Portfolio Rebalancing Boosts Returns (2007-05-28)

Portfolio Rebalancing Boosts Returns

(2007-05-28) by David John Marotta

Rebalancing your investments can help boost your returns and minimize risk. This simple contrarian move can help you compound your investment gains over time. With the markets at an all-time high, this may be a good time to rebalance your portfolio.

On May 18, 2007, the Dow closed at another all-time high of 13,556.53 setting its 24th record high this year. The S&P 500 recently broke its all-time high of 1,527.46 set in March 2000. Many investors are getting nervous that these records mean that the markets are overvalued and due for a large correction.

Maybe. Maybe not.

One way to look at the S&P 500 is that this index of U. S. large cap stocks has not made investors any money in the last six and a half years. The S&P 500 has only just returned to where it was seven years ago. However, at the height of the bull market in the late 1990's, the P/E ratio of the S&P 500 index spiked above 30. Now, the P/E ratio is about 17, meaning the stocks look much more attractive to buy now than they did in 2000.

Other indexes such as the MSCI EAFE Index of international stocks, the MSCI Emerging Markets Index or the Russell 2000 Index of U. S. small cap stocks have been quietly setting new highs for some time now. One way to look at the markets is that when the markets are behaving well and appreciating at 11% percent each year, on average, they will be setting new highs almost on a daily basis.

But, of course, we know from experience that the markets are not that well-behaved. They generally do not return a nice steady 11% per year. Over time, market returns are more like 18% for three consecutive years and then negative 10% another year. Perhaps this is the year for negative 10% return.

If you have set a diversified asset allocation, then whenever you aren't sure about what to do, simply rebalance your portfolio every year. Rebalancing your portfolio is a contrarian move which will help you buy low and sell high and will save you from chasing performance.

Imagine your portfolio has only stocks and bonds. If stocks have done well, then applying a rebalancing strategy will help you sell some stocks when they are high and put money into bonds when they are low. If stocks have performed poorly, then rebalancing to sell some bonds and buy stocks will most likely be a good contrarian move. Rebalancing, will save you from trading too much to chase recent market performance, which is nearly always a bad idea.

Let's imagine you have an investment account with a value of $100,000 and your target asset allocation is half stocks and half bonds. Because you neglected to rebalance your portfolio for several years, the stocks have increased in value and now represent 70% of your account with bonds comprising only 30% of the account's value.

Imagine that bonds are expected to return 6% for the next two years, and stocks are either going to go up 10% for two years or else they are going to go down 10% the first year and then go up 10% the second year.

If you don't rebalance your portfolio and the markets correct by 10% the first year, and then rebound by 10% the second year, you will earn 3.01% over the two years. If you rebalance each of the next two years and the markets correct you will earn 6.23%. Failing to rebalance will cost you 3.22%.

In this case rebalancing takes money out of stocks before they correct and then puts money back into stocks before they rebound. Rebalancing moves the money in exactly the right direction.

If you neglect your portfolio and let your winners ride and the markets continue to go up, you will earn 18.41% over two years. If you choose to rebalance each of the next two years and the markets continue to go up, you will earn 17.07%. Rebalancing will only cost you 1.34%, and you will still earn 17.07% for the year.

In this case, rebalancing takes some of your money out of stocks. Then, in the second year, you take more profits off of the table as the remainder of your stocks continues to rise. In this case, rebalancing can save you 3.22% on the downside, but cost you only 1.34% on the upside.

While implementing a dynamic asset allocation may allow you to boost returns, the average investor usually does not have the time or the expertise to follow the numerous factors needed to construct this kind of model.

