What's in Your Retirement Account? NY Times on Dividend Stocks

June 16, 2010
Dividends Like BP’s Look Safe, Until They’re Not
By RON LIEBER

If you own BP shares and rely on the dividends for your retirement income, you now matter less than shrimp boat owners and tourism workers in the Gulf of Mexico. That’s the net result of the announcement on Wednesday that BP will suspend its dividend and set aside money for cleanup costs and the compensation of workers who have lost income because of the oil spill.

Whether the federal government was right to pressure BP to make this move (and whether BP should have buckled) is a question for the ages. But if you’re an investor in BP and rely on dividend income to pay your daily expenses, this should serve as another reminder that relying on one stock or even a handful of stocks is incredibly risky.

We’ve seen this movie before. Wachovia disappeared, hobbling many investors who counted on its dividends. Other big banks reduced their payouts drastically in the depths of the financial crisis. General Electric slashed its dividend as well.

This should have been a warning for anyone making big retirement bets on a single stock or a handful of stocks. Things that seem stable can wobble and collapse before our very eyes. And now it’s happening again.

It’s not supposed to work this way, at least in the minds of the many investors of the old school. To them, a stock that pays a dividend is a stock that is safe. “It told them that a company was still around and operating, it was in good health,” said Milo M. Benningfield, a San Francisco financial planner.

Just because a company pays a dividend now is no guarantee that it will forever, or that the company will even continue to exist. Nor is it any guarantee that the underlying stock is stable.

Still, plenty of people strap on the blinders and maintain their faith in the stocks they think they know well. A frightening article in the trade newspaper Pensions & Investments on Monday estimated that BP employees and others in the company’s 401(k) plan had lost more than $1 billion from the stock’s decline in the wake of the spill.

How can the loss be so high? Well, 29 percent of the plan’s assets were invested in BP stock as of last September. This, sadly, is yet another violation of the too-many-eggs-in-one-basket rule that company plan sponsors should have had inscribed in stone for employees — even before the Enron collapse and the resulting devastation in employee retirement accounts there.

Employees or retired employees are not alone. Devotees of white-hot companies (Apple comes to mind) simply refuse to believe that anything bad could befall the stock. Retirees reliant on dividend income may be averse to change if a stock has paid out regularly for decades. Others may have inherited a big slug of stock and may simply not know any better. Then there are those who are so tax-averse that they won’t diversify their holdings because they don’t want to give up some of their winnings to capital gains taxes.

If you know people who might fall into these categories, please do them a favor and send them to a financial planner post-haste if you can’t talk some sense into them yourself.

Or you could simply try to scare them. Very few people saw a spill of this magnitude coming, just as only a small number could have predicted a few years back that financial stocks would go from contributing 29 percent of the dividend payments of S.& P. 500 payments in 2007 to just 9 percent in 2009.

Today, consumer staples stocks contribute more than any other sector, according to Howard Silverblatt of S.& P. How might that sector or parts of it deteriorate? A prolonged terrorist campaign against large American retailers could begin, or a blight could emerge that wipes out a large percentage of the nation’s crops.

These things are unlikely but entirely possible, and they wouldn’t be a total surprise. Tempted by utilities? Mr. Benningfield suggested contemplating the remote possibility of solar flares frying the power grid.

As of Wednesday, there is now political risk to consider, too. Now that there is a recent precedent, legislators could again try to bully a company into suspending its dividends.

And if that weren’t worry enough for dividend fans, we must also rely on those same legislators to sort out our tax policy. Currently, no one pays more than a 15 percent federal tax on dividend income. If Congress does not act before the end of the year, however, investors will start paying much higher ordinary income tax rates on dividends come 2011. “Where it will wind up, no one knows,” said Kenneth L. Powell, a tax partner at the accounting firm Berdon L.L.P. in New York. Wealthier investors, meanwhile, may pay even more once a 3.8 percent Medicare tax on unearned income begins in 2013.
Everyone needs income in retirement, and dividends aren’t a bad way to get it as long as they don’t come from a single company. Again and again, we’ve seen out-of-nowhere scandals and crises and accidents bring big companies to their knees. Why, given the overwhelming evidence that these things do happen once in a while, would you not extract your dividend income from a low-cost, broadly diversified mutual fund that specializes in dividends?

The moral of the story, as always, is to diversify within each asset class you own, whether it’s dividend-paying stocks or municipal bonds or the emerging-market countries where you’re rolling the dice for big gains. Then, diversify your retirement income, too. The more sources the better, whether it’s dividend income, interest income, annuity income, rental income or periodic (and tax-savvy) outright sales of stocks or other assets.

Even this sort of diversification might not have protected you from the pain in 2008. But it can shield you from the ruin of betting too heavily on a single security like BP.

the Declining Dollar - Hedge Your Portfolio (Barrons)

Foreign-Reserve Bingo
By ROBERT FLINT
What investors seek as they exit dollar-denominated assets.



INVESTORS OF ALL STRIPES NEED TO BRACE THEMSELVES for a world in which the U.S. dollar no longer plays the dominant role.Although the greenback will remain the currency of choice in trade and finance for many more years, signs have already emerged that changes are under way.

