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Wednesday, 31 October 2007

As Fed meets, U.S. stocks see warning signs

By E.S. Browning
1401 words
30 October 2007

The U.S. Federal Reserve meets this week amid persistent signs of trouble in the stock market.
After the Fed's half-percentage-point interest-rate cut six weeks ago, major stock indexes rebounded, and the Dow Jones Industrial Average remains near its record high. But rising oil prices, mixed corporate-profit reports and the spreading effects of a housing slump continue to fuel tumult in the economy -- and some underlying patterns suggest that stocks may have trouble maintaining their high-wire act.

Major stock indexes are being supported by multinationals such as Microsoft Corp., Coca-Cola Co. and Procter & Gamble Co., which benefit from the strong global economy. Many other stocks, notably financial institutions and smaller companies dependent on the flagging U.S. consumer, have taken hits.

Other indicators also suggest thin support for the market. The ratio of the number of stocks rising versus the number that are falling has been getting worse since the spring, and the number of stocks at 52-week highs has been on the wane since last year.

"If you look at the economy, you see softening durable-goods orders, slowing manufacturing gains and a troubled housing market," says Russ Koesterich, head of investment strategy at Barclays Global Investors in San Francisco. "These problems are entrenched." Even if the economy escapes recession, he worries, "we could face a choppy, grinding stock market" next year.

At the other end of the world, the prospects are quite different. Abundant liquidity and expectations of a Fed rate cut pushed Hong Kong shares to new heights yesterday. Blue chips surged 3.9%, or 1181.68 points, to 31586.9, its third straight record close.

The market's advance was sharp enough to stir speculation of a correction, but some analysts say shares still have room to run. Francis Lun, general manager of Fulbright Securities, said the market could suffer a major selloff as early as November, though he predicted the benchmark Hang Seng Index might first soar as high as 35000. "The madness won't last too long," Mr. Lun said.

Money has been flooding into Asia, with a weak U.S. dollar prompting traders to seek investments across the region. In India, shares soared to a record as the key stock index crossed 20000 for the first time during the day, propelled by foreign-fund buying. The Bombay Stock Exchange's 30-share Sensex closed up 734.5 points, or 3.8%, at 19977.67. There are few signs of any slowdown, and some observers warned that the government may now have to make further moves to stem the flow of hot money.

In the U.S., the worrisome news, along with $90-a-barrel oil, so far has done little to push down the Dow industrials and the Standard & Poor's 500-stock index. Last week, the Dow had its best week in more than a month, rising 2.1% to 13806.7. It would need to rise only an additional 2.6% to surpass its record finish of 14164.53, hit Oct. 9.

Bullish investors point to low interest rates, which are fueling the world economy with lots of cash, and to the expectation that the Fed will cut interest rates following its meeting today and tomorrow. Some even see the weak U.S. economy as a positive factor for financial markets because it could force the Fed to cut rates by a half percentage point to 4.25%.

"The Federal Reserve is highly sensitive to this issue of credit getting squeezed in U.S. markets. If they see that happening, they will cut rates pretty aggressively," making it cheaper for banks, consumers and companies to obtain money and keeping the economy out of recession, says Rafi Zaman, head of U.S. stock investment at DuPont Capital Management in Delaware, which manages $15 billion in stocks.

Mr. Zaman is sticking with his holdings not only in the U.S. but also in such developing countries as Brazil and South Africa. Nonetheless, he says, a number of stock markets in developing countries, such as China and India, are starting to look like bubbles that could end badly.

"It is like being in the U.S. markets back in late 1998," he says. Professional investors then were almost forced to invest in bubble stocks, he says, for fear of trailing the competition, and the same is true today of some non-U.S. markets. He and others are prepared to start selling developing-country stocks at the first sign that the bubble may be getting ready to burst.
That is one reason to be wary of the view that the Fed will rescue the U.S. stock market. If global markets begin to teeter, and if U.S. consumers continue to struggle, rate cuts alone could have trouble holding the U.S. market up.

Few money managers consider this scenario imminent, as Mr. Zaman indicates. The warning signs are there, however. One stark way to see them is to compare the performance of the Russell 2000, an index of 2,000 smaller stocks, with that of the Dow industrials, the quintessential blue-chip index, made up of just 30 big stocks.

For most of the bull market that began five years ago, the Russell 2000 rose faster than the Dow, as its small, nimble companies benefited from low interest rates and a booming economy. Since Oct. 9, 2002, when the bull market began, the Russell is up 151%, while the Dow is up 89%.

Starting this past spring, however, they switched places. The Russell fell as consumer-spending growth finally began to suffer and as the housing crunch and troubled credit markets roiled the U.S. economy. The Dow industrials, dominated by multinationals that benefit from global sales, are up 1.3% since the end of May, while the Russell has fallen 3% over that period.

When a bull market is young, and the economy is vibrant, small stocks typically outpace large ones. When the bull market gets older -- five years is above average for a bull market -- and economic growth starts showing fatigue, the number of stocks that can sustain their gains tends to shrivel. The biggest, strongest multinationals keep rising, pushing up indexes such as the Dow. Finally, as the biggest stocks peak and decline, the bull market tends to end.

That isn't inevitable, of course. But there are other signs of below-the-surface weakness. Of the 500 stocks in the broad S&P 500, more than half were trading last week below their average levels of the past 200 days, says Phil Roth, chief technical market analyst at New York brokerage Miller Tabak. The overall index, buoyed by its biggest stocks, still was trading above its 200-day average. So while the index looked fine, most of its components didn't.

U.S. economic growth has slowed markedly in recent months because of the housing downturn, past Fed rate increases and a lingering credit crunch, with some banks still refusing loans to low-rated corporate borrowers and consumers. Oil futures have pushed above $90 a barrel, reawakening inflation fears. Faster inflation would push interest rates higher, making it harder to borrow money and taking away one of the main underpinnings of the economy and the financial markets -- cheap credit.

One big question now is whether the healthy job market and recent U.S. export strength, helped by growth in Asia and Europe and a weakening dollar -- which makes U.S. goods and services less expensive compared with foreign ones -- will offset those negatives.

Last week, stocks benefited from hopes that the Fed would bail out the market by cutting rates this week, which it almost certainly will do. But after that, the Fed won't meet again until Dec. 11. And in practical terms, it takes months for a Fed rate cut to percolate through the economy and actually boost corporate performance.

"I think the Fed is going to ease rates again. But as soon as the Fed eases, we won't have a Fed ease to look forward to, and we will be staring at the bad economic environment," says Mr. Roth of Miller Tabak.


Aries Poon contributed to this article.

Tuesday, 30 October 2007

Alert: Sunshine Empire

The Electric New Paper :

Blacklisted S'pore MLM company unveils lavish M'sian developments. But M'sian authorities say...
THEIR presentation was certainly designed to impress and strike awe.
By Hedy Khoo
29 October 2007

THEIR presentation was certainly designed to impress and strike awe.

With just $12,000, you stand to make many times more by being part of a 'global' company that has stakes in many high-profile projects in the region.

These include a trading portal that is supposedly better than eBay, as well as majestic theme parks in Malacca and Sabah that boast floating villas and underwater hotel rooms.

To prove the point to about 100 people who attended Sunshine Empire's talk last week, a slide show titled Anything Is Possible was shown.

Without any explanation, the audience was shown several pictures, including one of an overcrowded bus in India with some passengers on the roof and others with legs dangling out of the windows.

Another photo showed square watermelons from Japan.


The audience was told: 'To believe or not to believe is up to you.'

Sunshine Empire, a multi-level marketing (MLM) firm, is now on the radar of the Monetary Authority of Singapore (MAS). Though MLM companies are legal here, MAS has included the firm on its list of unauthorised companies that investors should avoid.

The Securities Commission in Malaysia has also listed Sunshine Empire on its investor-alert list. It advised the public not to make any investment with companies that are not licensed or approved by it.

The commission's website noted: 'Offers often come in the guise of seemingly attractive investment opportunities or schemes and may also be camouflaged as direct-selling or business opportunities.'

In Singapore, a visit to Sunshine Empire's office in Toa Payoh Hub saw several people there holding stacks of cash, presumably to pay for their investment.

One man had a thick stack of Indonesian rupiah.

Earlier, they had been given a brief overview of 'the Empire', as it is called, detailing its ventures in a range of businesses from telecommunications to health to property.

A representative showed various slides of the company's regional projects, including two impressive marine theme park developments in Malacca and Sabah.

Graphics of the park in Malacca showed an intricate network of floating villas and structures on the water which formed the shape of a lion's head. The park also has an adjoining condominium project.

Artists' impressions of the park in Sabah, called The Magic Kingdom, showed a lavish underwater hotel.

An aerial view showed a network of structures in the water which took the shape of an lobster. These structures are purportedly underwater hotel rooms.

'You can open the curtains to your room and see your friends swimming outside,' the representative said.

However, the Malaysian authorities appeared to be unaware of the projects.

When contacted by The New Paper on Sunday, the press secretary to the Minister of Tourism, Culture and Environment Sabah, MrFrancis Au Chee Thong, said he had not heard about the Empire's plan to build a water theme park in Sabah.

Mr Au said: 'To our Ministry's knowledge, we have no information relating to a water theme park project.

'And, at this point, there is no such project that is under construction or in progress in Sabah at the moment.'

As for the project in Malacca, Datuk Zaini Md Nor, the mayor of Malacca City Council, told The New Paper on Sunday that the council had indeed received an application in August for approval of a piece of 0.87-ha land (slightly larger than a football field).

The land, located at Pekan Klebang, is listed under developer Empire Property Venture, an affiliate of Sunshine Empire. It is supposed to be for a commercial building.

However, the mayor said the application is still being processed.

On the water theme park, Datuk Zaini said: 'No application has been made to the city Council for the building of a water theme park till today.'

Nevertheless, the Empire's projects were not the only thing that impressed visitors.

Its sprawling office on the seventh floor of Toa Payoh Hub exudes opulence. Crystal chandeliers cascade from the ceiling and the marble walls are trimmed in gold.

