smallest gap since the Barclays index began in 1991.

‘Overweight’ Rating

Goldman Sachs in New York advised clients last month to begin raising the proportion of equities they own relative to debt, citing the expanding economy. The world’s most profitable investment bank lowered its rating on investment-grade corporate bonds to “neutral,” saying they were likely to return next to nothing while equities gain 14 percent over 12 months, according to an Oct. 15 note to clients.

Junk bonds, which Goldman rates “overweight,” will likely trail stocks, offering returns greater than 10 percent in the coming year, according to credit strategist Alberto Gallo.

“It’s going to be harder for high yield to outperform stocks over the next 12 months,” he said in an interview. “We already had two years in a row where high yield did better.”

Investors should be buying stocks that “look like bonds” with international sales, below-average debt and growing dividends, said Chris Hyzy, New York-based chief investment officer at U.S. Trust, a Bank of America Corp. unit overseeing $339.9 billion in client assets.

‘Sweet Spot’

“That’s the sweet spot for a balanced investor looking to reallocate from excessive ownership of fixed income,” he said. “High yield is fairly valued. We expect the gap between the earnings yield on equities and fixed-income yields to close considerably in the next 12 to 18 months.” Shares of retailers and technology companies such as J.C. Penney Co. and Motorola Inc. have surged since June 30, outperforming their bonds in a reversal of the first half, when equities slumped and junk rallied.

Department-store chain J.C. Penney in Plano, Texas, has returned 47 percent since June 30, compared with a gain of 0.02 percent for its senior unsecured debt, rated Ba1 by Moody’s and BB+ at S&P. That contrasts with the first six months, when shares fell 19 percent and the debt rose 7 percent.

Motorola, the second-largest U.S. mobile-phone maker, has surged 23 percent this half, five times the 4.2 percent gain for its debt. In the first six months, Schaumburg, Illinois-based Motorola’s bonds returned 16 percent, while its stock lost the same amount.

Rental Cars

Avis Budget Group Inc. shares rallied 38 percent since June 30, while the company’s bonds returned 11 percent. Year-to-date, the bonds of the rental-car company have risen 16 percent, compared with 3.6 percent for the stock.

“If I had to add money into a portfolio, I’d add it into equities,” said James Dunigan, chief investment officer at PNC Wealth Management in Philadelphia, which oversees $105 billion. “Stock valuations remain attractive. The earnings prospects continue to be positive. We’ll likely get back to an economy which is expanding in the early part of 2011.”

While the S&P 500’s advance has restored $2.15 trillion to market values since July, shares are getting cheaper compared with profit forecasts. Income growth that analysts predict will top 13 percent in each of the next two years means the index is trading at 12.5 times 2011 earnings and 11 times projections for 2012, data compiled by Bloomberg show. The S&P 500’s average price-earnings ratio since 1954 is about 16.5, the data show.

Quantitative Easing

At the same time, the Fed’s so-called quantitative easing policy to buy as much as $600 billion of Treasuries has pushed down government bond yields that are the benchmark for corporate borrowing and mortgages. Rates on junk fell to a 5 1/2-year low of 6.97 percent on Nov. 9, from 9.5 percent five months earlier and a record 23 percent in December 2008, according to the Barclays Capital index.

“Quantitative easing is extremely supportive of equities in the short term,” said Lucette Yvernault, who helps oversee the equivalent of about 7 billion euros ($9.5 billion) at Schroders Investment Management Ltd. in London. “The detrimental impact of the QE is that investors don’t necessarily reinvest in the U.S. economy, but instead fuel more growth in emerging markets.” U.S. earnings may keep rising as more executives than ever increase forecasts compared with those lowering them. EBay Inc., United Parcel Service Inc. and 196 other companies raised profit estimates above analysts’ projections last month as 130 firms cut them, the biggest gap since Bloomberg began tracking the data in 1999.

Greed Kicks In
The S&P 500’s earnings yield averaged 5.6 percent through the last bull market that ended Oct. 9, 2007, according to data on reported profit compiled by Bloomberg. Using estimated income, the index yields 7.1 percent, 0.2 percentage point less than the average for speculative bonds tracked by Barclays.

“The greed will kick back in, and that’s what will propel the equity markets,” Huntington Asset’s Sorrentino said.

While stocks have beaten bonds in the past 4 1/2 months, investors have fared better this year with fixed-income securities. The Barclays measure of junk bonds has returned 15 percent since Dec. 31, double the advance in the S&P 500.

Investors piled about $190 billion into U.S. bond funds this year through Oct. 31, a pace that would surpass last year’s record-setting $214.1 billion, according to Cambridge, Massachusetts-based research firm EPFR Global. Clients pulled about $56 billion out of equity funds and $74.6 billion in 2009.

Flows into junk bonds fell to $1.7 billion in October from $3.35 billion in September, the most all year, provisional EPFR data show. That brought the total to about $8.6 billion as of Oct. 31, compared with $19.9 billion in 2009.

“Ultimately the Fed will succeed,” said Wayne Lin, a money manager at Baltimore-based Legg Mason Inc., which manages $677 billion. “It’s just a question of how well they will succeed and how long it’s going to take for them to convince people to take money out of the mattresses and start putting it to work.”
To contact the reporters on this story: Bryan Keogh in London at bkeogh4@bloomberg.net; Lynn Thomasson in Hong Kong at lthomasson@bloomberg.net.

To contact the editors responsible for this story: Paul Armstrong at parmstrong10@bloomberg.net; Nick Gentle at ngentle2@bloomberg.net.

Tips on Investing in the TSP (Thrift Savings Plan for Federal Workers) by Morningstar

Does the Government's Retirement Plan Measure Up?
By Christine Benz | 08-17-10 | 06:00 AM |

Question: As a government worker, I'm eligible to invest in the Thrift Savings Plan for my retirement. I'd like an objective view of the quality of the options, and I'd also like to be able to enter my complete portfolio on your site but can't find matches for the TSP funds on Morningstar.com. What do you think of the plan, and can you think of any funds that would be good proxies for the TSP's holdings? What is it missing?