Governments abroad have grown increasingly skeptical about the dollar as a store of value for their national reserves. China, Russia and others have expressed concern about their dollar-denominated holdings because of the budget deficits the U.S. faces in financing bailout and stimulus measures.
Some countries have taken steps to reduce the proportion of their reserves held in dollar-denominated assets by switching to investments that will hold their value as consumer prices rise.
The U.S. decision announced Wednesday to boost sales of Treasury inflation-protected securities, or TIPS, is largely seen as a nod to China, the world's largest holder of U.S. government debt.


The search for alternatives to the greenback, while still in its early stages, will eventually have broad implications. Diversification of foreign-exchange reserves is no longer an issue solely for central banks and monetary authorities.

So where does that leave individual investors? Is there such a thing as a diversification play?

There is, say analysts, but it's more a long-term strategy. The dollar's allure has been tarnished, but any significant shift away from U.S. assets by central banks will take years.

"It won't happen overnight," says Andrew Busch, global foreign-exchange strategist at BMO Capital in Chicago.

There's still no other country or region that can match the liquidity and depth of U.S. capital markets. The dollar will continue to play a key role in the placement of foreign-exchange reserves until a viable alternative emerges. So far, there's been no evidence of any officially sanctioned dumping of the dollar.

One strategy for investors would be to mimic central banks and slowly move more of their holdings into non-dollar-denominated assets. The euro is most obvious option, at least in the short run, says Busch.

James Trippon, editor of the China Stock Digest, suggests investors can position themselves to benefit from inflation and a declining dollar through commodity-related plays in energy, metals or even foodstuffs. Australia and New Zealand, with commodity-based economies, stand to benefit as the world economy heals and growth speeds up again in China.
Another option would be American depositary receipts of Chinese corporations in the energy, banking or insurance sectors, Trippon says.

For private investors as well as central banks, it amounts to slow and careful diversification away from the dollar. Coping with a less-than-almighty dollar is an unnerving prospect for many Americans, but one they are bound to face.




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Investing in Energy using ETFs (from Investopedia.com)

ETFs Provide Easy Access To Energy Commodities
by Rich White

If you fill up a car with gasoline or heat a home with oil or natural gas, you know that rising energy costs have put a dent in your budget. But do you also know how easy it is to buy shares in a brokerage account or IRA that can help you hedge energy commodity price increases?
This article will help investors understand the benefits of investing in energy commodity ETFs and detail choices available to interested investors. It specifically covers investments that seek to track commodities prices - not ETFs that invest in energy sector stocks, in which investment returns are influenced by the overall direction of the stock market and do not always mirror energy commodities prices.

Welcome to the World of ETFs
In recent years, thanks to the growth of exchange-traded funds (ETFs), ownership of energy-sector commodities has become more accessible for individuals. For example, buying one share of the U.S. Oil Fund ETF (AMEX:USO) gives you exposure roughly equal to one barrel of oil. If oil prices rise by 10% in a given period, your investment should theoretically appreciate by about the same percentage. You can own oil through this ETF without incurring the cost normally associated with storage or transport. The only costs that you will pay include brokerage fees to buy and sell shares plus a modest ongoing management fee.
USO is not mentioned as a specific investment recommendation. It is significant because it was the first energy commodity ETF introduced, in February of 2006, and remains one of the most popular by asset size and trading volume. Since USO's introduction, ETF energy commodity choices have greatly expanded.
Why invest in energy commodity ETFs?
ETFs are traded on exchanges (like stocks), and shares may be bought or sold throughout the trading day in large or small amounts.
At the heart of the "energy complex" is crude oil and products refined from it, such as gasoline and home heating oil. Natural gas is a by-product of oil exploration and a valuable product in its own right, used throughout the world for heat and power generation. Lesser products in the energy complex include coal, kerosene, diesel fuel, propane and emission credits.

Energy commodity ETFs can be useful tools for constructing diversified investment portfolios for the following reasons:

1. Inflation hedge and currency hedge potential - Energy has recognized value all over the world, and this value does not depend on any nation's economy or currency. Over time, most energy commodities have held their values against inflation very well. For example, the spot price of a barrel of crude oil increased at an average annual rate of 6.5% per year from 1950 through 2007. Over the same span, the annualized increase in the U.S. Consumer Price Index was 3.9%. Energy prices tend to move in the opposite direction of the U.S. dollar - prices increase when the dollar is weak. This makes energy ETFs a sound strategy for hedging against any dollar declines. (To read more on currency ETFs, check out Currency ETFs Simplify Forex Trades.)

2. Participation in global growth - Demand for energy commodities keeps growing in industrializing emerging markets such as China and India. In 2007, as in most years, the U.S. consumed about 25% of the world's 85 million barrels of total daily oil production, and U.S. consumption has been increasing by about 3% per year, according to the International Energy Agency. Some experts believe that it will be difficult for global oil production to grow in the future due to dwindling reserves, especially in Saudi Arabia. In addition, several of the world's leading oil export nations (ex. Russia, Iran, Iraq, Venezuela and Nigeria) are politically volatile and could be unreliable as future sources of supply.
3. Portfolio diversification - According to modern portfolio theory, investors can increase portfolio risk-adjusted returns by combining low-correlating assets in which returns do not tend to move in the same direction at the same time. However, few asset classes accessible to individual investors have consistently produced low correlations with U.S. stocks. Correlations are measured on a scale of 1 (perfect correlation) to -1 (perfectly negative correlation). Oil is among the few asset classes that have consistently produced very low (or negative) correlations with U.S. stocks. According to FactSet, the correlation between oil futures and the S&P 500 Index was -0.31 for the five-year period 2002-2007. For this reason, investors can expect oil commodity holdings to help diversify and balance stock-heavy portfolios.


