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Tuesday, 24 August 2010

How To Survive a 'Zombie Economy'

Rick Newman

Imagine if the U.S. economy grew just 1 percent per year over the next 20 years. The Dow Jones Industrial Average would plunge by 60 percent, to less than 4000. The average price of a home would fall by nearly 50 percent, from $184,000 to about $100,000. The economic carnage would make the Great Recession seem gentle, upending families, devastating communities, and transforming America for generations.

That's the outer edge of a "Japanification" scenario painted by economists at Bank of America Merrill Lynch, meant to examine what would happen if the U.S. economy got stuck in a deep rut like the Japanese economy did in the 1990s. It's an unlikely outcome, yet a weakening U.S. recovery has sent economists back to their textbooks to study the world's most famous "zombie economy." And there are some unnerving similarities between Japan then and America now. Both countries experienced a real-estate bubble fueled by greedy speculators and complicit banks providing the funds. In each case, the bust came quickly, leaving banks, investors, and consumers with steep losses that would take years to absorb. And both wipeouts challenged policymakers hoping to jump-start the economy by pulling conventional levers.

Japan's zombie economy is generating new interest now because a recovery that looked like it was taking root in the first half of the year seems to be unraveling in the second half. After a couple of impressive quarters, GDP growth is sagging again, and it might even turn negative if not for the remnants of last year's big stimulus bill. With weak demand for goods and services, companies aren't hiring. Unemployment seems stuck at nearly 10 percent. The housing bust persists despite government subsidies. Investors are bailing out of stocks. Even at the normally staid Federal Reserve, policymakers are starting to bicker over what to do.

This could all be part and parcel of a stutter-step recovery, with the economy shaking off the jitters and picking up steam later this year or next. But it could also be the early stage of a prolonged period of stagnation that bedevils policymakers, which is a growing concern at the Fed and on Wall Street. "The U.S. is closer to a Japanese-style outcome today than at any time in recent history," wrote James Bullard, president of the Federal Reserve Bank of St. Louis, in a recent study.

Japan's economy seemed to be on fire in the 1980s. Then its booming real estate market collapsed, sending the nation into a 10-year tailspin. From 1991 to 2000, Japan's economy grew a scant 0.5 percent per year, compared with healthy 2.6 percent annual growth in the United States. Deflation set in, which torpedoed spending and bank lending. Unemployment rose and stayed high. Living standards sank. Japan's rapid economic ascent stalled, and the erosion of confidence became self-perpetuating.

The lesson of Japan's "lost decade" is that chronic stagnation can be even more punishing than a sharp recession. But don't head for the ledge just yet--there are key differences between Japan in the 1990s and America in 2010, including the way the government reacted to the problem. In Japan, the real estate bust was even worse than it has been here, with bigger price drops. Japan's central bank waited until eight years after the peak of the bubble to cut interest rates, one antidote to a financial crisis. In the United States, the Federal Reserve cut rates just three years after the bubble's peak--and cut more deeply. And the American bank bailouts, as unpopular as they were, helped banks recover from deep losses and accelerated the healing in the financial sector. "One might say that the U.S. leap-frogged the first phase of Japan's decade of economic underperformance," says Alan Levenson, chief economist for investing firm T. Rowe Price.

If that's true, then that leaves the next phase of Japanification, in which banks restrict credit while they work through a large pool of bad loans, and the nation as a whole pays down excessive debt. This seems to be precisely where the U.S. economy is right now--and might stay for awhile. U.S. banks, for example, probably have enough reserves to handle underwater mortgages and defaults on credit cards and other consumer loans. But it's not clear that those losses have peaked, and the longer unemployment stays high, the worse that problem will get.

All those non-performing loans represent the "toxic assets" that were such a concern at the start of the financial crisis--and many of them are still there. The banks have argued that those assets will regain some of their value as the economy recovers, and the Fed's policies are basically allowing time for that to happen. Meanwhile, however, banks are lending less, which constricts home and car purchases and other economic activity. Instead of galloping forward, the economy just stumbles along.

Many consumers don't want new loans anyway, since they're overwhelmed with debt and their assets have plunged in value. Americans, on average, have a debt-to-income ratio of about 122 percent, which means the average amount of individual debt equals nearly 15 months' worth of earnings. That's down from a peak of 133 percent in 2007, but historical averages are well below 100 percent. That means many Americans have no choice but to dedicate leftover income to paying off debt instead of buying stuff. So money once dedicated to tomorrow's purchases is now dedicated to yesterday's.

If you're wondering what a zombie economy looks like, in other words, you're probably looking at it.

If we're lucky, that quick action by the government sped things up, and we might be facing a lost half-decade, with some time already served, rather than a full lost decade like Japan. But the next few years could still be challenging. It's a good bet that interest rates will stay low, bedeviling savers. Inflation will be so low as to flirt with deflation, likely to keep incomes depressed and consumers on the sidelines. Companies will remain reluctant to hire, and stocks will zig-zag.

But there are ways to ride the zombie, and Japan has shown us how. With interest rates painfully low and stocks volatile, investors should look for dividend-paying stocks and high-quality bonds. Consumers should keep paying down debt and resist any additional debt if possible. Tempting as it might be to replace an aging car or out-of-style appliance, it's okay to wait. Prices are unlikely to rise by much, and might even fall. Home prices in particular seem likely to keep falling, at least into 2011. And lenders might become more permissive over the next year or two, as they slowly improve their own financial health.

Job seekers should develop every new skill they can, since employers these days are looking for people with two or even three distinct skill sets. Even if the U.S. experience amounts to Japan Lite, the job market will stay tough. People need to go where the jobs are and prove why they're worth investing in during slack times. It doesn't hurt to have a secondary source of income, since raises are likely to be scarce.

However long it lasts, our very own zombie economy will wake from its restless slumber as soon as the Fed raises interest rates again. And the Fed will do that when it feels confident that the economy can stand on its own. A year ago, some prognosticators thought the Fed would raise rates by mid-2010. Instead, the Fed expressed unusual concern this year as the recovery faltered, continually renewing its pledge to keep rates low for "an extended period." Economists now guess that could last until late 2011 or early 2012. If they're right, Japanification here will have lasted only half as long as it did over there. That will be long enough.

10 Money Moves That Will Always Pay Off

by Brett Arends

Few things in life are guaranteed. When it comes to money, even fewer.

But these are nervous times. The stock market is swaying like a drunk debutante. The economy is wobbly. Who can trust anything any more? Most people are hard-pressed, nervous and unsure of what to do.

Relax. Here are 10 sure-fire money ideas.


1. Max that 401(k)

This is a slam dunk for you. Every dollar you invest saves you money on taxes because it comes off your taxable income. So Uncle Sam is effectively chipping in.

The money can then grow each year, free of any state or federal tax on the interest or capital gains (though when you withdraw your money in retirement it will be taxable income).

Even better: Many companies offer to chip in as well, up to a certain level, by matching contributions with money of their own.

2. Give up the vacation home

Sorry to be a spoilsport. But the finances just don't stack up. The math on most vacation homes -- unless it's dirt cheap, or so near that you go there most weekends -- is terrible. Most of the time we use them for a few weeks or months of the year. They cost money to buy. There are annual upkeep, maintenance, condo fees and taxes.

How much has the house risen in value since you bought it? How much do you expect it to rise? A home probably has to rise by maybe 7% a year, on average, to cover the costs. Sure, keep it if you want to and can afford to. But if you are looking for a quick financial win, this is one.