More often than not, trying to follow sector trends results in the exact opposite of what following a more sophisticated approach would suggest. You can avoid this temptation by simply rebalancing your investments annually, or more frequently, whenever the markets are hitting new highs as consistently as they have been recently.

from http://www.emarotta.com/article.php?ID=233

Financial Harmony in Marriage (2007-05-21)

Financial Harmony in Marriage

(2007-05-21) by David John Marotta

No married couple wants a scandal, even if it is just financial in nature. Money problems can ruin the love affair with your spouse. The work of blending two lives in harmony requires certain basic commitments. Many families today are financially troubled. Most of these are in denial. The rest of them are looking for a quick fix. Even a financial planner can't help unless the couple is willing to make five simple commitments. You can always choose to find something to fight about. But if you are serious about removing the financial obstacles in your love life, you should commit to the following money management rules.

First, take the time to provide open accounting to your spouse. Most financial arguments are not about how to spend your money but about how money was actually spent. Just like every publicly traded company is required to give a public accounting of its finances, couples should do the same. In the public sector, it's considered a scandal when a corporation fails to provide its financial information in a timely fashion. The same rules should apply at home. Financial accountability, openness, and honesty are essential in marriage.

Next, make saving money savings your first priority. Pay yourself first. Couples should agree on a savings rate and should prioritize their savings above all other budget categories. Savings should be automated and protected from impulse spending habits.

I've come to believe that savings should even be prioritized above debt reduction. I've found that couples that are in debt cannot seem to get out of debt because they are using what should be going into savings, They are servicing to service their debt rather than adjusting their lifestyle so that they are spending less than they make.

Set a limit on what you can spend without first getting the approval of your spouse. Each spouse must sign off on spending that might be a budget buster. If you are young or your finances are in trouble, the amount should be fairly low. As you get more experience and your finances are in harmony, you can raise the amount. Any purchases above that amount should require the agreement of both spouses.

In the same way, any purchases beyond what was budgeted should require the agreement of both spouses as to which budget category is going to be reduced in order to make up the difference. If your spouse asks you to wait before making the purchase, lean toward waiting graciously. Ask what you would do if you did not have the money at all. Then, do that instead. Delaying a large purchase even by a month can significantly increase your financial health.

Set rules for the acceptable use of credit. In my experience, the easy use of credit cards ruins much financial harmony. It is better when the use of credit cards is limited to only certain required budget items. Using a credit card for groceries or gasoline may be harmless. But when credit cards are used for clothes or eating out, optional spending is unnecessarily inflated.

There are several advantages to using credit cards. But each of these advantages becomes powerful disadvantages for a family struggling to make ends meet. Credit allows couples to avoid asking the tough question about what they would do if they did not have the money. Credit makes spending easy and simplifies check-writing. These advantages are as helpful as giving an alcoholic a place to sleep in the back of the bar.

Either spouse should be able to veto the use of credit cards entirely. Only if both parties agree to the use of credit cards, should they be allowed - and then only within certain guidelines.

Credit should only be used for specific required monthly categories, and then only by the spouse who is less apt to make extra purchases on impulse. If you are struggling with your finances, stop using credit cards entirely.

Agree together that ignorance will not be used as an excuse. Both parties must be willing to learn. Just like a good love life, finances cannot be handled well by just one party. Many problems stem as much from ignorance and abdication by one party than spending by the other. If you don't have the time or the interest to be involved in the family's finances, then you may be the problem. Ask for help and start learning.

A financial planner can help, but only if both parties pledge to practice open accounting, prioritize savings, co-sign on budget busters, limit the use of credit, and avoid ignorance and abdication. To find a fee-only financial planner in your area call the National Association of Personal Financial Advisors at 1-800-366-2732 or visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=229

A Short History of Wall Street (2007-05-14)

A Short History of Wall Street

(2007-05-14) by David John Marotta

Last month I was in New York City for the weekend. Although our hotel was in Times Square, we had a chance to visit Wall Street while we were there. Wall Street is a testament of the spirit and vitality of free markets.

The Dutch first settled lower Manhattan in the 1600's. They purchased the entire island from the Indian tribe living there are the time. Property boundaries were divided by plank fences. The stockade's fence was strengthened into a twelve foot wall out of fear of the Indian tribes who did not leave the island.

A major thoroughfare in front of the wall developed connecting the east and west sides of lower Manhattan. This passageway continued to be called Wall Street even after the British tore down the wall in 1699.