4. Backwardation - Backwardation is the most complex (and least understood) benefit of some energy commodity ETFs. These ETFs place most of their assets in interest-bearing debt instruments (such as short-term U.S. Treasuries), which are used as collateral for buying futures contracts. In most cases, the ETFs hold futures contracts with the least time left to delivery - so-called "short-dated" contracts. As these contracts approach the delivery date, the ETFs "roll" into the next shortest-dated contracts.

Most futures contracts typically trade in contango, which means that prices on long-delivery contracts exceed short-term delivery or spot prices. However, oil and gasoline historically have often done the opposite, which is called backwardation. When an ETF systematically rolls backwardated contracts, it can add small increments of return called "roll yield", because it is rolling into less expensive contracts. Over time, these small increments add up significantly, especially if backwardation continues.
Although this explanation may sounds highly technical, roll yield historically has been the dominant source of investment return in oil, heating oil and gasoline futures contracts. According to an analysis by author and analyst Hilary Till, long-term annualized returns of these futures contracts exceeded spot prices significantly, as shown in Figure 1, below, and the major reason for this differential was backwardation roll yield.


Annualized Returns from 1983 to 2004
- Futures Contract Spot Price
Crude Oil 15.8% 1.1%
Heating Oil 11.1% 1.1%
Gasoline (since Jan. 1985) 18.6% 3.3%
Source: "Structural Sources of Return and Risk in Commodity Futures Investments" by Hilary Till(Commodities Now, June 2006)
Figure 1


It should be noted that these energy contracts occasionally move from backwardation to contango for intervals of time. During such times, roll yield may be lower than shown in the table; they may even be negative. Historically, natural gas has not shown the same tendency toward backwardation and roll yield benefit as the three contracts listed in the table.
Types of Energy ETFs
Energy ETFs can be divided into three main groups:

Single contract - These ETFs participate principally in single futures contracts. For example, the iPATH S&P GSCI Crude Oil Total Return Index (NYSE:OIL) exchange-traded note (ETN) participates in the West Texas intermediate (WTI) light sweet crude oil futures traded on the New York Mercantile Exchange. Note: An ETN is an exchange-traded note, a structure that works much the same way as an ETF. PowerShares DB Oil Fund (AMEX:DBO) participates in the same WTI contract.

USO, the pioneering energy commodity ETF, is a subject of some controversy because it nominally participates in a single contract (WTI), while also dabbling in several other energy complex contracts. Therefore, most investors do not consider it be a pure single-contract ETF.
Multi-Contract - These ETFs offer diversified exposure to the energy sector by participating in several futures contracts. The iShares S&P GSCI Commodity-Indexed Trust (NYSE:GSG) has about two-thirds of its total weight in the energy sector and the remaining one-third in other types of commodities. It tracks one of the oldest diversified commodities indexes, the S&P GSCI Total Return Index.

PowerShares DB Energy Fund (AMEX:DBE) is a pure energy sector fund diversified across commodity types. It participates in futures contracts for light sweet crude oil, heating oil, brent crude, gasoline and natural gas. The ETF seeks to track an index that optimizes roll yield by selecting futures contracts according to a proprietary formula.

Bearish - Energy sector commodities can be volatile, and some investors may want to bet against them at times. The first "bearish" energy commodity ETF is Claymore MACROshares Oil Down tradable Trust (AMEX:DCR). It is designed to produce the inverse of the performance of WTI oil. This ETF is one-half of a pair of MACRO shares, a concept through which two ETFs are issued together but traded separately to track, respectively, the up and down movements in a commodity. (The other half of this pair is Claymore MACROshares Up tradable Trust (AMEX: UCR).
Final Points
While ETFs have made energy sector commodities more accessible to investors, it's important for investors to understand the mechanics of how individual ETFs work. Specifically, investors should realize that virtually all of these ETFs participate in futures contracts, and the "roll yield" of these contracts can be a major source of positive or negative return, depending on patterns of backwardation or contango. Multi-contract ETFs such as GSG and DBE can be a good way to add broad energy exposure across multiple contracts. But at times, some of these contracts may be in backwardation (producing positive roll yield) while others are in contango (producing negative roll yield).
For investors who own stock-heavy portfolios denominated in U.S. dollars and wish to increase diversification and inflation-hedge potential, some energy sector exposure may be advisable. However, it's a good idea to have a long-term horizon for such investments because they can be volatile over brief periods. Crude oil can be an especially valuable commodity for adding diversification because it has consistently produced negative correlations with U.S. stocks.

Safety First (from Barrons)

Monday, September 15, 2008




Retirement: Safety First
By KAREN HUBE

Risk experts explain how to keep your nest egg from cracking in shaky markets. Also, which investments offer the most stable returns during slumps? And, exotic real estate -- with an American twist.