The company's logo - a lion's head - is imprinted everywhere, from the carpet to a painting spanning an entire wall of the lobby.

At the reception was a stream of people queuing up to hand money to the receptionists. At least two people in the queue held wads of $50 notes.

The New Paper on Sunday had earlier phoned the number listed on the Sunshine Empire website and the woman who answered said it was not an investment company.

She also asked for the name of our 'introducer' and recommended we attend the 8pm presentation.


At the presentation, the speaker was a young woman who appeared to be in her mid-20s. She was dressed smartly in a black blazer over white business shirt and skirt.

The talk took the tone of a motivational speech with the speaker running up from the back of the room to the stage energetically.

The audience of about 50 (with 50 more in another room) appeared to come from all walks of life. There were housewives in their 50s, 20-somethings in office wear and a handful of teenagers. Among them were several people dressed in black suits.

At regular intervals, the speaker would urge the audience to applaud themselves.

She would ask: 'Who is here to learn how to make more money?'

When some in the audience responded with a show of hands, she exclaimed: 'Give yourselves a big round of applause!'

A 17-year-old student, who wanted to be only known as Tan, told us he was approached by a friend from the company two weeks ago.

He said: 'My friend told me about a part-time job with many benefits and I can start with just $2,000.

'All I need to do is to keep the money in the account for 11 months and every month, the company would pay me a sum.

'At the end of 11 months, I would get my money back, and the company would still pay me a monthly sum. My friend said he earned $1,000 in two weeks.'

In the end, Tan said he did not sign up as he did not want to have his money tied up for 11 months.

The Electric New Paper :
THE returns for this investment is supposedly so 'good' that even famed billionaire investor Warren Buffett can't hold a candle to it.
By Alvin Chiang
29 October 2007

THE returns for this investment is supposedly so 'good' that even famed billionaire investor Warren Buffett can't hold a candle to it.

MrJames Phang, Sunshine Empire's international president, had told The Straits Times in an interview earlier this week that he was a 'legend'.

'I'm very good - better than Warren Buffett,' he declared.

And the company's promises are indeed sweet. It told people at its talk this week that they would get back their $12,000 investment in a year, plus $1,000 every month for the next seven years.

That roughly translates into a 700per cent profit within eight years - compared to Buffet's 21 per cent a year.

That's not all. Each investor would also get $21,000 worth of mobile talktime with Emcall, a local company with links to Sunshine Empire.

The claimed returns are mind-boggling and 20,000 people have signed up here since it was set up last July.

Responding to The New Paper on Sunday's queries, the Monetary Authority of Singapore (MAS) advised investors not to deal with Sunshine Empire.

Noting that the company was put on the Investor Alert List last month, a MAS spokesman said 'entities on this list are not authorised by MAS to conduct regulated activities'.

'In making financial investments, we urge all investors to deal only with persons regulated by MAS,' the spokesman said.

'If investors choose to deal with persons not regulated by MAS, they forgo the protection afforded under laws administered by MAS.'

The concern seems to be that Sunshine Empire, unlike other multi-level marketing firms, allows its members to notch up what seem like profits without buying or selling products. This makes its business model look like a pure financial investment scheme.

MrPhang had said that Sunshine Empire is not an 'investment firm'.

If so, then how does it give such super returns to its investors?

A LawNet check showed that MrPhang - described as 'international president' on the company's website - is not listed as a director or shareholder of Sunshine Empire.

It also showed that Sunshine Empire, which changed its name from Niutrend International in January, is a company 'providing entrepreneur and self-improvement courses'.

It has a paid-up capital of $150,000.

On its website, it said it is involved in 'network marketing' and is interested in 'wealth redistribution'.

It also listed offices in Malaysia, Thailand, Korea, Indonesia, Taiwan and Hong Kong.

There are reasons that MAS raises caution to those who guarantee high returns in a short time. In the US, for instance, some get-rich-quick schemes are known as 'Ponzi' schemes, named after convicted conman Charles Ponzi.

He took US$10million ($14.6m) from 10,000 people in Boston in the early 1920s by guaranteeing investors 50 per cent returns on investments in postal coupons after 45 days.

The website of the US Federal Bureau of Investigation (FBI) noted: 'A Ponzi scheme is essentially an investment fraud... Instead of investing victims' funds, the operator pays 'dividends' to initial investors using the principle amounts 'invested' by subsequent investors.

'The scheme falls apart when the operator flees with all the proceeds, or when a sufficient number of new investors can't be found to allow the continued payment of 'dividends'.'

In other words, money is taken from Ah Kow to pay initial investor Ah Seng. No goods are bought and sold. Neither is the money collected invested in anything.

Ah Kow's position is riskier than AhSeng's as Ah Kow joined the scheme after Ah Seng. This is because the purpose of recruiting AhKow is to pay Ah Seng, but there is no guarantee someone else can be recruited to pay Ah Kow.

But if everything goes smoothly, no one will complain so long as they are paid on time.

Mr Leong Sze Hian, president of the Society of Financial Service Professionals, thinks that such schemes are normally too good to be true.

He said: 'It's very rewarding and lucrative to those who join at the start. But the funds will dry up eventually and the company will close and set up shop elsewhere, or in another country.'

Monday, 29 October 2007

Millionaires focus on freedom

Jay MacDonald

Want to get to the top financially? Take advice from those who are already there. At a glance Name: Keith Cameron Smith Hometown: Ormond Beach, Fla. Education: Calvary Christian Academy, Ormond Beach, Fla. Career highlights:

Author of the national best-seller, "The Spiritual Millionaire" and "The Top 10 Distinctions Between Millionaires and the Middle Class"

Entrepreneur and self-made millionaire at age 33

Hosted "Flames of Truth," a motivational radio program, for five years

Hosts seminars and teaches success principles to individuals, churches and companies across America Financial guru Keith Cameron Smith, author of the best-selling "The Spiritual Millionaire" and himself a self-made millionaire at age 33, invested $100,000 and two years of his life to meet face-to-face with some of the world's wealthiest people to learn what makes them tick.

Overwhelmed by the life lessons they imparted, Smith holed himself up in a North Carolina cabin and, in one week, distilled their wisdom into a 100-page crib note for successful thinking, "The Top 10 Distinctions Between Millionaires and the Middle Class."

Some of the distinctions are commonsensical (millionaires think long-term, the middle class, short-term; millionaires take risks, the middle class avoids risk). Others are quite illuminating (millionaires ask themselves empowering questions, the middle class ask themselves disempowering questions; millionaires learn and grow, the middle class, not so much).

Smith, who became independently wealthy with a string of furniture stores in his hometown of Ormond Beach, Fla., continues to seek opportunities in networking and real estate as he travels the country teaching financial success principles to individuals and companies.

As part of our Financial Literacy tuneup, Smith shares with Bankrate his insights into how to think like a millionaire.

You were not born wealthy.

(Laughs) Oh no. I grew up on the lower end of the middle class. My dad never made more than $25,000 a year. He sold auto parts to different garages. He had different routes to a couple of different towns around Florida.

Did you attend college?

I went to college for two weeks and said that's not for me. I'm on the list of millionaires that just did it in the real world and didn't go to school. School is phenomenal for some people. Some people absolutely need to go to school as part of their purpose. But some people don't need to go to school. They don't need to get a good job so the government or your corporation can take care of you, because as we know, that formula doesn't work anymore.

When you go through failures like I have and like other millionaires have, you learn something on an emotional level that you cannot learn when you go to college. When you get intellectual knowledge from a book or a lecture, it's not the same as investing money in something and then seeing all that money disappear. When you learn something on an emotional level, that is what really starts making you stronger.

Your original goal was to be a golf pro, right? What happened?

I had an apprentice position at the LPGA International in Daytona Beach when they first got started. I helped them get their pro shop up and running and I had my handicap down to about a four and I thought for sure I was going to pursue golf as a career. I took the PAT, the player's ability test, a couple of times; that's where you have to play a couple of rounds and shoot like 150 between two rounds of golf. And I could never do it; my nerves just couldn't handle it. But that was one of the turning points in my life. I sat down with the pro there at the time and asked how long it was going to be before I could really start making good money. I was making $20,000 a year as an apprentice. He said, "I'm going to be honest with you, it's going to be at least five or six years before you can move up." And I said no way, I'm not going to sit here and make $20,000 a year for five or six years.

How did you lift yourself out of the middle class?

Education. I started learning, but it wasn't education in the school system. It was education from my real-world experience as an entrepreneur and taking risks and having some good successes and some failures, too. Those are always tough when you go through them, but I honestly can say, thank God for those, too. Because those are the situations I really learned the most from, so I had some new knowledge to apply on the next endeavor.

Your book seems to strip down dozens of motivational books to their essence.

What I tried to do in my book was to stay away from specific areas like real estate or stocks or small businesses and instead encourage people to pursue their own passion to create wealth. What would they love to do to wake up and make money every morning? That's the key to it. By far, one of the biggest things I learned talking to all these millionaires was they really enjoyed whatever they were doing.

You maintain that the wealthy expect different things from money than the rest of us. How so?
The very poor and the poor are stuck in survival mode; they just want to survive. The primary goal of middle-class people is comfort; I just want to have enough; I just want to be comfortable. When you get into the rich and the very rich, their primary goal is freedom; I'm going to do whatever it takes to experience freedom. That's the biggest difference. It's OK to have a plan for survival, it's OK to have a plan for comfort, but just make sure that most of your mental energy is focused on freedom. Then you'll start experientially understanding the old saying, "Seek and you will find." If you seek to survive, you will. If you seek to be comfortable, you will be. But if you seek freedom, you will find it. It just takes longer to create freedom in your life than it does to create survival. Does it take longer to grow a weed or an oak tree? Financial freedom is like an oak tree, where survival or comfort is like growing a weed or a little bush; it doesn't take too long.

Do you remember when you turned the corner and began to think like a rich man?