3. Put $5,000 into an individual retirement account or Roth IRA tax shelter

If you're over 50, put in $6,000. And make sure your spouse does too. IRAs are a great deal. A regular IRA works much like a 401(k) -- your contribution cuts your taxable income, and grows tax-free inside the shelter, but it's taxable income when you take it out. In a Roth, you contribute after-tax dollars, but then it's tax-free forever.

In the past, these were limited to those making less than, roughly, $100,000 to $160,000 a year, but as of this year there's a special deal. Anyone can contribute to a Roth, by contributing to a traditional IRA and then converting it to a Roth. You can also convert your IRA savings from previous years (Note: there will be tax to pay).

4. Pay off your credit-card debt

Haven't you heard? If you're still carrying a balance each month, this is a quick win. Eat macaroni and cheese for three months if you have to, but pay off those balances. You're probably paying at least 15% interest. You may be paying a lot more. You'd have to earn maybe 17% before tax on an investment just to keep pace. Boring? Nobody's making 17% these days. So pay off your credit-card debt and brag to all your friends that you just beat Wall Street.

5. Fire your banker

This isn't just good financial sense -- it's fun, too. If you're like most people, you're probably paying hundreds of dollars a year in account service fees, ATM charges for access to your own money and the like.

Banks need to sock you with these fees to pay for all their overpriced and useless overhead, like the expensive marketing campaigns and the executives. Fire them all. Chances are you have a local community bank, savings and loan, or credit union that will do the job of looking after your cash for a lot less. It's Uncle Sam, not the institution, that guarantees your money anyway.

6. Get your tax refund early

How? By not overpaying your taxes in the first place. Every year, millions of people cheer when they get a check back from Uncle Sam. But that just means they paid too much withholding tax during the year. So Uncle Sam got an interest-free loan. Good for him, not so good for you.

Go to your employer's payroll department and file a new W-4 form and raise your number of allowances. You'll see extra money in your paycheck straight away.

The average tax rebate is nearly $3,000, according to the Internal Revenue Service. The average credit-card balance? Also about $3,000, according the Federal Reserve. Borrowing from a bank at 15% and lending the money to Uncle Sam for free is no way to run your finances.

7. Buy inflation-protected bonds

Treasury inflation-protected securities, or TIPS, aren't sexy. They won't make you rich. But they're guaranteed -- twice over.

They're issued by the U.S. government, so they are guaranteed against default. And they are protected against inflation because coupons and principal will adjust to reflect it. Right now a long-term TIPS bond will guarantee you an interest rate of about 1.8% a year above inflation. (Note: Hold them in a tax-sheltered account as they are highly susceptible to taxes).

Dull, maybe. But a sure thing.

8. Buy a bread machine

You want a certain winner? If a $50 breadmaker saves you, say, $7 a week on buying bread, that's $350 year. The easiest dough you'll make. Modern breadmakers are, well, a piece of cake to operate. The return on investment: 600% in year one and 700% after that.

Wall Street's best year ever? Just 74%, in 1915. Ha. Amateurs.

9. Play hardball with your insurance company

Call competitors and ask them to quote you prices for your current house and auto policies. You'll be amazed at the differences. Prices for the same policy can vary as much as 50% between carriers. And there's little rhyme or reason to it.

While you're about it, ask about raising your deductibles too. This can be a quick win: Raising your deductible by $500 to $1,000 can cut hundreds off your annual premiums.

10. Get a freebie from a bank

Why not? You bailed them out. I'm not just talking about stopping in for a free lollipop or cup of coffee (though my local Bank of America brews an OK cup).

Sign up for a credit card with a big bonus -- like a free air ticket or weekend hotel stay. Use the card enough to qualify. Then cancel the card.

No, it's not quite that easy. You have to double-check the fine print first. You'll sit on hold for half an hour when you try to cancel. And if you did this too often it might affect your credit score. But where else can you get a free (or nearly free) air ticket?

Write to Brett Arends at

How Much Money Will You Need to Retire?

Retirement savers need to figure out how much money they need to accumulate and make sure that money lasts at least as long as they do. But first you need to answer another question. How much will you spend each year once you are retired?

Most retirement planning professionals recommend that you initially withdraw no more than 3 to 4 percent of your retirement assets to cover your first year's living expenses. Each year after that you can increase your withdrawals enough to cover inflation's bite, according to research by certified financial planners William Bengen and Larry Bierwirth.

The recent recession has made many of us wary of any standard rules of thumb when it comes to retirement planning. But we can rest easier knowing that this research data includes some pretty rough patches in history: several recessions, some extremely inflationary periods, and the 1929 stock market crash and Great Depression.

What the research shows is that the safest initial withdrawal rate is 3 percent. There was no historical 50-year period during the 80 years studied where you would have outlived your money using a 3 percent withdrawal rate. And using a 4 percent withdrawal rate, your money would have lasted no less than 33 years.

Figure out how much you will spend. Unfortunately, none of this means anything to you if you have no idea how much you will be spending in retirement. Your first assignment is to figure out exactly what you want your retirement to look like. A good place to start is to examine your spending right now. Retirement may allow you to cut back in some areas, like commuting, work clothes, and lunches out. But other costs will probably increase, such as health care, entertainment, and perhaps travel. You need to estimate your retirement expenses. Do not use the shortcut of assuming some fixed percentage of your current income.

Calculate how much you need to save. Once you've nailed down your annual retirement budget, you'll need to figure out how much of that will not be covered by sources such as Social Security, pensions, or annuities. Let's call this your shortfall. You're going to need to cover that shortfall with your own nest egg: 401(k) accounts, IRAs, and other personal savings accounts.

That's where all this research comes in handy. If you are retiring in your 60's or 70's and think you are likely to live 30 more years, you should be safe using a 4 percent withdrawal rate. That means you'll need a nest egg of 25 times your annual shortfall. If you are retiring at a younger age, with up to 50 years in retirement, you'll want to use the 3 percent rate to be safe. So, you will need a nest egg of 33 times your annual shortfall.

It's worth noting that these studies were based on portfolios that included at least 50 percent stocks, the rest in bonds. If you want an allocation of less than 50 percent stocks, you're going to need a bigger nest egg.

Can you retire with less? Maybe. The data shows that for most periods, 25 times your annual shortfall would have been enough to see you through 50 years of retirement. More recently, studies have shown that if you are willing to be a bit flexible in your annual spending, you might be able to get by with a smaller stash. This approach requires a little more vigilance on your part. You would need to withdraw less of your nest egg in lean years and return to higher levels when things perk up. But the payoff could mean an earlier escape from the rat race.

Sydney Lagier is a former certified public accountant. Since retiring in 2008 at the age of 44, she has been writing about the transition from productive member of society to gal of leisure at her blog, Retirement: A Full-Time Job.
Copyrighted, U.S.News & World Report, L.P. All rights reserved.

Sunday, 22 August 2010

Are stocks still a good investment?

Walter Updegrave

Money Magazine) -- You could say that Roger Ibbotson wrote the book on investing. After all, Ibbotson Associates publishes the Ibbotson SBBI Classic Yearbook, a tome that analyzes historical data for stocks, bonds, Treasury bills, and inflation and is usually the source of those historical returns you see bandied about in the financial press ("Since 1926 stocks have gained an annualized 9.8% ...").