THESE ARE SCARY TIMES FOR INVESTORS TRYING to protect and increase their retirement portfolios. With stock prices gyrating and major financial institutions crumbling, the mattress may look like as good a place as any to stash your holdings.

Not so fast. Take it from five titans of risk management: There are steps you can take to protect your nest egg for as longs the tumult lasts -- steps that will make sharp market dips much easier to endure.

Even better, without sacrificing those safeguards, you can position your retirement funds to participate in the earliest gains as the stock market begins to recover. And yes, these experts say, the market will recover.

So heed the practical advice and recommendations of the intellects whose views you'll read on the following pages -- Barton Briggs, Peter Bernstein, Charles Ellis, David Darst and Jeremy Siegel -- and reserve that mattress for some peaceful sleep.


Brad Trent
Peter Bernstein
Founder, Peter L. Bernstein Inc.

After almost six decades of contemplating market risk, Peter Bernstein knows how to spot investors' worst-case scenarios before they do. These days, what he sees concerns him deeply.





As the current economic crisis unfolds in ways that even the most bearish Wall Street strategists never predicted, Bernstein says any number of disasters could still be in store for investors. For those saving for retirement, in particular, taking protective measures is critical.

"The goal for investors right now should be survival, not making a killing," says Bernstein, who has been an economics professor and money manager, and is the author of several books, including Against the Gods, a classic on risk. "You should be thinking about how to hedge against extreme outcomes."

With markets down and unemployment and home foreclosures rising, what more could happen?

"A major bank failure, causing a run on banks in general," Bernstein speculates. Or "a run on the dollar, perhaps provoked by what foreigners view as too big a fiscal deficit."

Or runaway inflation or deflation, either of which could be disastrous for long-term retirement investors.

The next step of this crisis is hard to predict, Bernstein says, because the crisis is so unusual. "Nothing like this has ever happened before," he continues. "There have been credit crunches and housing crises and dollar crises, but having all the chickens coming home to roost at the same time and interacting with one another is unique. We have historical perspective on the parts, but not the whole, and that makes things both interesting and scary."

He suggests diversifying a portfolio so that it is not only exposed to many different markets, but also to ensure it can weather all kinds of scenarios.

For example, to guard against rampant inflation, every portfolio should contain at least a sprinkling of Treasury inflation-protected securities and short-term Treasuries, Bernstein suggests.

The TIPS come with a guaranteed return above inflation, and short-term Treasuries enable you to roll your money into higher-yielding issues every 90 days if inflation rises and interest rates follow.

"Short-term Treasuries aren't a very good holding under normal conditions, but they are a hedge against extreme conditions," Bernstein says. Long-term Treasuries are a good hedge against deflation, he adds.

Bernstein also recommends holding some gold as a hedge against a collapse in the value of the dollar if China or other nations decide they no longer want to invest as much in U.S. Treasuries. "In a total disaster, where there is a run from paper currency, you'll get your biggest bang for your buck in gold," he says.

You don't have to buy much gold to have an effective hedge, he adds, noting that "if everything hits the fan, gold could be worth several thousand dollars an ounce." It is now valued at about $750 an ounce.

Above all, don't let your defensive attitude waver, Bernstein counsels.

"Every day, we are faced by the possibility that something we never dreamed of will happen," he cautions.

"In 1958, I'd been in the business for seven years when, for the first time in history, bonds yielded more than stocks. My associates said, 'It's an anomaly, don't worry, it will be reversed.' It's 50 years later, and I'm still waiting."


Gary Spector
Charles Ellis
Founder, Greenwich Associates

In Japan, investors fill their stock portfolios primarily with Japanese companies. The French place their biggest bets on French companies. The story is the same in New Zealand, India, Russia, and around the globe: Investors favor their own countries' stocks.

For U.S. investors it's easy to criticize foreign investors for being provincial. But Charles Ellis, a former chair of Yale's Investment Committee and a consultant for institutional investors, has a suggestion for them: Look in the mirror.

The typical U.S. investor holds at least 85% of his stock portfolio in domestic stocks, even though the U.S. stock market accounts for only 40% to 45% of the world's total stock-market value.

"People feel more comfortable emphasizing their own country, because they recognize the company names," says Ellis, whose internationally renowned book is Winning the Loser's Game. "But from a pure investment point of view, it doesn't do any good" -- particularly for folks investing for retirement and other long-term goals, he says.

A U.S.-centric stock portfolio creates high levels of volatility, and denies investors the benefit of surging markets around the world, Ellis notes.

The best risk-adjusted returns over the long term can be scored by matching the market capitalization weightings of the world's markets, Ellis says. That would mean putting 45% in domestic stocks, 47% in developed foreign markets and 8% in developing foreign markets.

The idea is to have no bets on whether one market or another will be stronger in coming months.

"If you said, 'I don't really have a smart idea about the direction of the markets, I'm just a sensible person, what should I do?,' the answer is to go to a global index and start there," Ellis says. "If you have reason to make any changes from there...then you can adjust it from a neutral to an opinionated portfolio."