Yeah, I do. I can remember banging my head against the inside of an elevator. I had just worked 11 hours at a golf course as an assistant pro and I was going to work at a high-dollar restaurant that night from 7 until midnight, and I was banging my head against the elevator, thinking, "God, there's got to be an easier way to make money than this." Shortly after that, I decided I was done working for somebody else. I was going to learn how to earn profits. That has made all the difference. From the age of 15 to 25, I worked for wages. At 25, I started working for profits, and at 33, I became a millionaire for the first time.

Your book seems to strip down dozens of motivational books to their essence.

What I tried to do in my book was to stay away from specific areas like real estate or stocks or small businesses and instead encourage people to pursue their own passion to create wealth. What would they love to do to wake up and make money every morning? That's the key to it. By far, one of the biggest things I learned talking to all these millionaires was they really enjoyed whatever they were doing.

You maintain that the wealthy expect different things from money than the rest of us. How so?
The very poor and the poor are stuck in survival mode; they just want to survive. The primary goal of middle-class people is comfort; I just want to have enough; I just want to be comfortable. When you get into the rich and the very rich, their primary goal is freedom; I'm going to do whatever it takes to experience freedom. That's the biggest difference. It's OK to have a plan for survival, it's OK to have a plan for comfort, but just make sure that most of your mental energy is focused on freedom. Then you'll start experientially understanding the old saying, "Seek and you will find." If you seek to survive, you will. If you seek to be comfortable, you will be. But if you seek freedom, you will find it. It just takes longer to create freedom in your life than it does to create survival. Does it take longer to grow a weed or an oak tree? Financial freedom is like an oak tree, where survival or comfort is like growing a weed or a little bush; it doesn't take too long.

Do you remember when you turned the corner and began to think like a rich man?

Yeah, I do. I can remember banging my head against the inside of an elevator. I had just worked 11 hours at a golf course as an assistant pro and I was going to work at a high-dollar restaurant that night from 7 until midnight, and I was banging my head against the elevator, thinking, "God, there's got to be an easier way to make money than this." Shortly after that, I decided I was done working for somebody else. I was going to learn how to earn profits. That has made all the difference. From the age of 15 to 25, I worked for wages. At 25, I started working for profits, and at 33, I became a millionaire for the first time.

Some people reject the idea of wealth, "It's lonely at the top" and so forth. What do you say to them?

A lot of people are still stuck in the comfort mode, they just want to have enough, and they think if they pursue all that money, they'll lose their family; they'll lose their health. That's not me at all. God, family and finances are my priorities. I never wanted to be somebody that went after financial freedom and lost my health or lost my family. I refuse to go down that path. But I've known people that do that. They put money as such a high priority in life that they lose the things that matter most. But if you keep your priorities in order and focus on financial freedom, it's a wonderful world. I love people and I use things. There are some millionaires out there that love things and use people and that is definitely the wrong formula.

Do you manage your own money?

I did everything on my own, yes. I never went to a professional to handle my money for me. What I've come to find out is, while some of those guys are great, a lot of those guys just put on a front; they're making $50,000 a year and they're trying to tell someone who is making a million dollars a year how to invest their money and they really don't know; they're just doing what they've been told to do. I'm not knocking anyone; if you're going to use one, make sure you find a good one who is doing very well financially themselves.

What do you see yourself doing 10 years from now?

There are some things we do for money that are only good for a certain season. That's why we have to keep our eyes open for new opportunities. I'm constantly polishing my portfolio and looking at different forms of income. I never got heavily involved in the stock market. I am still dabbling in real estate but nothing real serious right now. I'm still a young entrepreneur. I still have a lot to learn. I haven't mastered all those principles; I'm still living them on a daily basis. When I focus on them, it seems like opportunities come my way and I make some better decisions. It's not just about the money, it's about the learning process.

What's the best advice you've gotten?

Dana Dratch

When you need advice, it's usually best to go to the experts. So Bankrate did, collecting the thoughts of eight personal finance gurus on increasing your wealth.

In some cases, the experts had to learn the lesson themselves (usually after a few hard knocks).

Many times, a sound example was offered by someone successful who was already living it.
And in every case, the person who later became an expert recognized the wisdom for what it was -- and is still using it to build wealth.

Learn what these successful people said they consider the best personal financial advice they ever received.Experts' best advice Get advice from the authorities. Here's what these personal finance experts had to say:

Gary Belsky, co-author of "Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics":

"Be afraid when people are greedy, and greedy when people are afraid. It's basically, 'Buy low and sell high.' In general, I've been doing better than market averages when I've been handling my investments. I've basically done that by being conservative when the market is frothing and aggressive when the market is down."

Wayne W. Dyer, Ph.D., author of "Your Erroneous Zones" and "It's Not What You've Got: Lessons for Kids on Money and Abundance":

The lesson "for me was, first, pay yourself," Dyer says.

While in the Navy stationed in Guam, Dyer saved 90 percent of his pay over the last 18 months he was there. "So I came home with enough money to pay tuition for four years of school and a car. Even today I pay myself first. If you want to be financially independent by the time you're 30 years old, pay yourself first.

"When you get your paycheck, take a percentage -- between 10 percent and 30 percent -- and put that away," Dyer says. "You'll be rich enough to be financially independent within a short period of time."Neale S. Godfrey, author of "Money Doesn't Grow on Trees: A Parent's Guide to Raising Financially Responsible Children," and chair of the Children's Financial Network:
"Step away from the television and the magazines. All they serve to do is show you how stupid you are because you've missed whatever they're talking about. It's old news. It's already happened."

The advice came from her financial adviser, she recalls. "I used to call him and say, 'Why didn't we ...?' He'd say, 'Stop it. Step away from the television. It's done.'"

She realized that he was right. "By the time you see it or read it, it's done; it's happened," Godfrey says. And if you listen and follow the hot news, she says, "You will buy at the top and sell at the bottom -- exactly what you're not supposed to do."

George Kinder, Certified Financial Planner, author of "The Seven Stages of Money Maturity: Understanding the Spirit and Value of Money in Your Life," and founder of The Kinder Institute:

"It's about the meaning, not the money. If my investing is not really deeply tied to what I think is most important in my life," he says, then, "the asset allocation, the estate plan, the retirement plan might as well be thrown out the window."

His best advice: "Hire a Registered Life Planner (a financial planner with additional training in helping clients identify and reach life goals) to help you through this," Kinder says. "Nobody can do this themselves."

A life trainer, he says, "is trained in how to elicit from a client what is meaningful and how to keep their eyes on the prize."

Robert Kiyosaki, co-author of "Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money -- That the Poor and Middle Class Do Not!":

"My rich dad gave me lots of advice. One of the better ones: There's good debt and bad debt. Bad debt is debt you have to pay for and makes you poor. If I use credit cards to buy new shoes it makes me poor. Good debt makes me rich and someone else pays for it."

One example: "I'm closing on a $17 million property and financing $14 million. That $14 million is good debt. It makes me richer every month by putting $20,000 in my pocket."

Rieva Lesonsky, co-author of "Start Your Own Business," and senior vice president and editorial director at Entrepreneur magazine:

Lesonsky's best advice "was from the owner of our magazine, Peter Shea," she recalls. "He said, 'Housing prices have gone up -- get a second mortgage and pay off your debt.' I did, and I'm debt-free."

Peter Navarro, Ph.D., author of "The Coming China Wars: Where They Will Be Fought and How They Can Be Won," and associate professor of economics and public policy at the University of California, Irvine:

"Take every piece of advice you get from any investment adviser with a barrel of salt. Most are trying to sell you things that you probably don't need or want. Think for yourself."

Navarro says he learned that lesson after a bad experience with a financial adviser. "I lost some money, then took control and never looked back," he says.Best financial advice What's the best financial advice you've gotten? And who gave you that advice? Dave Ramsey, author of "The Total Money Makeover: A Proven Plan for Financial Fitness" and host of a nationally syndicated radio show focusing on personal finance:

"A friend of mine who is a billionaire told me that he reads a book to his grandkids and I should read that book. The book is 'The Tortoise and the Hare.' Every time he reads the book, the tortoise wins. Slow and steady wins the race, and consistency matters. Get-rich-quick never wins.

"If you try to impress other people, you'll lose the wealth race, as well," Ramsey says. "It sure did give me a nice metaphor. It's a good reminder to somebody like me to keep me in check. It has implications for debt, for mutual funds, for budgets -- an overlay for everything."

As China's bubble fears grow, choosy investors favor large caps

Beijing -- AS CHINA'S stock markets have zoomed to new highs this year, local investors have become increasingly worried about a bubble and are getting pickier with their choices.
The result? The market is going still higher, as investors pour cash into the large companies that dominate the broad indexes. Such stocks are seen as safe and conservative investments in the context of China's market, and are favorites of domestic mutual funds and institutional investors.

So even as concerns about a bubble grow, many analysts are still saying that China's biggest listed companies are worth buying, since they are generally seen as well positioned to deliver decent earnings growth at a lower risk. These tend to be state-controlled companies in sectors from energy to telecommunications to metals and real estate.

The shares, traded in Shanghai and Shenzhen, are generally off-limits to foreign investors, although shares of some companies also trade in Hong Kong. Also, foreign fund managers who get licensed as Qualified Foreign Institutional Investors can buy into the mainland's own stock market. "We suggest investors still focus on large-cap blue-chip companies, as they turn out faster revenue growth than others, and they can gain more strength by expanding to overseas markets," says Cheng Weiqing, chief strategist with Citic Securities Co. in Beijing.

Blue-chip stocks have become the biggest driver of the recent rally. Since hitting its recent low on July 6, the broad Shanghai composite index has surged 57%. But the Shanghai Stock Exchange 50 Index, which measures the performances of 50 large-capitalization companies, has done even better, rising 64%. The Shenzhen Stock Exchange's index for small and midsize companies has gained 23% during the same period. Overall, the Shanghai composite index has risen 109% this year, while the Shenzhen counterpart has gained 150%.