So when Money's editors wanted insights into how the financial markets might fare in the future and whether time-honored strategies like asset allocation and international diversification were still worth pursuing given recent upheavals here and abroad, it was only natural that we turned to Ibbotson (the man, not the book).

In a wide-ranging discussion, the money manager and Yale finance professor proved quite optimistic about stocks' prospects for superior performance, and he's backed up that confidence with action, launching two mutual funds that will employ a novel investing strategy (more on those later).

At the same time, though, Ibbotson cautioned that if you want the high returns he thinks stocks have to offer, you'll need to brace yourself for a bumpy ride.

Edited excerpts of our conversation follow.

Should investors expect superior gains from stocks in the future? Or has something changed that suggests equities won't be as dominant?

Stocks are going to outperform bonds long-term. That's almost assured. Yes, we've had a decade where the stock market underperformed, actually had negative returns, but that was very unusual. You have to go back to the 1930s before you had another negative return for a decade in the stock market.

It makes sense, though, that we have some periods of negative returns because the whole key to getting higher returns in the long run is that stocks are risky. People have to be afraid to take the risk of investing in stocks for them to deliver superior returns going forward.

Now, future stock returns might be lower than the near 10% historical average. We think maybe 8% or so, although others say they could be even lower because they don't see strong economic growth for the next decade.

But the equity risk premium, or the extra return you get from stocks vs. less risky investments, isn't much different than it was historically. What is unusual about the last 30 years, though, is that the bond market often outperformed the stock market over long periods. You won't get that again.

Why not?

You started in 1980 with double-digit yields, which provided high income, and those yields then dropped, creating capital gains. [Bond prices and yields move in opposing directions.] That combination made it a great period for bonds. But today yields are 3% to 4%. So we're starting out with a low yield that, if anything, is more likely to rise than fall, which means you won't get any capital gains. So the bond market will not repeat its performance.

The stock market can repeat, and the kind of returns you got over the last 30 or 40 years might be indicative of future returns. But they'll come with up and down periods that can be very disheartening.

Disheartened is how many investors feel about stocks today. What makes you so confident? Is there something inherent about stocks that makes them likely to outperform?

What's inherent about stocks is that they're risky. And we don't like risk. So every time something bad happens, we're really wary of the stock market. Of course, we were especially wary in March 2009 after the market had fallen well over 50%, but that turned out to be a great time to buy stocks. It's when you're most afraid of stocks that they have the most potential.

But to get this risk premium, don't you have to be correctly pricing in the risk? Some would argue that recent prices don't reflect stocks' true risk, that price/earnings ratios are too high.

P/Es are hard to measure coming out of the recession because earnings are changing quickly, and P/Es from trailing earnings are much different than estimated P/Es from forward earnings.

The stock market surged in the early stages of the recovery not because companies increased their revenues but because they cut their costs. Now if they can start increasing their revenues, they can improve their bottom lines a lot. If that happens, stocks will turn out to have been rather attractively priced now.

Let's talk some more about volatility -- those up and down periods. Conventional wisdom now is that the next 30 years are going to be way more volatile than the last 30. Are people overreacting to what's happened in the recent past?

We've had a long period of relatively low, maybe artificially low, volatility. After World War II, volatility dropped and, despite a few spikes like the crash of '87, it's remained tame. The financial crisis produced a big pop in volatility, and it's remained high recently. But it's going to gradually dampen, probably not to the same level it was before the financial crisis, but it will come down.


The problem with risk is it's always the surprises that get you. And very few people contemplated the financial crisis ahead of time. So people did not sufficiently allow for it. But we've now had two big market collapses in a decade. In many ways this is great news.

I doubt that's how our readers see it.

We now recognize that things can happen that weren't on the radar screen. People will remember what risk is all about. It isn't just that with more risk comes more return, but you can really have a downside.

You've recently started managing two mutual funds -- American Beacon Zebra Large Cap and Small Cap -- that will invest in less liquid stocks, those that trade less frequently. Why, at a time when investors are wary, would you want to focus on shares that would seem riskier?

There are gradations of liquidity. These stocks trade every day. But research shows that the stocks that are more liquid historically have lower returns, while those that are less liquid have higher returns. We're buying companies that have strong fundamentals but are relatively less liquid, companies that there's less interest in, the ones not talked about in your magazine. Effectively, you get an out-of-favor stock, and if it ever comes into favor, you get a big kick-up in the returns.

One way investors mitigate stock risk is by spreading their money among several asset classes. But in a recent study you concluded that asset allocation accounts for much less of the difference in returns than many advisers have claimed over the years. Does that mean investors shouldn't focus as much on asset allocation?

Previous research has said 90% of the variation of returns comes from one's asset allocation policy. We disagree with that.

We say that there are really three things that determine how much your returns go up or down from year to year. The first is just that you're in the market at all. In 2008 you lost money; in 2009 you made money.

The second is that you have a different asset-allocation policy than the average. Maybe the average is 60% stocks/40% bonds, but you're 50/50 or 70/30. You have a different mix.

The third factor is all the active things you do. You pick some securities that don't match the indexes, you pay fees, maybe you change your mix from time to time.

When we look at these three factors, the one that explains the most variation of returns is the fact that we're all in the market in general. That explains about 70%. The second two are about equal -- the fact that you may invest mostly in bonds and I mostly in stocks and that you buy, say, GM, and I buy Apple.

So what lesson should individual investors take from your study?

That what's most relevant to you is whether and how you're doing something different from what everybody else is doing.

If individual investments are so important, what does that mean for people deciding whether to invest in index funds or actively managed mutual funds?

To the extent you're in index funds, you're going to have less risk because you're eliminating the impact of active management. You'll also have lower fees.

In actively managed funds, your risk level goes up, as will what you pay in fees. The question is, Do you think the funds you pick can compensate for the extra risk and higher fees? On average, the answer is no, but there can be a subset of investors who outperform.

Given what's going on in Greece and Europe generally, does it still pay to diversify abroad?

Europe has had its difficulties, as has Japan. But that doesn't mean they're going to continue to do poorly. We can't tell which markets are going to do best at any particular time, so you want to hold a mix of them.

But what if Europe's problems lead to slower economic growth in the future? Wouldn't that translate to subpar returns in those markets?

The stock market looks forward. To the extent that investors recognize that these markets have already dropped enough to reflect that, then you would get reasonable returns.

That's what happened in March 2009. Everybody had a bad view of the U.S. economy, but prices had fallen more than enough to reflect that outlook. Ultimately, I don't have a strong opinion on whether you should buy Europe, Asia, the U.S., or whatever. My view is that by diversifying, you reduce your risk.

Do you have what it takes to be wealthy? :)

Thursday, 19 August 2010

9 Investing Strategies for This (Or Any) Market

Ben Baden and Kirk Shinkle

It has not been a relaxing summer for Wall Street. Economic blues at home and debt crises abroad, a sickly job market, and a general fearfulness among investors over the future direction of the market are still weighing heavily on the minds of many Americans. At times like these, it's worth taking stock of some of the investing basics that can make any portfolio a less fraught proposition. Consider the following a checklist for staying sane when markets seem to be anything but friendly.