Traditionally, investors have been hesitant to plunge more deeply into foreign markets -- because of perceptions that foreign-currency exposure presents too much risk, foreign companies don't get enough oversight from their governments, and foreign markets are simply too volatile.

To Ellis, however, the truly global allocation of assets trumps all those concerns.

"There really is a free lunch, and it's called diversification," he says. "By diversifying, you reduce your risk substantially. It doesn't cost anything, and you get something for it."


Evan Kafka
Barton Biggs
Managing Partner, Traxis Partners

When the herd zigs, Barton Biggs zags. So it shouldn't be a surprise that while U.S. investors can't dump their technology stocks fast enough these days, Biggs has been declaring that now is the time to get into the trampled tech sector.

The best values right now, he says, are in large-cap, high-quality stocks around the world, "but particularly in the U.S., and within that category, technology appeals to me the most."

Biggs, co-founder and managing partner of the $1.3 billion hedge fund Traxis Partners in New York, is the former global investment strategist at Morgan Stanley.

"We've been in a period of stagnation in terms of tech spending since the bubble burst in 2000. The next recovery is going to be marked by unusual spending in all types of technology...and the sector will be one of the first areas to pick up as the U.S. and the world begin to recover," Biggs says.

A market recovery, he believes, will begin in the first half of 2009. By then, oil prices should be consistently below $120 a barrel, and the housing market should have started stabilizing.

Due to the government's takeover of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) -- which he characterizes as "one of the most important events of the last 20 years" -- further declines in home prices are likely to be more moderate than expected earlier.

But don't wait for an economic recovery in order to step into large domestic stocks and global tech stocks, or "the markets will already be up," Biggs says. "I wouldn't be surprised if later, in retrospect, we will find that the stock market is at its bottom about now."

Biggs is a notoriously trend-bucking strategist, which has sometimes paid off massively for those who follow him. In the late 1990s, he spared his clients huge losses by predicting the technology-driven bull market was going to plummet. And in 2003, when investors were steering clear of Japan, he moved into the Japanese stock market, adding untold wealth to clients' portfolios in the following three years as Japan soared.

Today, while many Wall Street strategists are recommending an underweighted position in stocks, Biggs is defiantly upbeat." The public has been selling stocks and has an incredible amount of liquidity, and so have institutions and hedge funds," he says.

"The fact that everyone is cautious has raised a lot of investable funds, and that's bullish," he adds. "We're in a stage where ordinary investors ought to be buying on weakness," says Biggs.

Some of his top picks: Cisco (CSCO), IBM (IBM) and Google (GOOG).

Biggs is steering clear, for now, of stocks in the materials, energy, agricultural and industrial- and oil-commodity sectors, but notes that "those will come on strong again -- but not until further into the recovery."


Dave Moser
Jeremy Siegel,
Professor, Wharton School

To most investors, dividend-paying stocks seem about as cutting edge as a corded telephone. Yet Jeremy Siegel talks about stock dividends with the enthusiasm and sense of discovery of a first-time iPhone user.

Through his recent research, Siegel, a finance professor at the University of Pennsylvania's Wharton School of Business, has become enamored of the dividend, and hopes to elevate its status from a humdrum staple for retirement-income seekers to a punch-packing contributor to younger investors' retirement portfolios.

He argues that the tendency of investors to look solely at the growth rates of earnings, sales and cash flow hurts them in the long run. The bias toward high-growth companies causes them to miss out on the high dividend-paying companies whose total returns, contrary to popular perception, have historically outshined the performance of growth stocks over time, he says.

"Everyone thinks it's old-fashioned to think about dividends, but investors have historically gotten about an extra two or three percentage points a year of higher returns by investing in the highest dividend-yielding stocks and reinvesting the dividends," says Siegel, author of The Future for Investors, Stocks for The Long Run, and other books.

One of his most striking examples is the difference in fortunes between people who invested in IBM rather than Standard Oil, now ExxonMobil (XOM), in 1950. Over the next five decades, through 2003, IBM trounced Standard Oil in per-share growth of revenue, dividends and earnings. But Standard Oil had a higher total return: A $1,000 investment in Standard Oil would have grown to $1.26 million with dividends reinvested, compared to $961,000 -- 24% less -- for IBM investors. "And that was before the recent energy price increases," Siegel says.

While financial companies historically have been reliable dividend payers, the dividends on Fannie Mae and Freddie Mac have been halted, and 21 financial-services firms have cut their payouts since the beginning of this year, according to Standard & Poor's. In a typical year, two or three financial firms cut their dividends, but the majority of them increase their payouts.

Long a supporter of index investing, Siegel now favors index funds that rebalance on a dividend-weighted basis. Siegel is a senior investment strategy adviser at WisdomTree, which has developed a series of funds that operate this way.

A dividend-weighted index rebalances regularly to favor stocks that pay the highest dividend. Most indexed portfolios, in contrast, rebalance based on the market capitalization of the stocks. With a dividend-weighted index, investors end up buying stocks when their prices are low relative to their fundamentals. A high dividend yield is a strong indication that a stock is undervalued, Siegel says.

Throughout history, dividend-paying stocks have gotten the spotlight. When the tech bubble burst in 2000, many investors sought out dividend-paying stocks to try to steady their portfolios. In 2003, payouts got a boost when the tax rate on dividends was changed to the 15% capital-gains rate, versus the higher income-tax rates.