Answer: I recently wrote an article about workarounds in case you can't find information for one of your investments on Morningstar.com. And the TSP options, while they have millions of investors in the U.S. government and armed forces, fall into that category. In short, I'd call the plan a winner and well worth investing in if Uncle Sam is your employer.


Cheap, Simple, and Effective
Although some retirement plans are chock-full of overpriced investment options and layers of administrative costs, the TSP lands at the opposite end of the spectrum. Most of the options are index funds (or index-based funds), meaning they track a given market benchmark and don't need to pay an active stock-picker for his or her services. ( BlackRock BLK) manages the index funds in the plan.) TSP participants paid just 0.028% in total costs in 2009, meaning that $0.28 of every $1,000 invested went for expenses. Although that's a touch more than what participants paid in 2007 and 2008, it's still an amazing deal.


The plan also earns points for simplicity and ease of use. The streamlined lineup, with four index funds, a government-securities offering, and five target-maturity vehicles, is about as utilitarian as they come, and provides exposure to the basic asset classes that should form the foundation of every investor's portfolio.


Here's the lowdown of the investment options in the TSP, as well as ideas for proxies you can use in Morningstar's portfolio-tracking and X-Ray tools. Note that the proxies aren't perfect because in all cases their expenses are higher than the options in the TSP.


C Fund (Common Stock Index)
The C Fund tracks the S&P 500 Index, which focuses on large-cap U.S. stocks.


C Fund Proxy: iShares S&P 500 (SPY SPY) or Vanguard Institutional Index (VINIX)


S Fund (Small Cap Stock Index)
The S Fund tracks the Dow Jones U.S. Completion Total Stock Market Index, which consists of U.S. companies not included in the S&P 500 (mainly small- and mid-caps).


S Fund Proxy: Fidelity Spartan Extended Market Index (FSEMX)


I Fund (International Stock Index)
The I Fund tracks the MSCI EAFE Index, which tracks the performance of developed foreign markets.


I Fund Proxy: iShares MSCI EAFE (EFA)


G Fund (Government Securities)
The G Fund invests in short-term U.S. Treasury securities that are specifically issued to the TSP.


G Fund Proxy: It's tricky to find a precise proxy for the G Fund, mainly because the securities it owns are for G Fund participants only; you won't find them in other mutual funds. However, Vanguard Short-Term Treasury (VFISX) is a reasonable stand-in.


F Fund (Fixed-Income Index)
The F Fund is a total market bond market index fund that tracks the Barcap U.S. Aggregate Bond Index, which includes U.S. government bonds, mortgage-backed bonds, and corporate bonds.


F Fund Proxy: Vanguard Total Bond Market Index (VBMFX) or iShares Barclays Aggregate Bond (AGG).


L Fund
The L Funds are target-date offerings composed of the above-mentioned funds. In general, the L Funds tend to be more conservative than other target-date offerings geared toward the same retirement date; that conservatism is especially pronounced in the funds for investors nearing retirement. Not only do the funds have more bonds than the typical target-date fund for that same age band, but they also feature heavier exposure to government bonds.


L Fund Proxies: Because target-date funds vary so broadly in terms of their asset allocations and underlying holdings, L Fund holders would do well to find the allocations of their particular L fund, then use the proxies above to simulate an L fund's weightings in each holding.


What It's Missing
As good as the TSP is, it doesn't provide exposure to every nook and cranny of the market. Thus, investors looking to add to their holdings outside the TSP (such as in an IRA or Roth IRA) should explore a few key areas.

For example, the two bond funds in the plan, while solid, don't provide exposure to Treasury Inflation-Protected Securities; nor do they own lower-quality (junk) bonds or international or emerging-markets bond funds. Thus, TSP investors might devote a small share of their fixed-income portfolios to these asset classes. Morningstar's Fund Analyst Picks are a good place to start. (The inflation-protected bond and multisector bond categories would be good ones to explore.)


And though the I Fund provides broad-based foreign-stock exposure, the MSCI index it tracks doesn't encompass fast-growing emerging markets such as those in Asia, Latin America, and Eastern Europe. Thus, risk-tolerant investors might want to venture into an emerging-markets stock or small-cap international stock fund for a small share of their portfolios.


Finally, as noted above, the L funds within the TSP lineup are generally pretty conservative, so risk-tolerant, longer-term investors in the L funds might consider tipping more of their portfolios into equities than is the case for the prepackaged target-date versions.

Investing Behavior - Men vs Women (N Y Times)

March 12, 2010
How Men’s Overconfidence Hurts Them as Investors
By JEFF SOMMER

MEN and women invest differently, a growing body of research has found. And in at least one important respect, women may be better at it.

The latest data comes from Vanguard, the mutual fund company. Among 2.7 million people with I.R.A.’s at the company, it found that during the financial crisis of 2008 and 2009, men were much more likely than women to sell their shares at stock market lows. Those sales presumably meant big losses — and missing the start of the market rally that began a year ago.

Male investors, as a group, appear to be overconfident, said John Ameriks, head of Vanguard Investment Counseling and Research and a co-author of the study. “There’s been a lot of academic research suggesting that men think they know what they’re doing, even when they really don’t know what they’re doing,” he said.
Women, on the other hand, appear more likely to acknowledge when they don’t know something — like the direction of the stock market or of the price of a stock or a bond.

Staying the course and minimizing costs — selling high and buying low, if you trade at all — are the classic characteristics of good long-term, buy-and-hold investors. But during the financial crisis, the Vanguard study showed, men were more likely than women to trade — and to do so at the wrong times.