Some of the market's 10 largest stocks by market capitalization have done even better. At a peak on Oct. 15, shares of Aluminum Corporation of China, also known as Chalco, were more than triple their close on their first day of Shanghai trading, in April. Shares of China Cosco Holdings are 3 1/2 times their first day close, on June 26, of 16.38 yuan.

As the market's gains become focused in a smaller group of big companies, some once-popular stocks are starting to stumble. Beijing Urban Construction Investment & Development, once a hot pick for investors looking for a play on the 2008 Olympics, has lost 30% compared with its peak in June. Zhejiang China Commodities City Group, a wholesale marketer for industrial goods, has dropped 37%.

That's one reason Yang Liu, an analyst at China Chengxin International Credit Rating, is advising a more defensive strategy. He favors companies he says can post stronger earnings when the economy is good, while also holding up well during a recession. Among those meeting the criteria, he says, are real-estate developer China Vanke, coal miner China Shenhua Energy and financial institutions China Merchants Bank and China Construction Bank.

While the surge in China's inflation this year increases the risk that the central bank will keep raising interest rates, potentially denting stock prices, Citic's Mr. Cheng says investors can benefit from rising prices by buying energy and other natural-resource stocks. Mr. Cheng likes China Petroleum & Chemical, the refiner better known as Sinopec, and PetroChina, China's largest oil supplier. While some analysts think Sinopec is overvalued, Mr. Cheng thinks the stock -- among the biggest on the Shanghai exchange by market cap -- is Shanghai's most attractively valued blue chip. PetroChina is in the process of a giant share sale to add a Shanghai listing to the one it already has in Hong Kong.

For those worried that the market has risen more than the fundamentals justify and is likely to experience a big decline, the most-conservative strategy is to stay on the sidelines. Jiang Zuoliang, director of the investment department for E Fund Management, says his team largely hasn't bought anything in the past two months. "We are waiting for a correction," he said.
But such views are the exception. Indeed, stocks and mutual funds are so popular in part because other investment options offer such poor returns. Chinese government bonds and bank deposits pay fairly low interest rates, currently just over 3%, which doesn't keep up with an inflation rate expected to surpass 4% for this year.

So domestic mutual funds are raising money and launching at a fast pace. According to research by Beijing-based TX Investment Consulting, new mutual funds have raised 417.7 billion yuan ($55.78 billion) from investors so far this year. In 2006, mutual funds raised 393.5 billion yuan.
Many strategists and analysts are happy to concede that the stock market is in a bubble. But they think it isn't going to pop anytime soon and aim to profit from further rises.

"There's definitely a bubble, but it's not yet the time for it to burst," says Lin Wenjun, strategist with Fullgoal Fund Management. She says she believes the outlook for the economy remains positive, and there is plenty of investor cash available to push stock prices higher.

-- Zhou Yang

With inflation monster tame, Fed can manage risk

CHICAGO (Reuters) - With inflation pressures relatively tame for now, the Federal Reserve appears to have a wide-open window to pursue a "risk management" interest rate policy that insures against a steep economic downturn created by the housing market slump.

Recent mild inflation data has been applauded by policy-makers, and even as the dollar sags and crude oil prices climb many Fed watchers guess that inflation will stay contained by anemic economic growth.

"The cost of cutting with regard to inflation risk is low, but the cost of doing nothing in terms of economic growth may be high," said Cyril Beuzit, economist at BNP Paribas.

The Fed's Open Market Committee meets Tuesday and Wednesday to decide its next move. In September, the central bank surprised markets with an aggressive 50 basis point cut in the federal funds rate, its first in more than four years. That took the key lending rate to 4.75 percent from 5.25 percent.

Financial contracts handicapping expectations on Fed rate policy show a one-quarter basis point rate cut is fully priced for the upcoming meeting, with another half-point move not out of the question.

Fed Chairman Ben Bernanke is thought to favor the increased "juice" that the bank can get from markets if it does more than simply match expectations with policy moves.

With that in mind, a significant minority of bets has been placed on a 4 percent fed funds rate by year end, or 75 basis points in cuts at the next two FOMC meetings.

Deep into the quarterly earnings season, businesses such as freight-hauling companies are keeping up a drumbeat of talk about recession as the residential housing slowdown drags consumers to the ground.

Tapping Truly Emerging Markets

By Andrew Tanzer

It's been hard to go wrong investing in emerging markets in recent years. Chris Alderson, lead manager of T. Rowe Price Emerging Markets Stock has made the most of this bull run.

His fund returned a sizzling 62% in the year through October 24, six points better than the MSCI Emerging Markets Index -- the most common benchmark for funds that invest in developing countries Korea, Taiwan, Russia and Brazil. Over the past five years, he's returned an annualized 40%, an average of four percentage points per year ahead of the benchmark.

So now he's turning to relatively virgin markets with T. Rowe Price Africa & Middle East, which launched in September and gained 10% in its first month. "This represents the last frontier," says Alderson.

You don't want to put your life savings in such a narrow and essentially untried geographic sector, but there are quite a few intriguing aspects to this new fund.

Stock exchanges in Africa and the Middle East, only recently opened to foreign investors, are under-researched and under-discovered (Alderson says that on average only one analyst covers a stock). That creates stock inefficiencies and fine opportunities for shrewd investors. The correlation with the U.S. stock market is a remarkably low 10% at a time when most international markets have been moving closely in sync with the U.S.

Gulf States such as the United Arab Emirates, Qatar and Oman are drowning in new oil and gas wealth from petroleum selling for more than $80 a barrel. Oil is a state-owned industry, but Alderson says asset prices, including stocks, are destined to rise.

That's because most of these countries peg their currencies to the dollar but run higher inflation rates than the U.S. does. That creates the negative real interest rates (inflation higher than stated interest rates), and that's conducive to asset inflation.

Examples of Alderson's holdings are Bank Muscat, which has a 42% share of financial services in Oman, and Orascom Construction Industries of Egypt, which is the largest contractor in the Middle East. (Africa & Middle East fund does not invest in Israeli stocks, which are instead held in T. Rowe Price Emerging Europe and Mediterranean, also managed by Alderson.)

Strong commodity prices, from oil in Nigeria to gold, platinum and diamonds in South Africa, are also driving African economies. As a continent, Alderson says, Africa has grown by a respectable 6% annually over the past five years.

Africa & Middle East requires a $2,500 initial minimum investment. Anticipated annual expenses of 1.75% are on the high side but are not surprising given the exotic fare in which the fund invests. The fund does not levy a sales charge, but there's a 2% redemption fee on shares held 90 days or less.

The Only Investment Style You'll Ever Need?

By Michael Breen

Casting your net in the fishiest waters gives an edge in fishing. The same is true in investing. The ability to slice and dice data using hundreds of specialized statistics can cause us to lose sight of the fact that the underlying goal for most investors remains very straightforward: compound capital at the highest possible rate over time. Beating the overall market over time is a common goal for many funds and investors. We looked at the performance of broad investment styles over time to see if a particular style had done a better job at helping investors meet this goal. A clear pattern emerged.

Top Fishing Hole
Here's what we did. We compared the performance of all domestic-equity share classes with the Dow Jones Wilshire 5000 Index for the trailing 15-year period through Sept. 30, 2007. We chose this index because, unlike the large-cap-leaning S&P 500 Index, it covers the full market-cap spectrum. This stretch of time also represents more than a full market cycle, encompassing the last bear market from 2000 through 2002 and the fantastic bull-run from 1995 through 1999. And it contains enough funds to make meaningful comparisons. We then placed funds into value, blend, and growth groups based on their investment style. Where possible, specialty categories were placed according to style. For example, specialty technology and communications funds landed in the growth camp, while utilities and financials ended up in the value group. Some specialty categories were tough to pigeonhole, so they were not assigned a subgroup.

As the table below shows, one style stood out from the pack. (To see the table, click here: Ibbotson Associates has shown that value stocks have outperformed other styles by a wide margin since 1927. And they've done so consistently, beating all other styles in nearly every decade over the past 80 years. But because of active management and fees, stock performance doesn't always translate into fund performance. In this case it does. More than 70% of value funds topped the Dow Jones Wilshire 5000 in the trailing 10- and 15-year periods. That's a much better record than domestic-equity funds in general, and growth and blend funds in particular.

Averages Aren't Equal
The Russell 1000 Value Index has easily topped the Dow Jones Wilshire 5000 over the past 15 years, so value funds have had a leg up. But that's the point. Since value has been the superior style over time, even average value funds have beaten the market. For example, the typical large-value fund has equaled the Dow Jones Wilshire 5000 over the past 15 years. Slightly better-than-average value funds have left it in the dust. And value funds haven't just ridden a tailwind. Nearly 40% of them beat the Russell 1000 Value over the past 15 years, even though it was one of the strongest-performing domestic indexes during that time.

Avoiding Losses Pays Off
Two words explain value's long-term outperformance: downside protection. The math is simple. If a fund loses half its value, it needs to gain 100% just to get back to break-even. In the last bear market from 2000 through 2002, the Dow Jones Wilshire 5000 lost about 40% of its value. And excluding value funds, nearly 80% of domestic-equity funds were in the red in that downturn. In fact, many growth funds shed nearly two thirds of their value--a huge hole that would take years to dig out of. Meanwhile, more than 60% of value funds were in the black during the same stretch. Such a big head start coming out of a downturn means that value funds can still outperform over the long haul even if they lag in every bull market.

Never Goes Out of Style
Of course, the past isn't always prologue. But we feel confident about value's prospects. Because of their parsimonious ways and tendency to hold some cash, value funds have always fared better than others in market downturns. There is no reason to believe that this trend will change. So even though growth has been leading a strong market lately, value remains appealing. It may not happen tomorrow or next year, but at some point stocks will experience an extended downturn. When that happens, value's appeal will be even more readily apparent.

Wednesday, 24 October 2007

John Bogle shares his wisdom

Cheryl Allebrand
If you can't beat the market, be the market: That's the logic behind index funds. More than 30 years ago, John Bogle set up shop to help investors capture market returns at minimal cost. He had realized a quarter-century earlier that complex mutual fund investing strategies don't consistently outperform market returns.