Don't pay too much. High fees can really cut into a fund's overall returns. This week, Morningstar released new data showing how important fees are in predicting the success of mutual funds. Morningstar looked at the expense ratios of funds in multiple asset classes from 2005 through 2008, then tracked their progress from 2008 through March 2010. Bottom line: Research found the cheapest funds outperformed the highest-cost funds in each asset class over every time period. For instance, in 2005, the cheapest quintile of U.S. stock funds returned 3.35 percent, on average, over the five-year period, versus 2.02 percent for the highest-cost quintile of funds in the category. When selecting funds, keep in mind that some asset classes are pricier than others. Large-cap funds are generally cheaper than small-cap or international funds, for example. It's a good idea to compare your funds' expense ratios with the annual fees of their peers. Christine Benz, Morningstar's director of personal finance, says generally, investors shouldn't pay more than 1 percent in annual fees for domestic large-cap stock funds, about 1.2 percent for international stock funds, and between 0.65 and 0.75 for bond funds.

Keep it simple. Index funds and exchange-traded funds track indexes, so they're generally cheaper than funds that rely on managers to pick stocks. ETFs, which look like mutual funds but behave like stocks, offer a simple, low-cost way to invest and gain instant diversification. When you invest in an ETF or an index fund, keep in mind that your fund won't likely underperform its index, but it won't beat the index, either. "I'm a huge fan of simplification strategies, and I think indexing a broad-market segment is a great way to do that," Benz says. "It's possible to pick active funds that outperform index funds, but in terms of something that's low cost and hands-off, it's hard to beat indexing." Funds that provide exposure to U.S. stocks include Schwab's Total Stock Market Index Fund and its U.S. Broad Market ETF. Funds for a globally diversified portfolio include Vanguard Total World Stock Index Fund or Vanguard Total World Stock Index ETF.

Dollar-cost averaging. Many investors pull money out of stock funds when the market gets bumpy. In a volatile market, it can be difficult to stick to your investment plan. One way to stay on track is by practicing dollar-cost averaging--investing a set amount of money on a regular basis instead of investing a large sum at once. "It can provide discipline, and it can give you the courage to invest in what could--in hindsight--turn out to be a good time," Benz says. Dollar-cost averaging ensures that you'll continually invest in the market regardless of how it's performing at any given time. You can begin dollar-cost averaging by setting up an automatic investment plan through a fund company. T. Rowe Price, for example, will allow you to invest in more than 90 of its no-load funds if you agree to contribute at least $50 per month to a fund. One offering is T. Rowe Price Spectrum Growth Fund, which provides broad-market exposure through 11 underlying T. Rowe Price stock funds.

Diversify within asset classes. The so-called "lost decade for stocks" makes a good case for diversification. If you had invested only in an index fund that tracks the S&P 500 over the period starting Jan. 1, 2000, and ending Dec. 31, 2009, you would have earned virtually nothing. The culprit? Large-cap stocks that performed poorly during this time period. Meanwhile, other asset classes provided a solid return. For instance, over the past 10 years the Russell 2000 (a small-cap index) has returned an annualized 4 percent.

Keep an eye on cross-asset allocation. Large cap? Small cap? Those distinctions matter, but not nearly as much as the mix of different classes of assets in your portfolio. And it's not just stocks and bonds anymore that make up a truly diversified portfolio. Experts now say equities and fixed income should be held side-by-side with a raft of assets, including real estate, commodities, and other alternative investments in an attempt to prevent just the sort of damage that hit portfolios during the 2008-2009 crisis, when wide swaths of assets (homes, stocks, bonds) all lost value at the same time. Research shows that almost all investment volatility is driven by asset allocation decisions--how you carve out investments among stocks, bonds, real estate, international investments, and commodities. A classic study of pension funds showed that 91.5 percent of investment variation in quarterly returns is explained by investment policy rather than stock picking or other factors. "It's not so much what you put in your account, it's how you allocate what you put in your account that's going to help reduce volatility," says Brian Rimel, an adviser with Raymond James.

Rebalance periodically. It's important to monitor your portfolio and make sure your asset allocation changes over time, says Benz. "Making the judgment about what is an appropriate stock, bond, and cash mix, and also taking care to adjust that over time as you get closer to needing your money is a hugely important and impactful step--arguably more important than individual security selection," Benz says. Some experts recommend that younger investors fill their portfolio entirely with stocks, then begin to shift into other types of investments, like bonds, as they get older. Benz recommends target-date funds, in which a manager handles the asset allocation through a set retirement date. Fund families often employ different "glide paths"--or asset allocation that changes over time. As you approach retirement, target-date funds generally shift to a more conservative mix over time. If you decide to choose your own funds, remember to rebalance periodically.

Don't try to time the market. It's a common investing error: buying funds when they're flying high and dumping them when they fall behind. Over the past decade, Morningstar research has shown that investors simply aren't successful in timing the market. To illustrate, Morningstar calculates what it calls investor returns, which reveal how much money actual investors actually make or lose in a fund based on when they buy and sell. The difference can be huge. Many individual investors do a poor job of timing the markets and tend to lose more in funds than the actual returns show. Take Janus Twenty. It's a large-growth fund that ranks in the top half of its category over the past 10 years that has lost 2 percent per year, on average. According to Morningstar, investors in the fund, on average, lost an annualized 7 percent over that time period because they jumped in and out at the wrong times. Research has shown that the most volatile funds in the most volatile categories, where big swings in returns can make for a wild ride, have the worst investor returns when compared to average reported returns. "We tend to see with the more extreme types of funds that those are the funds where investors badly mishandle their timing decisions, so the more volatile the fund category the more likely you are to see a pattern of investors foregoing gains because they timed their purchases poorly," Benz says. For all categories, over the past decade, the average investor returns among funds representing all asset classes have been about 1.5 percentage points lower than the funds' average reported returns, according to Morningstar's research.

Don't pick (all of) your own stocks. You won't hear it on CNBC, but stock picking isn't for everyone. For investors who aren't willing to spend a good amount of time scouring stock charts or company filings, it's best to treat individual stocks like any other exotic part of your portfolio: They're fine to own in moderate amounts. Experts say a good rule of thumb for part-time investors is to keep less than 10 percent of your total portfolio in individual names, with the rest of your equity exposure in low-cost index or actively managed mutual funds. If you aren't willing to invest the time in digging deep into a company or industry, leave the stock picking to the pros. If you're dead-set on owning individual stocks as longer-term holdings, financial advisers say it's not a bad idea to play it safe by sticking with large, well-known global companies that pay a decent dividend along the way. Rimel says companies like Intel (with its 3.2 percent dividend) fit that profile. "They're very important to keep you ahead of taxes and inflation," he says.

Cut your losses. Any investor who's done it knows that selling at a loss hurts. But the best investors know that limiting losses can be just as important as picking winners in the market. That's because investors can recover from small losses quickly, but digging out from a sudden loss of 25 percent or more can mean a small portfolio will take years to recover. Longtime investors like William O'Neil have long advocated selling stocks when losses hit 8 percent. Other experts advocate selling half of a position at a 5 percent loss, and bailing out completely when share prices dip 10 percent. Either way, the ability to fall out of love with a stock can be just as important as picking the right investment.

What your kids learned from the crash

By Dan Kadlec

(Money Magazine) -- Recently I asked my 20-year-old daughter what she had learned about money during the Great Recession. I half expected her to say, "Nothing, Dad. Can we skip the teachable moment?"

After all, she's been snuggled away in college with Mom and Dad footing her tuition, room, and board; her personal world remains secure. About the only financial dislocation she's experienced, as far as I could tell, was my refusal to upgrade her cellphone.