That fits the patterns found in path-breaking research by Brad M. Barber of the University of California, Davis, and Terrance Odean, now at the University of California, Berkeley. In a 2001 study titled, “Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment,” they analyzed the investing behavior of more than 35,000 households from a large discount brokerage firm. All else being equal, men traded stocks nearly 50 percent more often than women. This added trading drove up the men’s costs and lowered their returns.

The economists found that while both sexes reduced net returns through trading, men did so by 0.94 percentage points more per year.

In a telephone interview, Professor Barber said, “In general, overconfident investors are going to be interpreting what’s going on around them and feeling they are able make decisions that they’re really not equipped to make.”

Short-term financial news often amounts to little more than meaningless “noise,” he said. Far more than women, men try to make sense out of this noise, and to no avail.

Of course, gender generalizations must be taken with caution: they clearly don’t apply to all men or all women. “The differences among women and the differences among men are much greater than the differences between men and women,” he said.

Nevertheless, numerous studies show that men are more prone to make this particular mistake than women.

Women have also been shown to be more risk-averse than men. In portfolio selection, women tend to have a greater preference for fixed-income investments. That could cause their portfolio returns to lag over the long run, assuming that stocks outperform bonds — though in a shaky market like the one of the last decade, this greater caution might be beneficial.

Selling volatile stocks in a down market — as male I.R.A. investors did more often than women, according to the Vanguard data — might seem to protect a portfolio. But that isn’t necessarily so. Selling before the market falls and buying after it falls is the smart move. For long-term investors, though, the best strategy may be to ignore short-term market movements (perhaps rebalancing a diversified portfolio every so often).
Gender differences appear to extend to other financial behavior. For example, women who are C.E.O.’s and company directors tend to pay a lower premium in corporate takeovers, saving their shareholders a bundle, according to a 2008 study of mergers and acquisitions by Maurice D. Levi, Kai Li and Feng Zhang of the University of British Columbia.

What explains these differences? The answer isn’t clear.

“Is it biological, or cultural?” Professor Barber asked. “Nature or nurture? At this point, we don’t know.”

Plenty of research is under way, though. Over the last five years, brain-imaging technology has made it possible to determine “what is happening in the brain just before people make financial decisions,” said Brian Knutson, a Stanford psychologist and neuroscientist.

Researchers have found that activating the nucleus accumbens — a brain region that is stimulated when you eat delicious food or look at an attractive person — can affect financial risk-taking. When young Stanford men were shown pictures of partially clothed men and women kissing, he said, that region of their brains was activated. And when they were then given financial tests, the men became more likely to “make high-risk gambles.”

Women didn’t respond much to the same pictures, he said; it’s possible the researchers didn’t test enough women or that they haven’t found the right stimuli.

Others studying the effects of hormones on financial behavior have found correlations between testosterone and risk-taking.

Alexandra Bernasek, a professor of economics at Colorado State University, said that the weight of history — enormous gender disparities in earnings, wealth, power and social status — might explain many behavioral differences. It’s also possible, she said, that evolutionary psychology accounts for some of them. Before the dawn of history, aggressive risk-taking might have given men an advantage in finding mates, she said, while women might have become more risk-averse to protect their offspring.

Science may eventually provide some answers. In the meantime, she said, it would be a mistake to “force women into riskier financial behavior” that may be inappropriate, both for them and for society at large.

“Excessive risk-taking has gotten all of us into a lot of trouble,” she said. “That’s certainly one
of the lessons of the financial crisis.”

Re-Building Your Portfolio (WSJ)

RETIREMENT PLANNING JULY 25, 2009 How to Build a Portfolio Wisely and Safely


By JEFF D. OPDYKE

Inflation or deflation?

Even the experts can't agree whether rising or falling prices lie in our future.

That leaves investors in a quandary: how to construct a portfolio at a time of great uncertainty. A wrong bet could be devastating. If your portfolio is built for deflation, for example, your assets will slump if the country instead experiences a bout of inflation.

The answer is to prepare for the economic scenario you think is most likely, and then build in some insurance in case you are wrong.

"If you want to win the war," says Rich Rosso, a financial consultant at Charles Schwab, "you have to own both sides of the fight to some degree."

Such an approach necessarily means some investments will suffer no matter how the economy turns. That is OK: Buying insurance doesn't mean you actually want to use it.Here are three portfolios, each with built-in insurance. The first will do best in an inflationary period but won't be crushed if deflation instead rules the day. The second is for investors who fear deflation, but want some protection against potential inflation -- even if it is down the road. And the third is aimed at investors who believe the economy will muddle through without severe inflation or deflation.

Inflation
If you believe all the government spending in response to the financial crisis will ultimately beget inflation, you want a portfolio that thrives in a period of surging prices.


Commodities are the primary play, because everything from oil and corn to copper and pork bellies should gain. Plus, commodities -- particularly gold -- hedge against the dollar, offering a 2-for-1 benefit if a weak dollar accompanies inflation, as some expect.

Since commodities contracts can be a hassle for individual investors, consider a fund such as Pimco's CommodityRealReturn Strategy Fund, which offers exposure to a broad swath of industrial and agricultural commodities.

Though it seems counterintuitive, cash can do pretty well, too. The Federal Reserve would likely fight rising inflation by pushing up short-term interest rates, allowing investors with cash to capture the escalating rates through short-term certificates of deposit and money-market accounts.

Michele Gambera, chief economist at Ibbotson Associates, says his research shows that in the last five bouts of meaningful inflation, returns on cash essentially matched the inflation rate, meaning it isn't losing its purchasing power. Online banks and local credit unions tend to offer the highest rates.

Treasury inflation-protected securities, or TIPS, are an obvious investment since their principal adjusts upward along with inflation. TIPS exposure is available through mutual funds, such as the Vanguard Inflation-Protected Securities Fund, though Steven Fox, director of forecasting at Russell Investments, notes that holding individual bonds to maturity is more effective as an inflation hedge since "the majority of the inflation protection comes when the inflated principal is repaid." Individual TIPS are available through brokerage firms or TreasuryDirect.gov.