Some of this tax benefit may get rolled back if Sen. Barack Obama (D.-Ill.) is elected president; he has said he would raise the dividend tax rate to 20% -- "but that's still a preferred rate," Siegel points out. He adds that investors who keep a steady spotlight on the high dividend-paying stocks in their portfolios are likely to have a brighter retirement.


Gary Spector
David Darst
Global Wealth Management Group,
Morgan Stanley

David Darst is the Iron Chef of the investment world. As chief investment strategist at Morgan Stanley's Global Wealth Management Group for the past 11 years and one of Wall Street's foremost experts on asset allocation, Darst spends much of his time considering the perfect ingredients -- of a portfolio, that is. He takes a little of this, blends it with a little of that, and -- voilà! -- produces nourishing retirement portfolios.

Investors who have seen the air sucked out of their retirement portfolios lately might need convincing. The problem in the typical portfolio, Darst suspects, is that most people skimp on alternative investments like commodities, real estate and hedge funds.

"The perception is that they're too risky, but we view the benefits of alternatives more by the reduced volatility they bring to a portfolio than by an increased return," says Darst, who recommends that folks with $1 million to $20 million to allocate 20% to alternative investments, and those with less, 8%.

While any particular alternative investment may, indeed, be more volatile than the broad stock or bond markets, a portfolio diversified across stocks, fixed income, and a number of different alternatives will likely be less risky than one with fewer asset classes -- and it may even score higher returns, Darst says.

Consider a portfolio with 40% invested in stocks and the rest split between commodities and real estate. That may sound risky, but according to Ned Davis Research, in the 35 years through 2007, such a portfolio had the same risk as a portfolio with 40% invested in stocks and 60% in bonds. Yet it gained almost two percentage points more per year -- 12.47% versus 10.5%.

Within an alternative-investment portfolio, Darst recommends a 50% weighting in hedge funds, which gives investors the potential to benefit from talented money managers who have the freedom to invest where and how they see fit, without constraint.

Some 20% should be in real assets, such as commodities and gold. Both provide a hedge against inflation, and gold in particular has been a historic refuge in times of turmoil in the financial markets, political instability, or other crises.

Another 20% should be directed to managed-futures funds, Darst says. These invest by going long or short futures contracts in a broad basket of commodities and other investments, including metals, grains, sugar, foreign currencies, stocks and bonds.

Managed-futures funds provide a cushion to portfolios in down markets, because they typically are inversely related to the stock market, Darst says.

During the period 2000 to 2002, when the tech bubble burst and the Standard & Poor's 500 cratered 31%, the Barclay CTA Index of Managed Futures Funds was up 20%. In the fourth quarter of 1987, when the U.S. stock market crashed and the S&P 500 lost 22.5%, the Barclay index was up 13.8%. This year through August, the S&P 500 was down 14%, while the Barclay index was up 6.95%.

Lastly, Darst recommends placing 10% of a portfolio in Treasury inflation-protected securities to get their risk-dampening benefits, Darst says.

While he has usually included real estate in the alternative-investments portfolio through direct investments or REITs (real-estate investment trusts), he predicted enormous volatility in the sector last December and made a tactical move to eliminate real estate from his models.

For the average investor, however, it would take a rare event to prompt the removal of an asset class from the alternative-investments portfolio, because that could mean missing its next surge.

Says Darst: "You want to have all of your relatives at the table. Not just the 17-year-old singer in the family that everyone has always listened to, but the quiet nephew who turns out to win the Pulitzer Prize."

Follow advice like that, and investors themselves just might take home a prize.


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from Sun NYTimes Business Section - How to Survive Bear Market

July 6, 2008
Fundamentally
A Bear Market, Mauling Not Included
By PAUL J. LIM
WITH the Dow Jones industrial average and the Nasdaq composite index down about 20 percent from their recent highs, this sure looks like a bear market.

But does it feel like one yet? Before you answer, check how your overall portfolio has performed lately. You’re probably not happy with the returns — but if you have been a conservative, diversified investor, you may well be doing better than the overall stock market. “In most cases, the experience of your own portfolio is not what you’re reading in the headlines,” said Stuart L. Ritter, a financial planner at T. Rowe Price in Baltimore.

To be sure, this has been a particularly painful nine-month span, marked by a historic credit crisis, record-high oil prices, heightened inflation fears and perhaps even a recession. And considering that many foreign markets — like China, India and much of Europe — have declined sharply, there is a growing sense among investors that there is no place to hide.

But most individual investors don’t invest all their money in stocks. They put a portion of it into bonds, in part to stabilize their portfolios in a market storm.

This old-fashioned diversification has demonstrated its value. From the start of October 2007 — around the peak of the domestic stock market — to the end of June, a portfolio of 70 percent stocks and 30 percent bonds fell just 9 percent, according to the research firm Morningstar. The stock portion mirrored the Standard & Poor’s 500-stock index, while the domestic bond allocation was based on the Lehman Brothers Aggregate Bond index.

You would have fared even better if you had been gradually putting money into the stock market, a strategy known as dollar-cost averaging. In a falling market, this offers another form of ballast: it means that investors are buying new shares at ever-lower prices, thereby averaging out the returns they earn on each pot of new money.