Instead, Lexie surprised me with her thoughtful answer. Teacher cutbacks had resulted in fewer classes, she told me, so she'd been squeezed out of one of her major's requirements last semester. That made her realize that she's not insulated from the economy's ups and downs and that she must be able to adapt to events outside her control.

She also told me of friends who couldn't find summer jobs -- though the camp where she worked the past two summers rehired her in a heartbeat. That showed her the value of performing at work and of building a résumé.

What other insights will teens and young adults take away from the financial crisis? With the second anniversary of the fall of Lehman Brothers, marking the unofficial start of the meltdown, upon us, this seems like a good time to ponder that question -- and to contemplate what parents can do to reinforce the wisdom our kids have gained.
The lesson: Money isn't just for spending

One thing is certain: My daughter is not alone in feeling the economy's ripple effects. Some 95% of college students surveyed by the National Endowment for Financial Education reported the crisis had affected the way they manage money and their family's finances. Here's

As a result, they seem to be adopting more responsible financial habits. Since the economic crisis began, more than half of 18-to 29-year-olds have cut spending, and a quarter of them have beefed up savings, according to a survey by the Pew Research Center; 58% intend to save even more when the economy recovers.

Fellowes reports more college students are querying his site about how to pay off credit cards and build an emergency fund. "Kids are giving a lot of thought to creating an economic cushion," he says.


Talk about money. College students whose parents discuss financial matters with them are more likely to avoid impulse spending and less likely to run up credit card balances, according to a study in the Journal of Economic Psychology. So talk about budgeting, saving, borrowing, and investing as everyday opportunities present themselves.

Provide inducements. Create a homegrown version of a 401(k) by offering to match any money your child puts into a long-term savings account. You might even match his entire income from a summer job and deposit the money in a Roth IRA to give him a head start on saving for retirement, suggests Laura Levine, president of the JumpStart Coalition, which promotes teen financial literacy (he can also tap the account penalty-free to pay for grad school or a new home).
The lesson: Caution isn't just for old folks

The 37% plunge in stock prices in the six months following Lehman's collapse, combined with the volatility that's plagued the market ever since, may be turning young people into fogeys when it comes to investing. Four out of 10 twentysomethings in the Pew survey reported they've become more conservative investors since the recession hit.
0:00 /1:28Gen Y recession confessions

On the plus side, maybe that means they won't load up on tech stocks the way their parents did, and maybe they'll be less likely to fool themselves with unrealistically high expectations about the returns on stocks or real estate.

But being overly cautious won't serve them well either. After all, $10,000 invested in stocks 30 years ago would be worth about $180,000 today -- even after the lost decade just ended -- vs. $120,000 for government bonds and just $50,000 for bank CDs.


Share war stories. Explain how you took a big hit during the crash, but that you've since recovered all or most of your losses by staying diversified. Tell tales about people they know -- like how Grandpa was able to retire early and well on his stock portfolio.

"Negative examples, like the relative who's struggling now because he played it too safe when he was young, are even more memorable," says University of Washington professor Lewis Mandell, who studies teen financial literacy.

Start with the familiar. To get your adult child excited about investing, encourage her to buy shares of a company with good prospects whose products she enjoys, says Vince Shorb, president of the National Financial Educators Council. Prime examples: Nike (NKE, Fortune 500) or McDonald's (MCD, Fortune 500).

Teach her to spot such a stock by looking for market dominance and strong projected profit growth. Another option: the Monetta Young Investor Fund, which has a low minimum ($100 with automatic monthly investments of $25 or more) and is full of names teens and twentysomethings will be familiar with, including Apple (AAPL, Fortune 500), Google (GOOG, Fortune 500), and Starbucks (SBUX, Fortune 500). Over the past year, the fund is up 26%, beating the market by 11 percentage points. But warn your child that she shouldn't expect that outperformance to last indefinitely.
The lesson: Managing your job is a job

With the unemployment rate at 25% for teens and 15% for 20- to 24-year-olds, young people are acutely aware of the difficulty of landing a good job.

"The single biggest challenge for twentysomethings is finding work in a market full of down sizing," says Joline Godfrey, CEO of Independent Means, a financial education organization. Increasingly, they're stepping up to the challenge, building résumés and contacts while still in school through internships and extracurricular activities.


Be a career coach. Encourage your son to take a class in new-economy skills like digital technology or Mandarin Chinese. And those internships really do pay off: Three-quarters of companies recently surveyed by the National Association of Colleges and Employers said they strongly prefer job candidates with relevant experience as an intern.

Get the message across by letting your daughter know you're willing to bridge the gap between what an internship might pay and how much she can make next summer as, say, a lifeguard or waitress.

Make an introduction. Kids are most likely to find jobs through connections, just as Mom and Dad are. Don't be pushy, but do offer to help by, say, inviting your son to go with you to a conference or charity event where you'll be mixing with people who could turn into prospective employers, or suggesting acquaintances your daughter might contact for an informational interview.
The lesson: You are responsible for you

"The sense that someone else will always take care of you has been greatly diminished," says JumpStart's Levine. "Teens over the past couple of years are accepting a certain level of personal responsibility they did not accept before."


Put your teen on a budget. Give your child a set amount a week to pay for personal expenses, and don't bail her out if she runs low on cash. Instead, suggest ways she can earn more. "Saying no ignites the creativity in teens," says Sharon Lechter, founder of

Attach strings to help. Nearly a quarter of adults under age 30 have moved home since the recession started. Lend a hand when needed, but don't become a permanent backstop. If your child has been laid off, make it clear you expect him to look hard for a new job; if he's working, Godfrey suggests, charge a nominal rent, then put the money in an account you can later turn over to him to help pay for his own place.

Be a role model. The best way to reinforce sound financial habits is by example. That's why I refused my daughter's request for a cellphone upgrade until she'd spent two years with the old one, which worked fine, thank you just as I do myself.

Stop worrying about a double dip

By Paul J. Lim,

(Money Magazine) -- The great debate on Wall Street is whether the recovery that spurred stock prices to nearly double between March 2009 and April 2010 is about to be snuffed out. The evidence for a "double dip" recession: Europe's economy is teetering; federal stimulus that propped up the credit and housing markets is nearly exhausted; retail sales and manufacturing are declining again.

Plus, if the old saw is true that the stock market is a predictor of the economy six to nine months down the road, then look out. Stock prices have tumbled around 10% since late April and investor pessimism, by one measure, has fallen to lows not seen since 1987.

"You can't deny that there are some added risks of a double dip," says Jeremy DeGroot, chief investment officer for advisory firm Litman Gregory.

But before you start making major moves in your portfolio in anticipation of another slump, some perspective is in order.

For starters, actual double dips are rare. There have been three since 1913, the last in 1981.

What's common, on the other hand, is for recoveries to hit a major rough patch after the economy bounces off its lows. Nine of the 10 recoveries since 1949 hit a speed bump within about 10 months of the rebound, marked by dramatic drops in factory activity, consumer confidence, and stock prices. Sound familiar?

"These soft spots tend to last for several quarters," says Jeffrey Kleintop, chief market strategist for research firm LPL Financial, as government stimulus efforts fade and private-sector growth slowly takes over as the economy's driver.

In a way, though, it's moot whether the market is right in forecasting another recession. The economic expansion is clearly slowing. Economists have begun ratcheting down their expectations for gross domestic product growth from around 3.5% for 2010 to 3.1% -- and 2.7% in 2011.