At a glance

Name: John C. Bogle
Hometown: Valley Forge, Pa.
Education: Magna cum laude economics degree from Princeton in 1951

Career highlights:

  • Founded Vanguard in 1974

  • Voted one of the "world's 100 most powerful and influential people" by Time magazine in 2004

  • Institutional Investor's Lifetime Achievement Award (2004)

  • Named one of the investment industry's four "Giants of the 20th Century" by Fortune magazine in 1999

  • Received the Woodrow Wilson Award from Princeton University for "distinguished achievement in the Nation's service" (1999)

    Even Bogle's detractors have had to admit that the wisdom of his investing model has been borne out by time. Somewhat uncomfortable in his status as a present-day folk hero, Bogle remains an ardent defender of the common investor, and his zeal shines through in his latest work, "The Little Book of Common Sense Investing," published earlier this year by John Wiley & Sons.

    At age 78, the founder and former CEO of The Vanguard Group is still going strong. When he's not traveling to teach at a college seminar or to deliver a speech, he works 60 hours a week running Bogle Financial Markets Research Center, a unit of Vanguard that's funded by the company. He took time out of his hectic schedule to talk about investing with Bankrate.

    History of the index fund
    You wrote your senior thesis 55 years ago on index funds. Did you understand their potential back then, or have you been surprised with the developments since you founded Vanguard in 1974?

    It was just a thought that I had in my thesis, not about index funds, but about outperforming the market by managed funds. I'm quite happy I wrote it down, this little kid, one year out of his teens. In that thesis, I wrote: "Mutual funds may make no claim to superiority over the market averages."

    We didn't have as much data as we do today, but I looked at performance of a great number of funds and found that they couldn't beat the market. That was the seed that was planted that by 1974 had burst into flower when I created the first index mutual fund.

    Simplicity is key
    What is the most important piece of advice you have for someone who is new to investing?

    Rely on simplicity; own American or global business in broadly diversified, low-cost funds.

  • Do you think the average person could safely invest for retirement and other goals without expert advice -- just by indexing?

    Yes, there is a rule of thumb I add to that. You should start out heavily invested in equities. Hold some bond index funds as well as stock index funds. By the time you get closer to retirement or into your retirement, you should have a significant position in bond index funds as well as stock index funds. As we get older we have less time to recoup. We have more money to protect and our nervousness increases with age. We get a little bit worried about that nest egg when it's large and we have little time to recoup it, so we pay too much attention to the fluctuations in the market, which in the long run mean nothing.

    Switching to indexing
    Should someone who does not currently hold index funds sell their actively managed funds and move the money to index funds, or should they hold those and start investing their new money in index funds?

    A lot depends on the kinds of funds they own. We've got an industry that makes life very complicated for investors because we've got dozens of different types of funds, different investment styles, different market capitalizations, specialty funds that are in telecommunications, gold, technology or whatever it may be, and a whole variety of international funds, including some that invest in just a single country. The more concentrated those investments are, say, in a single country or a single industry, I'd say the answer is generally yes, move to an index fund -- but watch out for taxes. If the funds are in your retirement plan, you can ignore taxes, but if they're in your own account you want to take into account the tax cost involved.

    Another factor to consider is how much it's costing you. The record is very clear: High-cost funds do considerably worse than low-cost funds. How could it be otherwise?

    Think about diversification when you're deciding what to do, and think about cost.

    Costs add up
    That brings me to my next question. You've made the point time and again that costs dramatically impact investor returns. No-load funds are preferable to load funds, naturally, but how important is the expense ratio?

  • Let's take the question a little bit differently, if I might. There are three costs that are involved in mutual funds. The one that we talk about the most and the one that is the easiest to calculate is the fund's expense ratio. That averages about 1.5 percent for an equity fund and about 1 percent for a bond fund. That's a heavy drain on your returns, unless the money manager has superior ability, which over the long term very few do. People look good in the short term and then they fade in the long term. Working with low-expense ratio funds -- as I call it, fishing in the low-cost pond -- is one way to make sure your returns are improved.

    There's a second cost that we don't pay nearly as much attention to and which we don't quantify very often and that's the impact of a sales commission -- if you buy a fund with a load. For example, if the load is 5 percent, which is the typical load today, and you hold the fund for five years, that has cost you 1 percent a year. If you hold it for 10 years, it's a half a percent a year. Think about three-quarters of 1 percent a year, the combination of those two, as cost No. 2 after the expense ratio.

    The third cost is hidden, but we know it exists, we just don't know exactly how large it is. That's the portfolio turnover cost. Mutual funds turn over their portfolios at an astonishing rate, averaging about 100 percent per year. By my estimates, any fund that turns its portfolio over at that rate is costing you an extra 1 percent per year: a half percent to buy all those securities, including market impact costs, and a half percent to sell them. A 100 percent turnover means a billion-dollar fund buys a billion dollars' worth of stock and sells a billion. That's our definition of 100 percent, but that's $2 billion of transactions. You have to take into account that cost.

    If you find lower-turnover funds, and very few funds turn over at lower than 30 percent per year, you're talking about not 1 percent per year, but about a three-tenths of 1 percent cost per year -- in other words, the turnover rate with the decimal point moved over two places (0.003). So 100 percent turnover would cost 1 percent roughly. And a 30 percent turnover would cost three-tenths of 1 percent. So let's call it an average of seven-tenths of 1 percent per year for portfolio turnover.

    So adding costs together, we have a 1.5 percent expense ratio, if you're paying a sales commission, another 0.7 percent on average for a seven-year holding period plus another 0.7 percent for turnover costs if you're average, so that adds up to roughly 3 percent. That's an astonishingly high cost and investors are almost oblivious to nearly all of it, but totally oblivious to the second and third costs. We've got to pay attention, or as we say in "Death of a Salesman," "Attention must be paid."

    I usually estimate total costs at 2.5 percent; if someone wants to argue that's too high, say a minimum of 2 percent paid by the typical fund investor. If you don't like my estimates, knock them down a little bit.

    How much to pay
    What's the highest expense ratio that one should pay for a domestic equity fund?

  • I'd say three-quarters of 1 percent maybe.

    For an international fund?

    I'd say three-quarters of 1 percent.

    For a bond fund?

    One-half of 1 percent. But I'd shave that a little bit. For example, if you can buy a no-load bond fund or a no-load stock fund, you can afford a little more expense ratio, because you're not paying any commission. You've eliminated cost No. 2.

    One of the ironic things about this is if you want to eliminate turnover cost, the third cost I mentioned, it's like rolling off a log -- it's the easiest thing in the world: Buy an index fund.

    If you buy a no-load index fund, with an expense ratio of, say 0.15 percent a year, you've taken that typical 2 (percent) to 3 percent cost and reduced it by about 95 percent a year. And it's there for the taking. In the long run it's really quite certain, because the data show us that only about 5 percent of the managers will outperform the market over an investment lifetime.

    Bogle's portfolio
    Do you own any actively managed funds?

    I'm largely indexed, 85 (percent) to 90 percent in my equity funds, but I've hung onto some of my, what I call "legacy funds" that I'd been investing in over the years that I was running Wellington Management Co. That would include Wellington Fund, Windsor Fund, Explorer Fund, Primecap Fund; other funds like that. I've owned them, and they're going to give me more or less a market return because they're very diversified, but that's 20 percent of my funds and I don't intend to change that.

    I should say that on the bond side, in my retirement plan account, which is my largest investment -- because I never owned Vanguard, which is sad to relate because I'd be a billionaire, multibillionaire -- but I don't own that, so my retirement plan is my largest investment, and in my personal account I own 100 percent municipal bond funds, which are very indexlike in their nature.

    Money market investing
    You have said that most people hold five different funds, and that people should hold equity index funds and bond index funds. How much, if anything, should people hold in money market funds?

  • In general I look at investing as having no money market funds. If you're concerned about risk you're better off holding a short-term bond fund. While the returns will be a little jagged if you draw them on a chart, they're upward about 95 percent of the time. Where a money market fund, if you put it on the same chart, will go in a straight line but will end up at a lower level, because that reduction in risk comes with a reduction in return.

    When investing, do not own money market funds. In saving for your emergency reserves, yes, own money market funds. An important caution: Money market funds are pure commodities. What differentiates the highest- and lowest-yielding money market funds is cost. The correlation between high cost and low return or low cost and high return in money market funds is 0.99 -- almost perfect. Avoid high-cost money market funds at all costs in your emergency account.

    ETFs vs. index funds
    Recently we published a profile on Ben Stein and he mentioned you. Basically he said that you might disagree as to which are ultimately better -- index funds or exchange-traded funds -- but that he finds them equally attractive. You have been critical of ETFs. What don't you like about them?

    It is not the idea of ETFs that I find unpersuasive. After all, if someone wants to buy the Vanguard Total Stock Market ETF compared to the Total Stock Market fund directly, or to that point buy the SPDR, which is an S&P 500 ETF, compared to the Vanguard 500 (Index Fund), I don't have a bone to pick with them. I would tell smaller investors who are dollar averaging: Don't touch the ETF, because every time you touch them you pay a commission.

    In fact, I wouldn't buy the Vanguard ETF because you pay a commission. What's the matter with that? The answer is nothing. So Stein and I are on the same square. What troubles me and troubles me deeply is: What are ETFs? They are index funds that you can trade all day and they are index funds you pay a commission on. Those two things strike me as a great disadvantage.

    Trading is your enemy, because it's based on emotion. People do trade them with great rapidity. So I have a problem with trading ETFs, which you are lured into doing if you watch the market all day long, and also, the types of ETFs we have.

    There are now 690 types of ETFs and only 12 are broad-market ETFs, like the S&P 500 or the World Stock index or similar total-stock indices. That leaves 678 funds that are vehicles for speculating. Whether it's in emerging cancer shares or the Taiwanese stock market, or the Nasdaq, those are speculative things to do. I can't tell you they won't work, but I can tell you that when you have a speculative instrument that you can trade all day long, I would bet an awful lot of money that you would be better off instead of doing a lot of trading over the next 10 years in those narrow, specialized, undiversified and, in terms of commissions, costly instruments -- you don't have a fighting chance of beating the kind of index strategy that I just described.