Sharp inflation is generally a negative for stocks, because rising interest rates potentially pinch corporate profits and undermine economic growth. But a few stocks will likely do fine. Start with energy and metals stocks because higher prices for their commodities will boost earnings, says Mark Kiesel, a managing director at Pacific Investment Management Co., or Pimco. Include as well U.S. firms with pricing power, such as regulated utilities, domestic pipeline companies and manufacturers of specialty materials. Examples of companies to consider: miners such as Freeport-McMoRan Copper & Gold and energy giant Exxon Mobil, or companies indirectly tied to commodity prices, such as driller Diamond Offshore Drilling, farm-equipment company Deere and seed supplier Monsanto.

Insurance Component: Long-term Treasury bonds and municipal bonds.
Both will likely soar in value amid deflation because their long period of fixed payments would be an attractive source of income as prices for goods and services broadly fall, and as paychecks shrink. And Treasurys, in particular, would likely become a haven for foreign investors, further pushing up their price.

Deflation


Portfolio preparation is easier for deflationists: Put a chunk of money into long-term Treasury bonds and much of the rest into cash and some municipal bonds.

If broad-based deflation materializes, long-term Treasurys are likely to surge. The bonds' fixed-income stream, meanwhile, would be worth increasingly more relative to falling consumer prices.

Some investment-grade municipal bonds could serve a similar role while also providing tax advantages for high-income earners. But beware: Deflation would likely mean some taxing authorities struggle to service bonds reliant on a specific income stream, like user fees. Instead, stick to "investment-grade bonds tied to necessary services like water and sewage, power or necessary government offices like, say, a courthouse building," says Marilyn Cohen, president of bond-investment firm Envision Capital.

Round out your deflation portfolio with a big slug of cash. Though it won't generate much of a return in a low-rate, deflationary environment, cash in the bank will gain value as prices fall.

Insurance Component: Commodities react most drastically to surprise inflation, so they should be part of your insurance. Add in TIPS, too, and stocks geared "toward consumer-staple companies," says Ibbotson's Mr. Gambera. If inflation arises, companies such Coca-Cola, tobacco giant Altria, and toothpaste maker Colgate-Palmolive will have some pricing power.



Goldilocks Economy
Maybe, just maybe, world bankers will get this right, and the economy will experience neither severe inflation nor severe deflation.

"We think most likely the central banks of the world will get this close enough to right that we will settle in close" to a relatively benign inflation rate of between 1.5% and 2.5%, says Aaron Gurwitz, head of global investment strategy at Barclays Wealth.

In such a "Goldilocks" scenario -- where the economy is neither too hot nor too cold -- "risky assets would do best, so equities and bonds with some equity characteristics should receive the emphasis," says Scott Wolle, portfolio manager of the AIM Balanced-Risk Allocation Fund.

That means broad exposure to large-cap and small-cap U.S. stocks through funds such as the Vanguard 500 Index Fund or the Bridgeway Small-Cap Value fund; and exposure to developed and emerging markets through funds like the Vanguard Total International Stock Index Fund (mainly developed markets), and the T. Rowe Price Emerging Markets Stock Fund.

For the bond component, pick a fund such as the Fidelity Total Bond fund that largely owns high-grade, intermediate-term corporate bonds and mortgages, along with government and agency debt.

Insurance Component: Just in case the Goldilocks scenario is wrong, you will need insurance against either inflation or deflation. Pick up inflation protection through a commodity ETF, and deflation protection with long-term Treasurys. Cash also is OK in either situation.

Write to Jeff D. Opdyke at jeff.opdyke@wsj.com

Updating the Model Portfolio (from thestreet.com)

Kass: Updating the Model Portfolio
Doug Kass
07/27/09 - 12:01 PM EDT

This blog post originally appeared on RealMoney Silver on July 27 at 8:38 a.m. EDT.
In late April, I initiated the Kass Model Portfolio, intended to represent the general construction of a long-only model portfolio with a six- to 12-month investment horizon. My hypothetical portfolio depicts an overall equity weighting and positioning relative to S&P 500 industry benchmarks and weightings.

As I did in calling for a generational bottom in early March, I am again adopting a variant and unpopular view, but this time it is a more negative call. It is important to emphasize that in my March call, I expected a resurgence of economic and investment optimism during the summer to be followed by a multiyear period of weak investment returns. Specifically, I expected a mini production boom and an asset allocation away from bonds and into stocks to be embraced and heralded by investors, who would only be disappointed again in the fall as it becomes clear that a self-sustaining economic recovery is unlikely to develop.

Today's opening missive has another major change in our model portfolio, with a further increase in the cash component of the portfolio from 29% to 43%. I am further reducing both equity and credit exposure after a huge run in both asset classes.

As I see it, the bull market argument is that we are exiting the recession just like the many that preceded the current one. Consequently, corporate profits will exceed consensus forecasts in tandem with:


the resumption of revenue growth (seen in three months of improvement in the leading economic indicator, signs of stabilization in housing, etc.);

the record fiscal stimulation;

an export-led Asian recovery; and

the operating leverage associated with productivity gains achieved through draconian cost cuts and influenced by tame wage inflation.
Besides productivity being underestimated the bulls, further argue Say's Law of Production -- that it is business that drives consumer incomes and spending. Finally, the bullish cabal argues that the high-tax health and energy bills introduced by the President have been recently set back as the blue dog democrats and the liberal leadership are already battling.

The bear market argument (that I now endorse) is that we are seeing nothing more than a second derivative recovery and that owing to a temporary replenishment of inventories, the economy is only getting less worse (or getting better from a depressed level). From my perch, the ingredients for a durable and self-sustaining recovery are missing. An economic double-dip grows more likely in a climate of corporate cost cuts, which elevates jobless rates and leads to continued pressure on personal consumption expenditures. The bears reject Say's Law of Production and view consumer incomes and spending as driving business.