So what macro effects will the slowdown have, and what actions, if any, should you take with your investments in response? Here are the three big issues to consider.
Consumers will struggle

Even if another recession isn't in the cards, a slower expansion means companies are less likely to get back into hiring mode quickly. That's likely to keep unemployment high and wage growth low, which doesn't bode well for consumer spending.

What you can do: Avoid companies that make consumer goods other than necessities. (Think about what you see in Wal-Mart's aisles rather than at Tiffany.)

This doesn't mean you should avoid economically sensitive areas of the market, though. For example, many money managers say technology stocks, which are typically vulnerable in a double dip, are shielded this time around by a software-upgrade cycle driven by business, not consumer, spending.
Inflation fears will abate

Earlier this year, economists and money managers expected the economy to pick up steam, leading quickly to higher interest rates and inflation, which threaten bonds. That's why Money has advised cutting your Treasury bond stake.

In light of the recent slowdown, that call turned out to be premature. With the economy in a soft patch, inflation fears have been put on the back burner, says Jeremy Grantham, chief investment strategist for the asset manager GMO.

What you can do: Grantham, who was one of the few people in the late '90s to predict that stocks would tread water over the following 10 years, thinks slow growth and deflation fears will translate into another tough stretch for the broad market.

However, this long-term bear has surprisingly high hopes for high-quality U.S. stocks, which have been overlooked for years and are considered cheap. He thinks the bluest of blue chips could return more than 7% a year for the next seven years. That means stocks such as Johnson & Johnson (JNJ, Fortune 500) and mutual funds like Jensen (JENSX) could do quite well.

Another strategy: Seek out firms that don't depend on a fast-growing economy, says Money's stock strategist Pat Dorsey.
The bear may be back

While a second recession is unlikely, "the odds that the S&P 500 will slip into a new bear market are growing," says Sam Stovall, S&P's chief investment strategist.

But whether or not stocks cross the 20% down threshold that marks a new bear doesn't really matter. What's more important is how stocks do afterward. And a growing number of market strategists note that investor sentiment cratered especially quickly in the spring and early summer; historically that's been a good sign for stock performance six months to a year later.

What you can do: It may be time to modestly trim your exposure to equities in the short term -- say by five to 10 percentage points. "Given the headwinds to growth, our view is that stocks at their current valuations are not compensating you with as much expected returns," says DeGroot of Litman Gregory.

If you haven't rebalanced in more than a year, you'll want to take this step; a 60% stock -- 40% bond/ cash portfolio has morphed into a 70% stock -- 30% bond/cash portfolio since March 2009.

Since the bond bubble hasn't burst yet, Treasuries are still historically expensive. So move that money into cash, says Stovall, which will allow you to shop for stocks at lower prices later. If you'd prefer to stay fully invested rather than trying a bit of market timing, check out the investment bargains highlighted in, "10 ways to make real money again."

Saturday, 14 August 2010

The Fed Is Not Out of "Silver Bullets"

by Jeremy J. Siegel

The Fed’s move on August 10 to “keep the balance sheet of the central bank stable” and offset the run-off of mortgage-backed securities with Treasury purchases was just a baby step. Much stronger measures can and should be taken to combat the economic slowdown.

As readers of this column know, I am a strong supporter of Ben Bernanke, Chairman of the Federal Reserve Board. I think his bold measures to insure the liquidity of the banking and financial system saved us from repeating the misguided policy that led to the Great Depression of the 1930s. This is why I was disappointed in the Fed’s move on August 10 and Bernanke’s testimony July 21 before Congress, one of the Fed’s ritual semi-annual appearances that go back to the 1970s.

During his meetings before Congress, Bernanke responded to a question by Senator Bunning of Kentucky asking whether the Federal Reserve “was out of bullets” in its fight against the faltering economy. Bernanke responded, “I don’t think so.” Later he noted other measures the Fed might use to stimulate the economy, but only said “there is some probability they will be effective.”

Bernanke should not hedge. When you are the head of the world’s most powerful central bank, expressing doubt about the Fed’s effectiveness is a mistake. It is mandatory that the policymakers and central bankers display confidence in their policy tools. And the historical evidence is that Bernanke has every right to believe the Fed can still be very effective.

Quantitative Easing

In last month’s column I recommended that the Fed consider reducing the interest rate it pays on bank reserves to zero and engage in quantitative easing to help the economy emerge from the current soft patch. Quantitative easing, or QE as it is often called, occurs when the central bank expands the quantity of Federal Reserve credit by increasing the reserves in the banking system. QE is employed when the normal policy instrument of the Fed, the Federal Funds rate, is at or near zero.

In fact, Bernanke had already engaged in significant quantitative easing during the financial crisis in 2008 by supplying the banking system with over $1 trillion of reserves in excess of the banks’ statutory requirements. These reserves were far more than are required to bring the Fed Funds rate down to its current 0% to 0.25% level, a range that the Fed adopted in December 2008.

Some argue tha,t since banks already hold more reserves than required, additional reserves would not have any further effect on lending or economic activity. But that conclusion is not warranted. Banks hold large excess reserves because they wish to show regulators and investors a high level of liquidity.

This does not mean that banks would hold unlimited excess reserves. In fact, banks are not happy earning near zero interest on these reserves, nor are investors satisfied with similar rates on their money market funds. Placing more zero-interest reserves into the banking system will tempt more banks to make loans where the profit margin is much higher.

Although the Fed’s main policy tool, the Fed Funds rate, works on short-term interest rates, QE has the potential to lower longer-term rates, especially if the asset purchases are concentrated in long-dated securities.

In a recently published article, Taeyoung Doh, a research economist at the Federal Reserve Bank of Kansas City, gives evidence that asset purchases may be a much better instrument in lowering long-term rates than giving guidance in the FOMC directives, such as the “extended period” language which Wall Street watches so attentively in the statements following Fed meetings.

Japan’s Experiment

Those who object to quantitative easing point to Japan’s alleged failed experiment with QE from March 2001 to March 2006. During that period the Bank of Japan increased reserves markedly, yet that did little to improve Japan’s economic prospects.

But a close look at the Japanese data does not support this pessimism. Between 2001 and 2006, deflationary forces were arrested in Japan, the economy-wide price level remained constant, and annual GDP growth did increase by about 0.5% from the average of the previous decade. I admit QE did not lead to robust growth, but Japan’s slow growth over the last two decades is more related to structural problems in the Japanese economy and the rapid aging of the population, not to a bubble that burst more than 20 years ago. Furthermore, the effectiveness of the Bank of Japan’s QE policy was reduced by its implementation that began well over a decade after the markets collapsed in the 1990s. This lag allowed deflationary pressures to sink much deeper into their economy than now exists in the U.S.

One of the reasons the Bank of Japan finally abandoned QE was that the Japanese public was very uneasy about unlimited expansion of the money supply. Most Japanese still remember the post World War II inflation that devalued the purchasing power of Japanese yen by more than 100 to 1, and they feared that QE could bring about another inflationary episode.

The U.S. economy is far better suited to QE than Japan’s. Serious deflationary forces have yet to take hold, while inflationary expectations have been held well in check. Adding reserves will induce banks and investors to buy longer-dated and higher-yielding assets, reduce long-term rates, and spur more lending by the banks.