    Investing for everyone
    You were the first to introduce index funds in the form of mutual funds for everyday investors. Would you say that this was your greatest contribution to the investing public?

  • Vanguard 500 Index Fund is unequivocally the first index mutual fund. I don't dwell on my contributions such as they may be to the investing public. I've tried to do my best to build a better world for the average investor and, for that matter, for pension funds and institutional investors, too. Central to that was the creation of Vanguard, which was and is the only truly mutual mutual fund organization.

    The management company is owned by the funds; its profits, now running about $12 billion a year, are largely rebated -- 98 percent or something -- to our fund shareholders in the form of lower expenses. Without that kind of structure, it would be very difficult to bring out an index fund.

    We went no-load around the time the index fund was introduced. We then focused on being a low-cost provider in the mutual fund industry. And therefore following, when we became effective operationally in May 1975, the first thing on my agenda was to start an index fund, which depended on low cost to work. The chicken-and-the-egg is that Vanguard was the chicken, and the index fund, the egg. But which was the most important?

    We've been the most innovative company in this industry. And, I would argue quickly, soundly innovative. I don't give you points for innovation if you bring out an Internet stock fund at the height of the stock market boom in early 2000. That's bad innovation. In terms of good innovation, I think it's pretty clear we've led the way.

  • Tuesday, 23 October 2007

    You're Not Super Rich? You Lucked Out.

    By Jonathan Clements

    Great wealth is overrated.

    Whenever my kids swoon over a palatial home or a passing Ferrari, it always bugs the heck out of me. Before long, I am on my soapbox, insisting that they shouldn't be awed by such symbols of wealth.

    This might sound odd coming from a personal-finance columnist. But the fact is, while it is comforting to be financially secure, money is no measure of self-worth, no guarantee of happiness -- and no reason to be impressed.

    We all tend to sit up and take notice when we come across people with fancy titles, hefty incomes and immense riches. Yet these aren't signs of genius or virtue. Want proof? All it takes is two words: Paris Hilton.

    Wealth may be inherited, which means the beneficiaries' struggle for riches didn't extend beyond the delivery room. Legendary investor Warren Buffett, the billionaire chairman of Berkshire Hathaway, has described "the idea that you win the lottery the moment you're born" as "outrageous."

    What about the self-made rich? Shouldn't we be more impressed by them? While their hard work and perseverance are often admirable, I wouldn't be too quick to deify.

    Today, if you are adept at judging the chances that a corporate takeover will go through, you can make good money running an investment fund devoted to merger arbitrage. Such a skill, however, wasn't nearly so valuable in thirteenth century England -- or, for that matter, twenty-first century Afghanistan.

    In other words, in a different society or at a different time, your peculiar set of skills might ensure fabulous financial success. But in today's America, you are just another working stiff.
    Displays of wealth can also be misleading. Folks can appear wealthy -- but the mansion may be fully mortgaged, the cars might be leased and the landscaper may still be awaiting payment.
    Even if you come across somebody who can easily afford the trappings of wealth, the trappings themselves are not a sign of wealth, but of wealth that has been spent. The money lavished on the cars, homes and jewelry is now gone.

    True, these purchases could always be sold. But there's no guarantee they will fetch the price that was paid -- and, in the meantime, they may require hefty maintenance costs.
    Don't get me wrong: There is nothing wrong with spending. The whole reason for saving and investing now is so we can have money to spend later. That said, I can't imagine why I should find this spending impressive -- and I am not sure it is making the spenders happy.
    As the old adage goes, money doesn't buy happiness. Yes, those with high incomes and more wealth often say they are happier.

    This may, however, be a so-called focusing illusion. When the well-heeled are asked how satisfied they are with their lives, they contemplate their position in society -- and they realize they're pretty fortunate.

    But research has found that, when high-income earners are asked about their emotions on a periodic basis throughout the workday, they don't report being any happier -- but they are more likely to say they are anxious or angry.

    All this might have you scratching your head. It seems obvious that your life would be better if you had a gardener to maintain the yard, a chef to prepare your meals and a private jet to whisk you off to exotic locations.

    And if you were suddenly handed all these things, life would indeed be grand -- until you got used to them. Unfortunately, after a while, you would become accustomed to the great food and the no-hassle travel, and you would be hankering for something even better.

    Problem is, once you are used to life's finest, that hankering can be hard to satisfy. Suppose you go to the best restaurant in town with your wealthy friends. To you, the food is unimaginably good. To your friends, it is just another meal -- and yet there's no place better they can eat.
    As you might gather, I think it is important to realize that there is nothing that special about the wealthy or the life they lead. But my goal isn't to discourage folks from striving to be rich. That brings me back to my children.

    Not everybody will grow up to be president of the United States -- or, for that matter, president of a major corporation. Still, I hate the idea that my kids might be so awed by such people that they consider these lofty positions out of reach.

    Maybe, of course, my kids will decide that they aren't interested in spending their lives in pursuit of fame and fortune, and that would be fine. But I don't want them to be so awestruck by anybody -- whether wealthy, talented or powerful -- that they rule out such possibilities.
    Having enough money is important, but having heaps of it doesn't guarantee happiness. Instead, what matters is doing something that you enjoy and that gives you a sense of purpose -- and I don't want my children to be deterred from doing just that.

    Possible 2008 recession in US will hit Asia: Stephen Roach

    Asia needs to take events in US more seriously, he says

    THE United States could face a consumer-induced recession next year, which will also hit Asian economies, said Morgan Stanley's chairman for Asia, Stephen Roach.

    Speaking at the World Knowledge Forum in Seoul, Mr Roach - well known for his bearish views - presented what he called a 'decidedly sub-prime outlook' for the US economy.

    The so-called sub-prime mortgage crisis is 'the tip of a much bigger iceberg', he said. It has started to hit the American consumer.

    Mr Roach, who has long predicted a US economic slowdown, pointed out that the US consumer is facing the toughest times in 30 years, and the impact on the economy could be acute.

    He noted that in the first half of this year, US consumption accounted for a record 72 per cent of GDP, or about US$9.5 trillion.

    'The US consumer is about to take a long rest,' he said, 'and if the US consumer goes, there's nobody on the demand side who can fill the void.' Even China's total consumption is only about one-ninth that of the US, he noted.

    Mr Roach suggested that the US consumer is at risk because the consumption binge of the last seven years has been underpinned, not so much by rising incomes but by a wealth effect which has, in turn, been driven by 'an extraordinary property market'.

    In short, 'the US consumer has turned his home into an ATM machine', he added.

    But now, with the US property bubble deflating, the wealth effect, based on rising home values, 'is over, is done, is finished'.

    In fact, next year, home prices for the whole of the US could decline for the first time in history, he predicted, which would severely diminish US consumers' ability to extract equity from their homes.

    In the face of this, Mr Roach said that the risk of recession 'is quite high'.

    Although sub-prime mortgage assets account for only 14 per cent of all securitised assets, the sub-prime crisis has already spread.

    Moreover, 'the big story gets written in the real economy, not in the financial markets', he said.
    And worth noting here, he added, is that US consumption is about five times the size of US capital spending, which triggered the US recession of 2001.

    Mr Roach, who is based in Hong Kong, said that Asia needs to take developments in the US more seriously.

    'What's worrying is a complacency in Asian markets, based on a belief that Asia has 'decoupled' from the US,' he pointed out.

    But the decoupling thesis is fanciful, he said, noting that the US absorbs 21 per cent of China's exports, 22.5 per cent of Japan's and about 14 per cent of Asean's. 'If the US consumer goes down, Asia will feel it,' he said.

    Fund houses show their hand - and it's thumbs-up

    Teh Hooi Ling
    834 words
    18 October 2007
    Business Times Singapore
    (c) 2007 Singapore Press Holdings Limited

    BT survey reveals they are mildly bullish, still hot on China but worried about US slowdown
    (SINGAPORE) In a unique exercise to determine exactly what the smart money is thinking, BT has polled top fund houses and found that they are moderately bullish about the equities market over the next six months. The 10 fund houses who shared their views have combined assets of US$1.39 trillion under management.

    The average outlook of fund managers is +2, on a scale of -10 (being ultra bearish) to +10 (being super bullish). Their ratings are weighted by their fund size.

    The most bullish rating is +8 and the most bearish -3. Meanwhile, cash level stands at about 5 per cent.

    BT intends to conduct a similar poll every month and this will form the basis of a fund managers' sentiment index - a gauge of how they see things unfolding. The results of the poll will be published in Pulses, the Singapore Exchange monthly financial magazine from next year onwards. SGX has outsourced the production of the magazine to BT starting from January 2008.

    The latest snapshot, based on the first poll, shows that geographically, Hong Kong and China still feature among the top picks of fund managers despite the incredible run that the two markets have had in 2007. For the year to date, the CSI 300 - an index that tracks the daily price performance of the 300 most representative A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges - has surged a jaw-dropping 185 per cent.

    China is the best performing market in the world for the year to date. Meanwhile, Hong Kong's Hang Seng Index has risen 47 per cent during the same period.

    Singapore also appears as the top pick among a number of fund managers. Malaysia, Indonesia, Taiwan, South Korea and Thailand showed up on the lists of more than one fund manager.
    Said Geoffrey Wong, UBS Global Asset Management's head of global emerging markets: 'Within Asia, we are currently finding a lot of value in Indonesia, Thailand and India.'

    Thailand and Indonesia are favoured for their cost competitiveness. In addition, companies within these markets generate relatively higher return on equity and earnings growth compared with their regional peers, he said.

    Schroders, meanwhile, maintains a moderate overweight in the US market for its defensive qualities. 'The Fed has plenty of policy scope to cut rates while earnings growth and valuation remains attractive,' it said.

    It also likes European equities for their strong earnings per share growth and valuation - 'the most compelling compared to its own history and other regions'. Schroders is also positive on Asia as the region continues to show signs of decoupling from the US economy, with China providing the key support.