Importantly, the economic downturn of 2007-2009 has already been different this time in scope and duration. For example, unlike the other post-depressions/recessions of the last century, we have already witnessed two consecutive quarterly drops in nominal GDP. As well, the 20-month-old recession has resulted in a near 4% drop in real GDP vs. drops of between 2.5% and 3.0% in the mid 1970s and early 1980s recessions. The U.S. economy came out quickly from those prior downturns, with recoveries to new peaks in economic activity taking only three or four quarters.

My view, however, is that it is different this time: The typical self-sustaining economic recovery of the past will not be repeated in the immediate future for 10 important reasons that will come to the fore:


Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.

Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.

The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.

The credit aftershock will continue to haunt the economy.

The effect of the Fed's monetarist experiment and its impact on investing and spending still remain uncertain.

While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in the prior upturn.

Commercial real estate has only begun to enter a cyclical downturn.

While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.

Municipalities have historically provided economic stability -- no more.

Federal, state and local taxes will be rising as the deficit must eventually be funded, and high-tax health and energy bills also loom.
As I wrote last week, the most disturbing feature of the current business environment is the manner in which corporations are beating estimates. While it enhances the present profit configuration, it has the potential for a long and negative tail to the future. Cost-cutting, like another man's bread, will line the corporation with profits but, in the fullness of time, will not fill the belly of the consumer who is the victim of the realignment of expenses. Costs cuts have a finite life, and, as such, produce an inherently lower quality of earnings and a less positive lever to P/E multiples than does the classical cyclical improvement in top-line or sales growth.

Given the unusual nature and the severity of the downturn, it is hard for me to see anything typical about the domestic economy's rebound compared to previous recovery periods. I do not see the disproportionate role of housing and credit in the prior decade being replaced by anything similar as a growth lever in 2009-2011. Already job losses are unprecedented and cost-cutting's impact on unemployment will exacerbate pressures, acting as a greater drag in the years ahead. Meanwhile, other (nontraditional) headwinds -- such as the likely growth-inhibiting public tax policy, less available credit and an intrusive public sector's interference on the private sector (with attendant regulatory costs and burden) -- will weigh heavily on the economy. So will bloated budgets and poor planning, which have left municipalities in disarray, raise unfamiliar cyclical challenges.

My contacts with corporations are universally more downbeat than the optimism expressed by investors recently. Many in my hedge fund cabal say that this input from the industry is not unexpected, as company managements universally failed to see the coming downturn. This is a fair response, but I suppose they could be right for a change!

For now, the animal spirits are in force. Shorts are covering, and the longs are joining the ever more vocal and growing bullish chorus in the face of the enemy of the rational buyer -- namely, optimism.

In summary, my model portfolio's high cash position reflects a less optimistic view of the sustainability of corporate profit and economic growth as well as a renewal of excessive optimism in sentiment and a move toward more elevated valuation levels (which are not supported by the profit picture I foresee).


S&P Weighting Recommended Weighting Rationale for Weighting
Technology 18% 8% Business spending will remain subdued, and the sector is now overowned
Financials 13% 7% The risk of a double-dip augurs poorly for credit metrics
Energy 13% 5% Commodities, like energy products, are vulnerable to a slowdown
Health Care 13% 5% Government intervention threatens pricing
Consumer Staples 12% 5% Exposed to generic trade-down as consumer weakens
Industrials 10% 5% Shallow and uneven economic recovery remains a headwind
Consumer Discretionary 9% 4% Accumulated job losses and wage deflation weigh on consumer
Materials 4% 2% Shallow and uneven economic recovery remains a headwind
Utilities 4% 2% Exposed to a further spike in interest rates
Telecom 4% 4% Secular prospects remain strong
Total equities 100% 47%
Credit 0% 10% Opportunistic
Total exposure 100% 57%
Cash 0% 43%




Finally, I have included a shopping list of individual stock candidates (by sector) that could be considered in the aforementioned Kass Model Portfolio.


Technology: Previous selections Apple (AAPL Quote), Cisco (CSCO Quote), Research In Motion (RIMM Quote) and Oracle (ORCL Quote) are now fully priced and have been dropped from my buy list. Qualcomm (QCOM Quote) had a disappointing quarter and is also out. Remaining are Microsoft (MSFT Quote) and Dell (DELL Quote).

Financials: I'm dropping SunTrust (STI Quote), Regions Financial (RF Quote), Legg Mason (LM Quote), State Street (STT Quote), Berkshire Hathaway (BRK.A Quote) and Weingarten (WRI Quote) (convertibles). I added JPMorgan Chase (JPM Quote). Remaining are Bank of America (BAC Quote), Prudential (PRU Quote), MetLife (MET Quote), Hartford (HIG Quote), PNC (PNC Quote), Cohen & Steers (CNS Quote), SL Green (SLG Quote) (convertibles), Chubb (CB Quote), Loews (L Quote), National Financial Partners (NFP Quote) (convertibles) and SLM (SLM Quote).

Energy: I'm dropping extended integrated oils and several oil service companies and keepng Transocean (RIG Quote) and select master limited partnerships.

Health Care: I'm going with select depressed HMOs, a true contrarian play!

Consumer Staples: Remaining are Procter & Gamble (PG Quote), General Mills (GIS Quote) and Unilever (UN Quote).

Industrials: I'm keeping 3M (MMM Quote), PPG (PPG Quote) and Union Pacific (UNP Quote).

Consumer Discretionary: I have dropped Wal-Mart (WMT Quote), Nike (NKE Quote) and Starbucks (SBUX Quote). Remaining are Home Depot (HD Quote), Lowe's (LOW Quote), Disney (DIS Quote) and eBay (EBAY Quote).