The Fed is far from out of silver bullets. Fed Chief Bernanke must be confident in the potency of all the Fed’s policy tools, not just the Fed Funds rate. Quantitative easing is a viable policy and, when combined with a reduction in the interest rates on reserves and the continued support of the asset-based securities markets, the Fed can deliver a potent combination of policies to stimulate the economy.

Don't blame the consumer for sluggish economy

Nin-Hai Tseng

Consumers drive more than two-thirds of the nation's economy, and with growth hard to spot these days, it's easy to place the blame on stingy spenders. But that's a mistake.

Personal spending, in fact, has kept pace with the economy, accounting for a steady 70% of GDP before the recession, during the depths of the crisis, and into today's slow recovery. In fact, consumption relative to GDP rose slightly to 71% during the last two quarters of 2009 amid huge government spending programs -- such as the promotion of home and car sales -- to stimulate the economy. It has flattened out since.

But the market tends to get overly obsessed with consumer confidence whenever the government comes out with its latest growth figures. Business behavior is often directly influenced by how consumers say they feel about the economy. And it doesn't help growth much when consumer confidence falls to a five-month low, which the Conference Board reported at the end of July.

Consumption in America hasn't always been so high. Between the 1950s to the 1980s, it stayed relatively stable averaging about 63% of the total economy, says David Backus, economics professor at New York University. How it grew to its current levels are a bit of a mystery, but Backus points to a few factors, including growing wealth and government programs like social security that left consumers feeling good about the future (and took away a reason for them to save). The dawn of the credit card era played a major role as well.

The corporate factor

But today, it's unreasonable to depend on consumers to accelerate the pace of economic recovery. They're debt-ridden and worried about their jobs. They're exhausted from too much spending in the years leading up to the financial crisis. They're choosing to pinch pennies instead -- and they don't consider their growing savings accounts to be a negative development.

If anything is going to pick up the pace of growth again, Backus says, it will likely have to come from investment by companies.

Unlike consumption, the investment part of the GDP equation has seen some of the steepest declines since the recession began. Spending by companies on everything from buildings to new equipment to software has risen steadily since 2009, but it's still below the ratios prior to the recession. During the latest quarter, investment made up 12.7% of GDP, compared with 15% during the same period in 2008.

It's not as if companies don't have the cash to invest. Cash balances of non-financial companies are markedly high at $837 billion at end of March, a 26% increase over the previous year's $665 billion, according to Standard & Poor's. Companies are holding cash equal to 10% of their value, much higher than the average 6.6% held since 1999.

Companies have significant debt on their balance sheets, too, but that's not primarily what's keeping executives from spending on investment or even hiring more workers, says Chris Christopher, economist with IHS Global Insight. He says it has more to do with overall uncertainty with the economy following a financial crisis that rattled companies into a kind of wait-and-see position.

GDP growth in the second quarter slowed to 2.4%, compared with 3.7% in the previous quarter. Christopher says companies probably won't feel good about hiring and investing again until the country grows above its 3% average prior to the recession.

The economy appears locked in a self-defeating cycle, where consumers won't spend more unless the jobless rate improves and companies won't hire more until GDP growth steadily recovers -- like two gunslingers, both waiting for the other to draw first.

"It's like you've been through a terrible accident and you're waiting for something to make you feel better again," he says.

Christopher may be right, but that 'something' likely won't be the maxed-out consumer.

Buffett's Lesson on Inflation and Bonds

ByDon Dion

NEW YORK (TheStreet) -- Warren Buffet's Berkshire Hathaway has shifted its portfolio towards bonds with shorter maturities. The sage investor eschews gold as an asset, but is tightening up the Berkshire portfolio as inflation concerns weigh on his mind.

The representation of bonds in Berkshire's portfolio with a year or less until maturity has increased from 16% in early 2009, to 18% as of March 30 this year, and to 21% as of June 30. This shift means that the average maturity of the entire bond portfolio has been getting shorter.

A portfolio heavy in long-term bonds is locked into today's low interest rates. As interest rates increase, long-term bonds lose value because the market readjusts relevant securities to account for the new interest rate. If these rates increase enough, the price of the bonds may fall below par value. In contrast, short-term bonds reach maturity, at which point the investor can reinvest the principal at a higher interest rate.

Investors expecting a spike in interest rates can follow Berkshire's moves by overweighting their fixed income allocation in short-term bond ETFs such as iShares 1-3 Year Treasury. They can go even more short term with iShares Barclays Short Treasury Bond.

Aggressive investors who want to speculate on the same strategy can buy ProShares UltraShort 20+ Year Treasury, which delivers double the daily inverse of the index tracked by iShares Barclays 20+ Year Treasury.

If investors are wrong and interest rates fall, holding SHY means investors will forego higher interest rates and some capital appreciation in longer-dated bonds. If they're wrong and they hold TBT, they could suffer staggering losses. TBT is down about 30% in 2010 and nearly 20% in the past three months, which is why this fund is only for speculation and should not be confused with fixed income ETFs.

Another strategy for investors expecting inflation is inflation-protected securities: iShares Barclays TIPS is the ETF play here, although investors can also use mutual funds such as Fidelity Inflation Protected Bond.

The principal of a TIPS bond is adjusted based on the CPI. If interest rates move higher with the CPI, these bonds should do well, but if for some reason interest rates increase greater than inflation, TIPS will behave more like long-dated bonds that lack inflation protection.

The portfolio moves by Berkshire come as Buffett has repeated his forecast for higher inflation thanks to deficit spending by the U.S. government; if higher interest rates are in the cards, he's made the right play.

But Buffett has also said that all currencies could lose value. Back in May, while the world was anxiously watching Europe's response to the Greek crisis, he claimed that government responses to various debt crises around the world made him "more bearish on all currencies."

An asset that holds its value against widespread currency devaluation is gold, but Buffett sees no use for the metal, as I discussed in Professor Buffett's Anti-Gold Lesson .

On this score I disagree with the Oracle because adding gold to a bond portfolio offsets the risk that currencies will not hold their value. ETFs such as iShares Comex Gold offer investors easy access to the yellow metal.

The downside of gold investment is that it doesn't always protect against moderate inflation. If the inflation rate went back to 3% to 5% and the economy enjoyed stable growth, gold would probably decline in price as investors shed safe haven assets, as was the case during the 1980s and 1990s.

Buffett may also be wrong in his inflation expectations. Bond giant PIMCO would argue against his claims, instead stating that deflation may be the bigger threat, and that low rates will be with us for some time.

If this is indeed the case, shifting bond assets into shorter maturities will be costly to investors, as I outlined above. However, if deflation results in cheaper asset prices, investors may ultimately come out ahead as long as their principal is protected.

Therefore, in uncertain times, investors worried about deflation should gravitate towards the most secure debt, that of the U.S. government or blue chip corporations with manageable debt levels. ETFs such as TLT will tend to deliver some of the largest gains as long as rates are falling across the board.

At its heart, Berkshire's move is a conservative one. In all cases, shifting from long-term to short-term assets is a hedge against uncertainty, with cash as the ultimate example of the latter category. Whether Buffett is right or wrong on inflation, Berkshire's fixed income portfolio is better positioned for a change.

-- Written by Don Dion in Williamstown, Mass.

What the Double-Dip Recession Will Look Like

by Douglas A. McIntyre

"Nearly two-thirds of Americans believe the economy has yet to hit bottom, a sharply higher percentage than the 53% who felt that way in January," according to a recent Wall Street Journal poll.