Wall Street continued to serve as the site of trade and commerce during the 1700's. City Hall, a church and many merchant's shops and warehouses were located along this street. Federal Hall was built on Wall Street where George Washington was inaugurated as our first President.

In 1792, two dozen of New York City's leading merchants met secretly and negotiated an agreement to eliminate the power of the auctioneers in order to gain better control over trading fees. Their agreement restricted them to trading securities only among themselves and did not allow participation in any other auctions. Their agreement was called the Buttonwood Agreement, named after their traditional meeting place, a buttonwood tree at the end of Wall Street.

The first American Stock Exchange was started in Philadelphia in 1790. In 1817, the New York merchant group visited the Philadelphia exchange and after returning established the New York Stock Exchange.

Initially, the New York Stock Exchange simply rented a room on Wall Street. But by 1903, the exchange completed its current building at a cost of $4 million. It boasts 72-foot high ceilings and the current beautiful marble façade.

In 1817 a seat on the exchange cost only $25 dollars. Recently, a seat on the exchange sold for $4 million dollars.

Even by 1886, daily share volume passed one million shares. In 1929, volume passed ten million shares. It did not pass a hundred million shares until 1982 and reached one billion shares in 1997. Just this year, daily share volume passed four billion shares.

In 1889 the Customer's Afternoon Letter changed its name to The Wall Street Journal after the street of the exchange.

Although all trading could be done remotely by computer, members of the New York Stock Exchange still perform significant work on the floor of the exchange.

One of the best known symbols of the exchange is Arturo Di Modica's “Charging Bull” sculpture. Arturo Di Modica designed and created the sculpture after the 1987 stock market crash at his own expense. He dropped the seven thousand pound statue in front of the New York Stock Exchange in December of 1989.

The police impounded the illegal sculpture, but the public loved it. It was reinstalled in Bowling Green where it is the most photographed piece of art in the city. Di Modica, however, still owns the copyright to the statue. In 2006, he sued Wal-Mart and other companies for selling replicas of his statue.

As the owner of the statue, Di Modica wants to protect that value of what he owns. Investors are no different.

Wall Street has been around for over two hundred years, but only recently has Main Street been so fully invested. With today's exchange traded funds, a few hundred dollars can buy fractional shares in most of the publicly traded companies in America

And when people have significant assets invested in the success of corporate America it changes their political views. Fewer are the angry mobs with torches and pitchforks clamoring for regulation and wanting to destroy immoral profits.

Replacing them is an investor class who is more strongly committed to free markets and free trade. While this movement is slow, the rise of the investor class logically follows the rise of the middle class. And just as the middle class brings about a political freedom and stability, so an investor class brings about economic freedom and stability.

With such a large percentage of Main Street rooting for Wall Street, its future should be as bright as its history.

from http://www.emarotta.com/article.php?ID=232

How to Pay Off Student Loans While Building Wealth (2007-05-07)

How to Pay Off Student Loans While Building Wealth

(2007-05-07) by David John Marotta

The average college student graduates with almost $20,000 in student loans. While this is a daunting sum, it is still possible to build wealth even while paying off student debt. But earning the degree and paying for the degree require two different kinds of smarts. In fact, some students may be better off not taking their parents' advice on how to get out of debt. Unlike most types of debt, student loans are usually best when paid as slowly as possible.

Almost all debt is bad debt. But, there are two important exceptions to this rule: home mortgages and student loans. Diligent savers can use these types of debt to their advantage.

Students often assume the best thing to do is to pay off student loans as quickly as possible. The sooner you pay off your loans, the sooner you can start building wealth, or so the thinking goes. But, given the opportunity, which answer should you choose: A) Make extra principle payments on your loan each month, or B) Pay the minimum amount due and save and invest the difference?

The real answer is: it depends. However as a rule of thumb, the lower the interest rate on your loans, the better off you'll be just paying the minimum monthly payment and nothing more. Take the extra money you were going to pay on your loan and invest it instead.