Materials: I'm dropping BHP Billiton (BHP Quote), and only Freeport-McMoRan Copper & Gold (FCX Quote) remains.

Utilities: Duke Energy (DUK Quote), Dominion Resources (DRU Quote) and PG&E (PCG Quote) remain.

Telecom: The model portfolio continues to hold Verizon (VZ Quote) and AT&T (T Quote).

Credit: I added SLM debt to the other select bank loans/debt and high-yield debt.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

At the time of publication, Kass and/or his funds were long MSFT, DELL, BAC, JPM, PNC, MET, PRU, HIG, CNS, CB, WRI (convertibles), SLG (convertibles), NFP (convertibles), SLM (straight debt), RIG, HD, LOW , DIS, EBAY and FCX, and short JPM calls, PNC calls, MET calls, PRU calls and HIG calls, although holdings can change at any time.

Getting Back What You Lost (NY Times)

July 26, 2009
Up 40%, but Still Feeling Down
By JEFF SOMMER
DEAR Shareholder:

While we are not satisfied with our performance in the last quarter, we are happy to report that we didn’t lose as much money as the average stock mutual fund.

That wouldn’t be a very sexy sales pitch: mutual fund managers don’t typically phrase their shareholder letters quite that bluntly.

But the truth is that for most investors, it’s more important to avoid big losses than to rack up big gains. That may seem a milquetoast approach, but in the miserable market of 2008 and early 2009, minimizing losses was the best that most people could do. And because of the ugly math of investing, it has been extraordinarily difficult to recover from big declines.

“People often don’t understand why they are still in a deep hole, even after they’ve had a year of great returns,” said John Bogle, the founder of Vanguard and the creator of the first index mutual fund. It is because when your portfolio shrinks substantially, you need an enormous gain, in percentage terms, to climb back to where you started. This is part of what Mr. Bogle (citing Justice Louis Brandeis) calls “the relentless rules of humble arithmetic.”

Here’s how the math works:

Suppose you lost 40 percent in 2008 — roughly the decline in the Standard & Poor’s 500-stock index. One dollar at the start of the year would have been worth 60 cents at the end. Then say that after that loss, you posted a gain of 40 percent (the rough increase in the S.& P. 500 from its March low through the middle of July). That’s a spectacular return.

Time to celebrate? Not really.

A 40 percent gain on 60 cents is 24 cents. Your original $1 is now only 84 cents — you’re still down 16 cents.
Mr. Bogle did some calculations based on the assumption that you invested $1 in the S.& P. 500 at its peak. By March this year, the index had dropped 57 percent, reducing your dollar to a mere 43 cents. After a 40 percent gain, your little stash was worth only 60 cents. Even worse, he said, is the “exponential factor” in losses and recoveries. If your initial investment fell 50 percent, you would need a 100 percent gain to return to the starting line. If you lost 75 percent, you would need 300 percent.

Although stocks tend to outperform bonds over the long haul, gains that big are hard to come by. And that, in a nutshell, is why it’s better to avoid big losses in the first place.
Hersh Cohen, chief investment officer of ClearBridge Advisors, a Legg Mason subsidiary, says he believes in this philosophy wholeheartedly. “Make sure you don’t get killed on the downside,” he said. That’s more important, he said, than “worrying about the upside.”
Mr. Cohen has managed the Legg Mason Partners Appreciation fund for 30 years, over which he has beaten the S.& P. 500, according to Morningstar. The fund has returned 11.9 percent annualized, compared with 10.9 percent for the index and 10.4 percent for the average large-capitalization stock fund. (For the last 14 years, he has co-managed the fund with Scott Glasser.)

Last year was “the worst in my career in 40 years of managing funds,” Mr. Cohen said. Partners Appreciation lost 29 percent, and he said he “went home depressed about it every night.” Still, that performance was much better than the overall market and a vast majority of stock mutual funds.

MR. COHEN focuses on companies with “superior balance sheets” and rising dividends. At the moment, in his estimation, those include Wal-Mart, Travelers, Johnson & Johnson, Cisco Systems and Berkshire Hathaway.
Mr. Cohen holds a doctorate in psychology — a background he calls most helpful in “market extremes.” He says he tries “to act on extremes — but to act the other way,” cutting back when the market is euphoric, and increasing his bets when others panic “and stuff is being given away.”

For his part, Mr. Bogle has reduced the risk of big losses by diversifying most of his own portfolio into safer fixed-income holdings — 80 percent of it — which, he said, is appropriate for his age. He is 80 and holds index funds, and while he remains bullish for the long term, he said that by being cautious he has enjoyed a “consistently good night’s sleep over the last few years.”

Safer Strategies for Retirement Portfolios (NY Times)

June 20, 2009
Your Money
For Older Investors, Old Rules May Not Apply
By TARA SIEGEL BERNARD
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.

But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)

This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.

The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.

But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.

So what should retirees and pre-retirees make of all of this?

“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”

What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.

Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.

But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement

Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.

Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.

But since retirees generally spend money on entertainment, health care and food — whose costs often exceed the general rate of inflation — he said he might invest 40 to 50 percent of their money in a portfolio of diversified stock funds (with at least 30 percent of that in international stock funds). But, he added, “Cash is risky, stocks and bonds are risky, life is risky.”

As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. “But I would take two years to do it,” he said. “Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally.”

And then? “Don’t touch it,” he said, emphatically. “One of my rules is don’t do something. Just stand there.”

Retirement

Several planners recommended different variations on a similar strategy for retirees. Set aside anywhere from eight to 15 years of your expected expenses — that includes food, utilities, housing, insurance — in bonds and cash. That way, you’ll never have to tap your stock holdings at the worst possible moment.
“Once you have that in place, you feel like you can weather any economic storm,” said Chip Simon, a financial planner in Poughkeepsie, N.Y.