“Times like these should remind people of the importance of the basics — like having a long-term asset-allocation strategy,” said Liz Ann Sonders, chief investment strategist at Charles Schwab.

Investors might also want to remind themselves of the following three basic rules:

DON’T PANIC Downturns like this one may be painful, but “they’re a normal part of the market,” Mr. Ritter said.

Generally, the market has experienced a 20-percent-plus pullback every five years or so since 1900, according to James B. Stack, editor of the InvesTech Market Analyst newsletter. Some market strategists, including Ms. Sonders, say they think this downturn won’t be as severe as the bear market of March 2000 to October 2002, which cut the Standard & Poor’s 500 in half and erased nearly 80 percent of the value of the Nasdaq index. That bear was marked by sky-high stock valuations amid weak corporate fundamentals. This time around, corporate balance sheets — with the exception of financial companies — are in decent shape and price-to-earnings ratios are generally in line with historical standards, Ms. Sonders said.

“So I don’t think we’re necessarily going to suffer the same type of market pain as the last time,” she said.

STAY PROPERLY DIVERSIFIED This means not only owning different types of stocks, but also committing a permanent portion of your portfolio to fixed-income investments.

Why? Bonds can be a remarkably valuable part of a portfolio when stock prices decline.

Peng Chen, president and chief investment officer of the investment advisory firm Ibbotson Associates, recently studied the diversification benefits of various assets under different market conditions. He found that when domestic stocks went south, there was a tendency for many other investments to follow suit.

In a recent article in the journal of the CFA Society of the United Kingdom, “Re-evaluating Asset Allocation in a One-Basket World,” he found that correlations between the S.& P. 500 and foreign stocks increased in periods when the American index declined. By contrast, the correlation between American bonds and stocks fell to virtually zero in months when the stock market declined, according to Ibbotson. That makes bonds, as an asset class, an extremely effective buffer when the stock market is shaky.

STAY THE COURSE “Sticking to the original plan is the best course of action,” said Alison Borland, the defined-contribution consulting practice leader for Hewitt Associates.

History certainly bears this out. Say you were dollar-cost averaging $1,000 a month — with 70 percent going into S.& P. 500 stocks and 30 percent into a diversified basket of bonds — during the bear market from 2000 to 2002. While the market slide reduced the value of the stocks around 50 percent, the value of the new investments you made during that period would have fallen about 14 percent during this stretch, according to Morningstar.

Moreover, by continuing to invest through the bad times, investors set themselves up to bask in the long bull market that started in October 2002.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

How Understanding Sectors Can Help to Minimize Risk - WSJ article by Chris Kenney

SHAREHOLDER SCOREBOARD
How to Weather Turbulence
What investors can glean from the Scoreboard; one key: understand relative risk among sectors.

By CHRIS KENNEYFebruary 25, 2008; Page R2
Investors are worried. The Dow Jones Industrial Average ended last year 6.4% below its October record close and has fallen further since then. The housing market is in turmoil, banks are posting big losses and economic growth may be about to grind to a halt.
What can the Shareholder Scoreboard offer investors as they weather market volatility and recession concerns and need to reassess their investment strategy?
The Shareholder Scoreboard was developed in 1996 to provide investors with a long-term perspective on the creation of value in the stock market. For various time periods, it reflects the trends, bubbles, corporate winners and laggards that have affected investor returns. But given the rising uncertainty in the economy today, it is likely that investors are much more concerned with the immediate future.
THE JOURNAL REPORT

Best Performers (1, 3, 5, 10-Year)
Worst Performers (1, 3, 5, 10-Year)
• See the complete Shareholder Scoreboard report.
FINDING THE COMPANIES THAT SHINE

PODCAST: Chris Kenney of L.E.K. talks with the Journal's Georgette Jasen about some of the main themes in this year's rankings, using the Scoreboard as a starting point for looking at companies and sectors, and other topics.