    Sector-wise, fund managers see upside in property, industrial, construction, energy, and consumer sector and technology.

    Said UBS' Mr Wong: 'In Asia, we like the consumer sector due to strong structural drivers such as a big reserve of young and under-leveraged individuals with rising disposable incomes.' UBS is also positive on the industrial sector as it relates to the infrastructure theme. 'Spending on infrastructure,' said Mr Wong, 'is expected to triple over the next ten years.'

    Meanwhile Schroders prefers large over small cap stocks, and growth over value. As for Roger Groebli, head of equity research, Asia at ABN Amro PrivateBanking, his three sector picks are energy, commodities and technology.

    When it comes to concerns, the biggest worries for fund managers include a slowdown in the US economy, over-valuation of equities, sharp appreciation of Asian currencies and volatility in the US dollar.

    One risk, noted UBS, is that 'higher interest rates and oil prices may result in an outflow of funds from emerging market assets.'

    There are a couple of bears amidst the majority of bulls. One particularly bearish fund holds the view that there are a number of imbalances now in the market that will cause a significant market decline at some point in the next few years. 'The most tenuous characteristics is record high profit margins across the board, particularly in lower quality companies,' said the fund manager.

    As such it recommended risk reduction and capital preservation to its clients. 'We are not averse to advising our clients to invest a chunk of their portfolio in cash at the moment...In the case where clients have to or want to take on some equity risk, we recommend high quality and large cap equities, particularly in the US.'

    A total of ten fund houses responded to BT's poll. The aim of constructing the index is to let the market have a snapshot of the collective outlook of the smart money. No firms will be highlighted without consent. The index is only as good as the number of fund managers who respond to the survey - and hopefully more will start to share their sentiment.

    Emerging Asia: positive outlook despite pitfalls

    Business Times Singapore

    Beware uncertain global economy and riskier financial environment, says DAVID BURTON
    EMERGING Asia's economies have been among the most dynamic in the world in the last decade. Today, the region accounts for almost half of global economic growth. Much of this success stems from broad reforms by these countries in the last 10 years.

    These reforms have led to healthier financial and corporate sectors and more robust macroeconomic policy across the region. But the recent financial turbulence, still playing out across the globe, highlights the question of just how vulnerable the region remains to developments in the United States and other industrialised countries.

    What, therefore, are the key strengths and vulnerabilities for the region today? And what challenges are Asia's policymakers likely to face in the period ahead?

    The International Monetary Fund's (IMF) Asia and Pacific Department addresses these issues in detail in its Fall 2007 Regional Economic Outlook ( ).

    The year 2007 has been another good one for the region so far. Economic growth has exceeded expectations. China and India have led the way, with growth rates in the first half of the year of 11.5 and 9.25 per cent respectively. The trend has been positive for others as well. Exports remain buoyant and growth is becoming somewhat better balanced in many countries, with private consumption and investment making an increasing contribution.

    For the year as a whole, we project that emerging Asia will achieve economic growth of nearly 9.5 per cent. Moreover, inflation continues to remain in check. While a recent modest pick-up in headline inflation in the region requires close monitoring, this rise mainly reflects higher food prices, especially in China, and is not expected to generate large second-round effects.

    The region weathered well the recent global financial turbulence, when concerns over rising defaults in the US sub-prime market led to increased volatility in equity and credit markets worldwide.

    Emerging Asia's equity markets did initially decline along with other emerging markets, Asian currencies did experience downward pressure, and financial conditions did tighten. However, what is striking is the speed with which emerging Asia recovered from this initial shock.

    Capital inflows to the region have returned, and its equity markets are now about 10 per cent higher than before the summer's turbulence. Reflecting this resilience, the IMF foresees only a modest slowdown in 2008, to about 8.5 per cent, resulting from lower external demand for Asia's exports, and an assumed effective policy tightening in China.

    The sub-prime crisis has, however, increased uncertainty about the outlook for the global economy - and for emerging Asia. First, it remains uncertain whether we have seen the worst of the global financial turbulence or if there are additional shocks ahead. The region's apparently small exposure to sub-prime mortgages and structured products more generally has helped moderate the impact of the sub-prime crisis on Asia. This in itself reflects the relatively unsophisticated nature of the financial sector in much of the region.

    But another bout of global financial volatility could have significant spillovers for the region. It could reverse recent inflows and make financing more difficult for a number of sovereign and corporate borrowers.

    But perhaps the main risk to the region is that of a sharp slowdown in the US and the euro area, resulting from the persistent US housing doldrums and associated global financial problems.
    Despite the view being expressed that Asia has 'delinked' from the US and other industrialised countries, the truth is that the region remains significantly dependent on exports to the rest of the world. While an increasing share of exports are within the region, much of this still reflects the integrated production processes within Asia, with much of the final demand still in the industrialised world.

    So, how big an impact would a US or global slowdown have on Asia? It would likely not be as big as during the dotcom bust of 2001-02. Then, the decline centred on information technology products, which are of particular importance for emerging Asia.

    Nevertheless, IMF staff estimates that a one percentage point decline in US economic growth could reduce growth in emerging Asia, through lower exports, by up to 0.4 percentage point. While sizeable, this would, however, not have a dramatic impact on emerging Asia's economies.
    Overall, then, the outlook for emerging Asia remains positive, but the economic environment will, as always, present a number of policy challenges.

    First, policymakers need to be ready to respond to a slowdown in the global economy including - in countries where inflation expectations are low and well-anchored - through more accommodative monetary policy.

    Second, the volatile global environment has raised uncertainty regarding capital flows to the region. Countries will need to continue to be pragmatic and allow for greater exchange rate flexibility to create two-way risk in foreign currency markets and promote a rebalancing of growth where necessary. This is especially pertinent in China, where the current account surplus has continued to grow and the currency remains considerably undervalued relative to medium-term fundamentals.

    Finally, the sub-prime crisis, while so far largely skirting the region, will provide a number of lessons for Asia, as its financial systems become more sophisticated. This is likely to include the need for enhanced financial supervision.

    At the same time, countries will also likely need to strengthen reporting and disclosure requirements, and pricing and provisioning rules to deal effectively with complex financial products, and the cascading system of risks they imply.

    The author is director of the International Monetary Fund's Asia and Pacific Department

    Monday, 22 October 2007

    This time it is different?

    Most observers are holding on to this view, the consensus outlook being that although the market may undergo more short-term pain in the next few weeks, its strong fundamentals should eventually prevail.

    In its Aug 3 Global Investment Strategy for example, Canadian research house BCA Research summarised this view when it said that although the damage from the sub-prime fallout will persist for a while because problems are more pervasive than first believed, it does not believe the recent selloff signals the beginning of a bear market.

    'There is plenty of growth outside of the US economy: economic news from China and the rest of Asia has been very strong . . . suffice to say that the world economy is still in a low-inflation boom, driven by an enormous supply-side expansion', it said.

    It all sounds very appealing - in cliched broker jargon, the present mini-crash qualifies as a 'much-needed correction' for an 'overbought' market that might even present 'bargain-hunting' opportunities.

    Once 'overbought' becomes 'oversold' and once the market has 'digested' the bad news, it should easily be able to resume its uptrend.

    To be honest, such a happy scenario is entirely possible. The problem, however, is that 'this time is different' can cut both ways. Over the past 15 months global markets have been rocked as violently as they are now on three occasions - in May last year when US Federal Reserve chief Ben Bernanke unwittingly stoked inflation/interest rate fears, in February this year when China crashed 9 per cent in one day and in April when China again crashed on fears of the unwinding of the yen 'carry trade'.

    In each instance prices recovered quickly, thus enhancing the complacency and conditioning referred to earlier. So it's no surprise that the prognosis for the present crisis is the same as before - a brief period of pain before the bull run resumes.

    But surely the spreading rot from the sub-prime crisis suggests the rather inconvenient truth that this time really is different because it is the crucial financial sector which is under threat, and that it would be too simplistic to expect a swift return to the heady days of May and June when stocks regularly rose to all-time highs?

    US broker Morgan Stanley is possibly the only big name so far to share this view. In its Aug 5 assessment of the exposure Singapore banks have to the US mortgage fiasco, it hit the nail on the head when it wrote 'the market has for some time exhibited excessive optimism, driven by liquidity rather than fundamentals and hence has been willing to extrapolate the positive and ignore the negative'.

    The truth is that no one knows yet the full extent financial stocks everywhere are exposed to the US sub-prime market's problems and it may take several weeks or maybe months before all the rot is uncovered. And if the financial sector is undermined, so is the entire market.

    Until then investors will remain nervous while hoping for salvation from the US Fed in the shape of interest rate cuts (the futures market is now pricing in at least two rate cuts over the next 12 months).

    However, buying heavily into 'this time is different' too soon would be a dangerously risky proposition because ironically, this time round, it is not the reasons to buy which are different but the reason to sell.

    Get Out of China While You Still Can

    By Morgan Housel

    As you've probably heard by now, today marks the 20th anniversary of the stock market crash of 1987, which yanked down the Dow Jones Industrial Average by 22% in a single day. I can hardly think of a better way to commemorate one of the most famous stories of irrational expectations that ended in calamity than to discuss the world's frothiest, most overheated, and biggest waiting-for-trouble market: China.

    The financial world is no stranger to bubbles. As we've seen with the stock market crash of 1929, the Nifty 50 in the early 1970s, Taiwan and Japan in the 1980s, the Nasdaq dot-com hoopla in 2000, and the real estate mania over the past seven years, there's rarely a shortage of stupidity somewhere in the markets.

    One belief that tends to characterize these bubbles is that "it's different this time." People justified the incredible surge in the Japanese Nikkei average because they knew electronics would change the way our world functioned. They justified the Nasdaq boom by saying the Internet would forever change the way people do business. In both cases, those people were right about the effects on our lives -- but that didn't justify the massive speculation that dominated the market.