When you have figured out how much it costs to live each year, the next step is to see how much Social Security will cover. Whatever is left needs to be financed by your retirement portfolio. And the general rule of thumb is that you shouldn’t withdraw more than 4 percent of your portfolio (adjusted for inflation) each year. There are different ways to invest your cash and bond holdings.

Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree’s tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.

Some advisers also say you can guarantee you’ll be able to cover your basic expenses by purchasing an immediate annuity from an insurance company. The annuity pays you a stream of income until you die. “You can buy four small ones from four insurers if you are worried about insolvency risk,” said Dallas L. Salisbury, president of the Employee Benefit Research Institute. “And if you are just worried about inflation protection, you can do TIPS.”

But you should probably delay any annuity purchases because payouts rise with interest rates. With current rates so low, and the possibility of inflation later, advisers said it’s best to wait a few years. You can also research inflation-adjusted annuities, but you’ll receive lower payouts in the beginning, Mr. Benningfield said, adding: “Less than most people can stomach.”

Investing - the New Normal (Bloomberg Opinion)

Gross, Grantham, Bogle Lift Lid on ‘New Normal’: John F. Wasik



Commentary by John F. Wasik

June 1 (Bloomberg) -- If this past year has taught investors anything, it is that conventional wisdom has suffered a thousand cuts.

Stocks don’t always beat bonds. It may not make sense to always have 60 percent or more in stocks and 40 percent in bonds. Stock markets may actually reward politicians.

Three pallbearers of the established canon are Bill Gross, the co-chief investment officer of Pacific Investment Management Co.; Jeremy Grantham, chairman of GMO LLC; and John Bogle, founder of Vanguard Group.

All are beacons in a troubled industry. When I caught their talks at the Morningstar Inc. investment conference in Chicago on May 28, I expected to hear dour forecasts. Yet I didn’t expect notes on the revolution that is undermining the beliefs that investors held during growth eras.

Gross, the world’s most successful bond-fund manager, described what his firm calls the “new normal” investing environment. While he sees “accelerating inflation” toward the latter part of a three- to five-year cycle, he says almost every accepted notion about investing should be examined.

Weak earnings growth translates into “getting used to a 301(k)” -- as opposed to a robust 401(k) -- retirement fund. Stocks won’t always outperform bonds and having dominant positions in equities may not make sense.
Changing Outlook

In Gross’s outlook, the dollar will lose its status as the reserve currency; Brazil, India and China (forget Russia) will offer the best growth; and the U.S. is “consumed out.”

“Everything in this new normal world should be questioned,” Gross said.

What is normal? Certainly not an environment that rewarded investors with 10 percent returns in stocks every year as Wall Street said it would before the dot-com, housing and credit crashes dashed that myth.

That means the accepted wisdom of having 60 percent to 80 percent in stocks may be obsolete and unprofitable. The only guarantees are that the U.S. government will be selling trillions in Treasuries; Americans may start seriously saving again; and the consumer economy may be shrinking long term due to the aging of the population.

Grantham, whose bearish views can often be amusing in the way he presents them, sees some reasonable values in the stock market now, although he’s not sure that a robust rally is in the offing. He also warns that “you can bet on” a bubble forming in emerging-markets stocks.
Grantham’s Optimism

Like many observers, Grantham also sees Americans saving more and consuming less.

“We forgot to save in the last decade because of home prices,” he said. “Now we’ll have to work longer and be more frugal in order to retire.”

Grantham’s only palpable stock-market optimism -- always in short supply in his forecasts -- is the third year of a U.S. presidential cycle.

“Historically, year three has outperformed years one and two by about 22 percent,” he noted. “And there’s never been a major bear market in year three of a presidential cycle.”

For most of us stung by the wretched returns of last year, though, 2011 is too long to wait. That’s why I prefer Bogle’s fundamental approach to portfolios. It doesn’t involve any charts and almost no forecasts.

Bogle says his formula is based on one’s age. The older you are, the more you should have in bonds, approximately matching a percentage of fixed-income investments to your age.

Sage Advice

As one who mostly takes his own advice, Bogle said his allocation produced only an 11 percent loss in his portfolio last year when others with higher percentages in stocks lost from 30 percent to 50 percent.
Of those who got scorched last year, “98 percent of all investors would be willing to swap places with me,” Bogle said.

In keeping with his bedrock views that passive investing through low-cost index funds prevails over time, Bogle eschews absolute return and commodity funds.

What each sage investor neglected to mention was an ever- greater need to customize portfolios not only to hedge market risks but personal labor-market risks as well.

Are you in a profession or industry that’s wobbly right now? Do you have the resources to retrain or re-educate yourself? At the very least, your savings and investments should support some vocational flexibility in these dynamic times.
That’s perhaps the only piece of conventional wisdom that hasn’t changed.

(John F. Wasik, author of “The Cul-de-Sac Syndrome,” is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net.

Last Updated: June 1, 2009 00:00 EDT

Why You Need Bonds in Your Mix (from dshort)

Retirement Income without Dividends (N Y Times)

April 1, 2009
Planning a Retirement Without Dividends
By TARA SIEGEL BERNARD

Many retirees have certain ideas about how they will occupy their days and how they will pay for it. Dividends are often a part of those plans.

But relying solely on regular checks from dividend-paying stocks or funds for retirement income is an outdated strategy, with little chance of supporting someone for, say, 30-years. This would be the case, even if dividends were not been disappearing at a record pace (as they have in recent months).
For one thing, relying on dividend payers will probably result in a portfolio that’s too concentrated in areas like financial stocks, which paid the most in dividends until recently. Financial companies accounted for more than 30 percent of the Standard & Poor’s 500 Index’s dividend income in 2007, but now account for just 10.6 percent.
Overall, constituents of the S. & P. cut nearly $42 billion in quarterly dividends this year, or 16.9 percent of 2008 payouts. That unprecedented decline followed another, of $15.9 billion, in the fourth quarter. “You are going to see significantly worse numbers this year, and there’s more bad news in the pike,” said Howard Silverblatt, senior index analyst at S.&P.