Although stock-market history clearly has limits in its ability to inform us about the future, there are several investment insights to be gleaned from this year's Scoreboard that may help investors calm their nerves and balance their portfolios as they look at 2008 and beyond.
The first thing is to put the stock-market volatility experienced in 2007 (and so far this year) in some perspective. Although investors with limited experience or short memories might have been struck by the market's turbulence, we have experienced far worse volatility in recent years. Second, for those who want to manage their portfolio risk more actively, it is important to understand relative risk across industry groups to avoid the next sector downdraft. Finally, individual-company risk can vary quite widely from one sector to another, so investors who like to pick individual stocks should examine the range of returns within a given industry.
A look at each of these issues can help investors manage market risk when it begins to feel most unmanageable.
Be Ready for Turbulence
Investors certainly had a bumpy ride last year. Average daily price swings for the companies in the Dow Jones U.S. Total Market Index were more than 50% greater in 2007 than in 2006. Turmoil within the housing sector bleeding into the financial sector led to both real and perceived volatility.
Because we are all most influenced by recent history, the roller coaster that investors rode in 2007 might lead some to believe that recent market volatility is at historically high levels. Investors might be inclined to keep their money on the sidelines and wait for calmer times.
But the truth is that relative to the past 10 years, 2007 market turbulence was well below average. Volatility is typically defined using a statistical measure called standard deviation, which looks at how much or how little data diverge from the average. As the first chart indicates, even though last year was turbulent, six of the past 10 years demonstrated even higher volatility.
What can investors do in turbulent times? Clearly, the tried-and-true strategy of diversifying across asset classes, geographic regions and sectors should be the first line of defense. For example, had you invested equally across all the Scoreboard industry sectors, the return would have been an average 13.8% annually over five years. Alternatively, the average annual return on just five sectors would range from 1.1% to 59.6%, depending on which sectors were chosen.
Broad diversification across stock sectors therefore is one of the most useful tools in managing risk. Ask yourself if there is any reason to have more than 10% of your stock portfolio in any one sector. Then be vigilant in rebalancing your portfolio as the value of your investments changes over time.
Watch Out for Maverick Sectors
Yet even reasonably diversified investors can be burned by industry sector risk. For example, just a 5% exposure to the home-building sector in 2007 would have reduced a portfolio's total value by 2.5%.
So it is also useful to understand the extent to which industry returns vary from the overall market. Investors who commit too much of their portfolio to "maverick" sectors -- those whose returns deviate enormously from the market average -- can inadvertently assume more risk than they intend.
To illustrate this, we have identified 10 industry sectors that, over the past five years, diverged the most from overall market returns on a month-by-month basis.
The measure used is called R-squared. Simply put, it shows the relationship of movements in each sector to movements in the overall market. If the movements are 100% correlated, this means that all the stock movements in a sector can be explained by movements in the market. Alternatively, if R-squared is 0%, then overall stock-market returns explain none of the returns in the sector and sector-specific factors are driving stocks. We consider sectors mavericks if less than a third of their returns are explained by returns on the overall market. Here are the top 10 maverick sectors for the past five years:
You can see that only about 5% of the returns in the home-construction sector were explained by overall stock-market movements. Similarly, the overall market explained less than 1% of the returns in travel and tourism.
There is a logical explanation for these sectors to be so detached from overall market returns. Pharmaceutical-company fortunes, for example, are not tied to the general economy nearly as much as to the prospects for specific drugs. Similarly, cyclical and capital-intensive sectors like autos, forestry and paper, and semiconductors can deviate substantially from overall market returns.
It is useful for investors to know what percentage of a portfolio is invested in maverick sectors. Though the past is not always prologue and industry dynamics can change, ask yourself how likely your target sectors are to move based on broad economic or sector-specific factors.
Another reason to identify maverick sectors is that, in moderation, they can be quite useful in diversifying portfolio risk. For the very reason that they tend not to move with the market as a whole, they can help offset movements in the market.
The implication is not to avoid these sectors but to keep your exposure manageable. Balance your stock investments with modest exposure to one or more maverick sectors, but don't let them grow to more than 10% of your total portfolio. And include a mix of more market-oriented sectors.
Among the sectors that most closely tracked market returns:
Some of these are sectors closely tied to industrial and commercial activity (industrial services, commercial vehicles and trucks). Sectors that are closely tied to movements in interest rates (utilities, life insurance) and relatively stable goods and services are also represented (medical supplies, waste and disposal services).
Stock Pickers Beware
Just as industry sectors can vary widely in their levels of volatility and risk, so too can companies within sectors. In some sectors, company stocks move quite closely with sector returns. In others, company returns can vary widely from sector returns. This is because company returns in these sectors are affected by unique factors rather than factors that affect all companies in this sector. In these cases, individual stocks carry greater risk.
Consider the semiconductor industry in 2007. Company returns deviated enormously from the average return of 28.6%. A top-performing company in this sector was MEMC Electronic Materials Inc., which generated a 126% return. The worst-performing company was Advanced Micro Devices Inc., whose return was minus 63%. Most investors diversify their investments to eliminate most of these company-specific effects. For those who may decide to own one or two stocks within a given sector, however, it is useful to know which sectors have companies whose returns deviate the most from the sector average.
Using standard deviation as a measure of how tightly data are clustered around the average (low standard deviation) or, conversely, how widely dispersed they are (high standard deviation), we can see that returns for companies in the following 10 sectors deviate the most from the sector average. Presumably that's where stock pickers are taking a proportionately greater risk when they invest.
Again, there is some logic behind "high deviation" sectors. Chemicals and semiconductors are capital-intensive and highly cyclical industries. The exposure of individual companies to these economic cycles can vary dramatically. Similarly, industries such as biotechnology, with companies that depend on the discovery and successful development of new products, should be expected to demonstrate a broad range of returns.
The sectors with the lowest standard deviation of company returns include:
These tend to be consumer-oriented products or slower-growth sectors where companies may have less opportunity to generate differentiated returns.
The key lesson from the Scoreboard data is that the market's volatility in 2007 wasn't extraordinary. If this volatility proves unbearable, you can always reduce your exposure to stocks. But there are two questions you might ask first:
• Am I too exposed to "maverick" sectors, those that don't track the overall market? • Am I too exposed to a small number of stocks in "high deviation" sectors, where returns on individual stocks deviate widely from the sector average?
Reflecting on the answers can help manage investment stress in turbulent times.