The lower the rate of interest on your loan and the higher the average market return, the more it makes sense to invest your extra dollars instead of paying down on your loan. The difference between these two rates is known as the "spread." If market rate of return is 11% and the interest on your student loan is 4%, then, the "spread" is 7% (11% minus 5%).

Let's look at two examples. Jane and Joe each have $20,000 in student loans which are to be paid over 10 years at 4% interest. Joe pays his monthly payments of $202 plus $100 extra to retire his debt as quickly as possible. By paying making bigger payments, Joe is able to pay off his debt in just over 6 years. Now, with his debt out of the way, Joe invests the full $302 per month that he had been putting towards his debt. Ten years after graduating, Joe has paid off his school debt and his investments have grown to $16,728.

Jane decides to adopt a different loan repayment strategy. Instead of paying extra on her loans, Jane pays only the minimum amount of $202. She takes the extra $100 per month that she could have been paying toward her debt and invests it. She continues this simple plan for the full life of her loan. Because she makes no extra payments on her loan, she takes the full 10 years to pay off her loan. Now, ten years later, Jane's loan is finally paid. However, her investments have grown to $21,700, beating Joe's return by $4,972!

Jane has made more than Joe even though she only paid the minimum balance due on her loan. Instead of making extra payments as Joe did, she invested her money for a longer period of time. And even though Joe was able to retire his debt sooner than Jane, his big monthly investments were unable to catch up with Jane's early saving. Jane was able to boost her savings by starting early and harnessing the power of compounding interest. In the investing world, we call this principle the 'time-value' of money.

However, this model is not ideal for everyone facing student loans. The smaller the spread between your loan interest rate and the average market return, the less appealing this strategy becomes.

But, there is one additional reason students should consider paying just the minimum monthly payment on student loans. Student loan interest, like home mortgage interest, is tax deductible. By allowing you a tax deduction of up to $2,500 for student loan interest, Uncle Sam is, in effect, helping to subsidize the cost of your loan. The faster you pay down principle, the faster you lose your tax deduction, which is one more reason that paying just the minimum may be the best option. And, with the savings from your tax deduction, you have more money to invest at higher rates of return.

In order to benefit from this loan repayment strategy, you must save and invest your money. If you don't invest the extra money, you would have been better off putting your extra dollars toward the repayment of your loan. But before deciding on a loan repayment strategy that's right for you, be sure to take care of the basics of first.

Learn about your loans. Many student loans allow for a 6-9 month grace period before loan repayment begins. During this time, your loans may be charged a lower rate of interest. Consider consolidating your loans and locking in your interest rate while your loans are at a lower rate. This may not only help keep the cost of borrowing lower, but it will mean you only have to write one check per month.

Establish an emergency fund. You should have enough money in your emergency fund to cover three months of expenses. This money should be used only in the case of emergencies, and not for those late-night runs to Taco Bell.

Pay off your credit card. It's estimated that college graduates carry an average of $2,500 in credit card debt. Most credit cards have very high interest costs. Be sure that you are not one of them. You cannot build wealth while paying 19% interest on your credit card purchases. Do not begin investing until you have an emergency fund and have eliminated your credit card debt.

Sign up for free money. If you have just started a new job, check to see what type of retirement benefits your company offers. Many companies will match your contributions dollar-for-dollar up to a certain percent of your pay. In other words, you get free money if you invest in the company retirement plan. Make every effort to contribute enough to get the full match. By doing so, you are, in essence, receiving a 100% return on your money. And, don't assume you are too young to save for retirement. By saving now, and harnessing the power of compounding interest, you'll have enough to retire long before most of your friends. Remember the time-value of money!

Contribute to a Roth IRA. Once you've built up an emergency fund, paid off your credit cards, and taken advantage of any free money available through your employer, make every effort to invest any remaining dollars in a Roth IRA. A Roth IRA is the ideal place to put those extra dollars you were otherwise going to apply to your student loan principle.

Building wealth takes time. By starting early, you'll be sure to make the grade.

from http://www.emarotta.com/article.php?ID=231