Even more disconcerting, especially for retirees, is that the cuts have come from many stocks that were once viewed as blue-chip stalwarts: General Electric, Bank of America, J.P. Morgan. And not only have many of these companies cut their dividends, but their stock prices have also dwindled. So retirees who were relying on the stocks for income may be forced to sell at the worst possible time.
“There is extreme danger in counting on a dividend strategy right now,” said Joel Framson, a financial adviser in Los Angeles. “In fact, too many of the decimated portfolios we are seeing in our new clients were caused by people thinking they could capture high dividend yields without taking risk.”

Of course, in these unpredictable times, there are no easy answers. Even the most diversified portfolios have taken devastating hits. But there are ways to structure your retirement portfolio so that you won’t be forced to sell investments at the most inopportune moments, as well as ways to create a paycheck, of sorts, in retirement.

TOTAL RETURN First, instead of focusing solely on dividend-paying investments, financial planners said that retirees should look at a retirement portfolio holistically. In financial adviser speak, this is known as a total return strategy, which includes drawing upon a collection of dividends, interest and capital gains (when they eventually return). You should devise an asset allocation based on your time horizon and tolerance for risk, among other factors. And all diversified portfolios will see the benefits of dividends — historically, they’ve accounted for more than 40 percent of stock market returns over the long haul.

In retirement, you withdraw a set amount of money from your portfolio each year, typically around 4 percent, and increase the dollar amount withdrawn each year to adjust for inflation. To ride out these tough economic times, many planners advise forgoing the inflation adjustment, or even withdrawing less. This is especially true for people who are still in the early years of their retirement and worried about outliving their savings.

FIVE-YEAR PLAN In the current environment, this strategy stands out. In the 1980s, Harold Evensky, president of Evensky & Katz Wealth Management, came up with what he calls a five-year mantra. Mr. Evensky believes you should not invest any of the money you’ll need in the next five years — whether it’s for living expenses or a large purchase or another anticipated expense.

Take a couple with a $750,000 retirement portfolio who needs $30,000 a year. Using Mr. Evensky’s strategy, they would set up three separate accounts. The first account would hold two years of expenses, or $60,000. About half of that money would be in a money-market account, while the balance would be in a short-term, high-quality bond fund (like the Vanguard Short-Term Bond Index). Each month, $2,500 ($30,000 divided by 12 months) would be automatically transferred from the money market fund into a second account — a local checking account — to pay their expenses.

“Knowing where their grocery money is coming from makes it a little easier,” Mr. Evensky said. “When things get bad, they will know they can look at it, they can touch it and they know they haven’t lost a penny.”

The third account, the investment portfolio, would hold the remaining $690,000. This money would be diversified among stocks, bonds and other asset classes based on the couple’s stomach for risk, age and overall goals. But part of the allocation would include at least three years of expenses in short-term bonds. If there isn’t a good time to replenish the cash account, the couple can tap the short-term bonds (that way, they don’t have to sell their investments when the markets are down). Otherwise, the cash account can be replenished through rebalancing the investment portfolio.

Mr. Evensky said he tested how this method might work during a period similar to the 1970s, when both stocks and bonds were decimated and inflation was rampant. His portfolio lasted 24 years, whereas a portfolio invested in 50 percent stocks and 50 percent bonds ran out of money after 20 years, and an all-bond portfolio ran dry after 12 years.

IMMEDIATE ANNUITIES With this type of annuity, you give a pile of money to an insurance company, and it provides you with a paycheck until you die. For a 65-year-old male, the payout rate is about 8 percent. So for every $100,000 that man purchases, he will receive $8,000 annually, according to New York Life. Women receive slightly less because they live longer. The payout will be less if you choose to adjust your payments for inflation. Of course, you need to choose an insurer carefully — especially now.

“The promise to pay lifetime income is only as good as the insurance company can deliver,” said Karin Maloney Stifler, a certified financial planner in Hudson, Ohio. “Investors must realize that annuities entail credit or default risk by the insurer.”

You can spread your risk by buying a few annuities from a few top-rated insurers and only buy up to the amount that the state regulator will insure in the event of a default. Ms. Stifler said that $100,000 is typical. The big downside with annuities, of course, is that you cannot get your money back. And if you die shortly after you buy the annuity, your heirs will get nothing.

How much annuity do you need? Generally, you shouldn’t put all your nest egg into an annuity. One approach is to tally up your essential living expenses (housing, health care, groceries, etc). Then, figure out how much reliable income you have from Social Security, for instance, or a pension. If there’s a gap between the two, it may make sense to purchase an annuity to fund the difference, Ms. Stifler said.

PAYOUT FUNDS These mutual funds, which are intended to provide retirees with an income stream during retirement, have only hit the market in the past 18 months or so. There are generally two types of funds, though they’re all generally funds that invest in other funds. The first type operates much like a university endowment: it aims to generate a stable income stream — say, 3 or 5 percent — while either preserving or increasing the initial investment. Vanguard and Schwab offer funds in this mold. The second type of payout fund also aims to generate income, but only until a specified date in the future, when the remaining money, if any, is completely distributed. The Fidelity Income Replacement Funds use this methodology.

But when a fund performs poorly, the income generated will also fall. In some cases, the funds will begin to return your principal. That’s why some experts say these funds will more likely be used to cover discretionary expenses. Given the complexity of these funds, you really need to understand them fully — and the supporting role they should play in your portfolio — before jumping in.

“They are all interesting approaches, but they are unproven,” said Dan Culloton, associate director of fund analysis at Morningstar Inc. “You can lose money, and people have thus far. But they are an interesting proposal for someone who wants to turn their nest eggs into a stream of payments and have some control over the assets and the ability to take money out.”