Invest in Women (2008-01-21)

Invest in Women

(2008-01-21) by David John Marotta

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

2007 in Review (2008-01-14)

2007 in Review

by David John Marotta

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

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

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

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

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

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

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

Investment	Year 1	Year 2	Total Return
Choice A	30%	0%	30%
Choice B	0%	30%	30%
A + B	15%	15%	32.5%

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How safe is your money market? (2008-01-07)

How safe is your money market?

(2008-01-07) by David John Marotta

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

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

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

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

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

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

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

Money market funds have several purposes in an investment portfolio.

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

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

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

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

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

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

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

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

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

Financial Help for the New Year (2007-12-31)

Financial Help for the New Year

(2007-12-31) by David John Marotta

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

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

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

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

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

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

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

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

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

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

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

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

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