    Sure, the Chinese economy has a lot going for it right now. For the first time since economic restructuring began in the 1970s, growth is being fueled by the citizens -- not the Communist government. Combine that with low interest rates, an increase in property values, growing corporate profits, and a sky-high personal savings rate ... and, heck, maybe it is different this time, right?

    Keep dreaming. Just as the day after Christmas used to depress me beyond belief, all excessively good things must come to an end.

    Regardless of a slew of factors stacked in its favor, China is no exception to the rule that speculation always leads to a fall. Here are some of the factors that make the Chinese stock market look more like a Las Vegas casino floor than an attractive place for your money.

    The big guys have left the building
    Big-timers like Li Ka-shing -- whom some regard as the Warren Buffett of Asia -- along with Chinese central bank governor Zhou Xiaochuan and Alan Greenspan all share a strong sense of pessimism about the Chinese market. Unlike the U.S. stock market, which is dominated by hedge funds and mutual funds (whose managers, in theory, should know what they're doing), 70% of Chinese market activity comes from regular people. One-sixth of all Chinese individual brokerage accounts have been opened in the past year; the fact that the indices have more than doubled in value during the same period should come as no surprise.

    Eastday, a Chinese government-run website, announced in April that 10% of all the maids in Shanghai have resigned because day-trading stocks became more lucrative than traditional work. Here's a quick rule of thumb to remember in investing: When everybody and his or her mother is rushing to get in, it's time to pack your bags and head for the exits.

    Rationality: a thing of the past
    So much speculation has entered the Chinese market that some traders have opted to focus on superstition. Some are picking lucky ticker symbols that include the number 8, which in Chinese is a homonym for good luck. At this point, Sylvia Browne is starting to look rational.

    The Chinese market has all but abandoned the idea of investing in companies. It's now completely based around the fear of not getting aboard before the train takes off. As Buffett said, "Like most trends, at the beginning it's driven by fundamentals. At some point, speculation takes over. What the wise man does in the beginning, the fool does in the end."

    As jittery as a hummingbird on Red Bull
    And talk about neurotic. All it took in February was a tax on trading to send shares down more than 9%. Even the slightest hint of bad news could send shares falling faster than you can panic sell. I bet that'll make you feel different about taking a bathroom break.

    Will China go any higher? It easily could. But that certainly doesn't mean you should hope to pick the top. Bubbles burst much more quickly than they form, and it could be far too late before you realize how much trouble you're in. Don't kick yourself for watching others make money by irrational means. Stick to sensible investing, and you'll always be left with the last laugh.

    And if speculation is your thing, go to Las Vegas. You're odds of winning are better, and you'll eat for free.

    Sunday, 21 October 2007

    "If I work hard, is it guaranteed that I'll succeed?"

    So what is your answer to the above question?

    Most people say 70% hard work, 30% luck.

    Do you agree?

    I don't.

    The truth is, if you work hard, you are guaranteed to succeed, period!

    "But I've worked very hard, why am I not successful yet?"

    I'll give you the answer later, but let me explain why hard work guarantees success.

    The world is governed by a set of laws and these laws work with mathematical certainty. Some of the well known laws are the law of gravity and the law of action and reaction. These laws are taught in school because they can be proven by science. Some laws cannot be proven scientifically and thus, they are not in the mainstream of our education. One of these laws is the law of compensation.

    The law of compensation simply states that you get compensated for whatever you contribute, nothing is lost and nothing is wasted. If you work hard, you will succeed. That's it. There is no other conditions. There is no BUT..... There is no UNLESS....

    Ralph Waldo Emerson (1803 ~ 1882), one of America's most influential philosophers, explains the law of compensation: “The whole of what we know is a system of compensations. Every defect in one manner is made up in another. Every suffering is rewarded; every sacrifice is made up; every debt is paid.”

    If you work hard, creative ideas will come to you. If you work hard, you will meet benefactors and other people who can help you to succeed. If you work hard, resources that were not available to you in the past will become available to you now. What other luck do you need?

    "But I've worked very hard, why am I not successful yet?"

    This question was also asked by a friend of mine, who said that he had worked very hard and yet his business was still not making money. He said he was not compensated for the hard work he had put in.

    Is it true? Let's see.

    The truth is this friend of mine had been working very hard to solve problems, not working very hard to make money. He had been working hard to solve his problem with his supplier. He had also been working hard to help his employees to solve their problems, which have nothing to do with him! He worked hard to solve all kinds of problems. So in the end, the law of compensation worked. He becomes a great problem solver. The only problem he didn't solve is to earn enough money to continue with his business.

    Take myself for example. I try to spend most of my time on money making activities. I'm either promoting my websites or networking with my customers or creating more products that can make more money in the future. As much as possible, I leave other tasks like customer service and accounting to other people. What about problems? Well, I have been "advancing" from my problems for a few years and I have little problems to solve now. What I have now are challenges. Problems are boring and annoying, challenges are exciting and interesting. See the difference? (If you don't know what I mean by "advancing" from my problems, please read last month's newsletter.)

    The law of compensation only warrants you success in the area where you've worked hard, not in the area where you "think" you've worked hard.

    For instance, if you have been working hard days and nights to provide for your family and one day your wife leaves you because she says you don't love her, please don't be mad because the law of compensation in this case only compensates you with financial stability, not love. See what I mean?

    Another example, you may be working hard to learn how to make money online. If you do just that, you may deserve a degree on how to make money online, but you will NOT make money. You will only make money when you work hard to do things that can generate profits, not learning how to make money.

    I hope I've given you enough examples to illustrate the idea.

    After today, I hope there is no more excuse for any underachievement in you. Work hard and success will be inevitable. Just make sure you are working hard at the right thing!


    Friday, 19 October 2007

    Profiting from subprime turmoil

    (Money Magazine) -- News this week that major banks are planning a massive fund to prop up the hardest-hit victims of the subprime mortgage crisis got investors worrying again.

    Specifically, they're concerned that potential losses from bad subprime bets could be much bigger than previously feared.

    In fact, the bailout fund is good news. And you actually have a chance to profit personally over the long term from today's turmoil, as long as you make your investment decisions cautiously.

    Shares of banks and financial services companies may not have hit bottom yet - but there will soon be bargains to be had. And some companies with exceptionally strong balance sheets are already good deals.

    Understanding the problems

    The credit crisis itself is very complicated, but here's pretty much what you need to know. As home prices kept rising over the past few years, more and more people wanted to buy houses. Lenders accommodated them by devising mortgages that required less money down and lower monthly payments.

    Often the interest rates on these mortgages could increase sharply from initial low levels. That created the risk that buyers who had stretched to the utmost to buy a house could be forced to default.

    The risks were greatly multiplied as the original mortgages were bundled into separate investments and sold off. This kind of packaging has been done for decades by institutions, and the resulting securities have long been part of a stable credit market.

    But the new packages, a type of collateralized debt obligation (CDO) known as structured-investment vehicles (SIVs) are far more complicated - too complicated, in fact.

    The packagers sliced and diced underlying pools of mortgages, mixing lousy loans with solid ones, until nobody could tell what was what. Even the resulting investments that had great credit ratings could ultimately be backed in part by shaky mortgages.

    In addition, long-term assets in the portfolios were financed with short-term borrowed money. That means that rising interest rates or tight credit could force banks to take losses as they scrambled for cash.

    The great risk is that the overall credit market freezes because lenders are afraid to lend.

    And that's why recent news has been encouraging. The Federal Reserve has made extra short-term credit available to banks and is clearly willing to do more. And the Fed aggressively cut short-term interest rates in September, which greases the wheels for more lending.

    In addition, the new fund that the major banks are proposing will ensure that the hardest-hit investors will be able to sell securities when necessary. Equally important, the fund will allow solid securities to be separated from those that are iffy.

    Ratings agencies and other experts estimate that there are as much as $400 billion of SIVs outstanding, although it's impossible to know the total amount. But not all of this is at risk - the actual losses should be in the manageable range for major banks that earn tens of billions of dollars a year.

    The credit crisis will require more big earnings writeoffs, like the one that slashed Citigroup's (Charts, Fortune 500) profits by 57 percent in the third quarter. Bank of America (Charts, Fortune 500) and Washington Mutual (Charts, Fortune 500) also announced weak results. But once they are completed, such writeoffs won't impair the value of the stocks involved.

    Bargains to be had

    When things calm down, top-quality financial stocks will likely be great bargains, as I discussed in the October issue of Money Magazine.

    Basically, there have been a couple of episodes, starting with the Savings & Loan crisis almost 20 years ago, that were similar to what's been going on recently. In those earlier cases, it took about six months for financial stocks to hit bottom.

    So far, the big banks are generally above their August lows. The notable exception is Citigroup, which is having the most trouble, because its exposure is estimated to account for about a fifth of the outstanding SIVs. Other banks should have an easier time.

    The good news is that once the past selloffs ended, financial stocks posted gains of more than 50 percent over the following two years.

    Still, take your time about adding more financial stocks to your portfolio. There could still be some unpleasant surprises between now and early next year when final 2007 results are known. At that point, however, financial shares will actually be a lot less risky because the extent of their problems will be known and reflected in share prices.

    If you're looking for stocks in other sectors that are smart buys now, you'll find bargain-hunting opportunities among companies with plenty of cash or pristine balance sheets. At a time when banks are cautious about making new loans, businesses that have ready money or that are still attractive borrowers will be able to expand, acquire weaker players and take advantage of other opportunities.

    Investors haven't yet fully recognized the competitive advantage of creditworthiness. But they will soon enough, and financially strong companies should then be accorded higher price-to-earnings ratios. The greatest bargains are likely to be stocks that are depressed and trade below their typical price/earnings ratios, such as Johnson & Johnson and Microsoft. For more on financially fit stocks, click here.

    While stock prices will likely be volatile over the coming year, the odds are still in favor of continuing growth rather than recession. So hold down your risk by adding stocks with relatively low P/Es to your portfolio and diversify as broadly as you can. But don't shy away from equities because of today's market troubles. Remember that after the S&L Crisis ended, stocks enjoyed a six-year bull market. Top of page

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