A growing and vocal minority of economists believes that there will be a double-dip recession primarily because of the intransigence of high unemployment and the rapidly faltering housing market. The notion of a "jobless recovery" has been around since the recessions of the 1950s and 1960s. It is a concept built on a relatively simple idea: employment lags during a recession but it is always part of a recovery cycle. Production rises as businesses see the end of a downturn and anticipate improving sales. They are reluctant to hire new workers until the recovery is confirmed, but once it has been, hiring picks up.

The 2008-2009 recession was — if it is indeed over — different from any other because of its depth and causes. The first trigger was the drop in housing prices, which robbed many people of their primary access to capital. As that access disappeared, so did the availability of credit. Consumer buying power evaporated and business cut inventory and production. Joblessness rose. Finally, consumer confidence plunged.

The last downturn was so great that in some months more than 500,000 people lost jobs. The unemployment rolls are now more than 8 million, and perhaps more gravely, over 1.4 million people have been out of work for over 99 weeks — which means they are no longer eligible to receive unemployment insurance benefits. This segment of the population has already begun to add to the number of indigent Americans and will continue to do so unless they can find homes with friends and family.

The second dip of the recession that ended in 2009, according to economists and the federal government, is likely to begin within the next two quarters if certain conditions are met.

Unemployment claims are running well above expectations, and recently hit a six-month high. The four-week average of initial claims rose 14,250 to 473,500 this week. The last peak, in February, was during a period when GDP was in the very early stages of recovery. There is nearly no jobs creation in the private sector. Real estate prices continue to drop, particularly in the hardest hit regions such as California, Nevada, Florida and Michigan.

The federal, state and local governments are in no position to lend assistance to businesses, most of which lack access to capital. Similarly, banks are not prepared to lend to small businesses, especially those with modest balance sheets and relatively low sales. This presents a problem for employment since companies with less than one hundred workers have traditionally been the largest creators of jobs.

This is what a double-dip recession would look like:

1. Housing

The cost of homes in the areas where prices have already dropped by 50% or more will continue to fall. These regions typically have the highest unemployment rates, the local governments are hard pressed to offer basic services, and potential buyers are aware that home prices could drop further. Real estate values in these areas could drop another 20%. In the rest of the country, protracted unemployment and the unwillingness of banks to lend would make otherwise attractive all-time low mortgage rates unappealing.

[See Housing's Future: 10 Million More Renters]

2. Unemployment

Unemployment would move back above 10% quickly. In the 1982 recession, the jobless rate was over 10% for 20 consecutive months and reached 10.8% for two months. During this period, the manufacturing base had not been destroyed. The economy is now arguably worse than it was in 1982. Many Americans who worked in manufacturing before the recession cannot be retrained, and the factories where they worked will not be reopened. Many companies have recently adopted the policy that they will keep as much of their work-force temporary for as long as possible. This keeps the cost of benefits low and allows firms to fire people quickly and without severance. A hiring strike by American businesses would contribute to putting 200,000 to 300,000 people out of work per month. At the peak of the recession that just ended, there were nearly six job seekers for every open job, according to the Labor Department. The job market could return to that point.

3. Consumer Spending

One of the primary reasons that consumer buying activity did not grind to a halt at the beginning of the last recession was that people still had access to a huge reservoir of home equity loans, most of which were taken out at the peak of the real estate market in 2005 and 2006. The New York Times recently reported that "lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same." Retail activity was helped somewhat by the capital available on these lines of credit, so store closings were probably deferred to the latter part of 2008. With more than 11 million mortgages underwater, 24% of the national total, and several million more within a few percentage points of being negative, the consumer will have no cushion as the economy deteriorates over the next six months.

4. Consumer Confidence

Consumer confidence, the critical gauge of the activity that represents two-thirds of U.S. GDP, will plummet again. The Conference Board's Consumer Confidence Index would certainly move back toward the all-time low it hit in February 2009 when it reached 25. Currently, the measure in most months is closer to 60.

[See 21 Things You Should Never Buy New]

5. Auto Industry

Auto sales, one of the primary barometers of consumer economic activity and manufacturing output, would probably drop back to recession levels. People concerned about employment will defer car purchases. Annual car sales in the U.S. were over 16 million in 2005 but dropped to just above 10 million in 2009. The car companies hope that domestic sales will rise to 11.5 million this year. In a double-dip recession, at least 1 million of those annual sales would be lost.

6. Trade

The nominal balance of trade would almost certainly drop, probably to a deficit of $25 billion a month, as the U.S. takes in fewer imports due to low demand for consumer goods and business inventory. Exports would also drop because an economic crisis in the U.S. would spread quickly worldwide. This is because of the tremendous size of the U.S. GDP in relation to that of any other country. The drop in imports would be a signal that business activity had slowed in China, the rest of Asia and Europe. Demand for consumer and business goods would drop in most regions, forcing a nearly universal cut in jobs outside the U.S.

7. Budget

The budget deficit would grow beyond the $1.5 trillion it should reach this year. Treasury receipts fell to $2.1 trillion in the federal fiscal year 2009 and are down to $1.7 trillion so far in the 2010 period. If history is any guide, receipts in a second recession could drop by as much as $200 trillion a year as tax receipts from both business and individuals falter. The demand on the federal government to render aid to the unemployed could add $50 billion to annual government outlays. Unemployment insurance will cost Washington $44 billion this year. As states run out of money to cover benefits, more of the burden could fall to the federal government.

8. National Debt

The rise in the deficit and a rapid increase in the American national debt would cause concern among the capital markets investors who purchase U.S. Treasuries. The inability of the Treasury to rein in spending will cause borrowing to increase. This in turn could bring the government's debt rating down, in turn causing U.S. borrowing costs to rise. Increasing costs will then raise the annual expenditure to run the government by increasing debt service.

9. Stock Market

If the performance of the equity markets in 2008 and early 2009 is any indication, the S&P 500 would drop from its current level of about 1,100 to a low of 676, which it hit in March 2009. This would take trillions of dollars off business balance sheets and from consumer retirement and brokerage accounts. Businesses would become less likely to invest in new plants, equipment and services. For individuals, many would see a large part of their retirement disappear. That would cause a huge drop in consumer spending as people attempt to preserve cash, perpetuating further drops in the stock market.

10. Banking

The effect on most of the financial services industry would be catastrophic, particularly at the regional and community bank level where a number of home and commercial real estate loans are held. The FDIC would be forced to borrow money from the Treasury to cover bank closings. The number of failed banks could reach the level of the savings and loan crisis during which over 700 banks and mortgage lenders were shuttered.

11. Interest Rates

As the great majority of economists have pointed out, the Fed has already dropped interest rates to zero. This means the central bank is out of ammunition.

Is a Crash Coming? 10 Reasons to Be Cautious

by Brett Arends

Could Wall Street be about to crash again?

This week's bone-rattlers may be making you wonder.

I don't make predictions. That's a sucker's game. And I'm certainly not doing so now.

But way too many people are way too complacent this summer. Here are 10 reasons to watch out.

1. The market is already expensive. Stocks are about 20 times cyclically-adjusted earnings, according to data compiled by Yale University economics professor Robert Shiller. That's well above average, which, historically, has been about 16. This ratio has been a powerful predictor of long-term returns. Valuation is by far the most important issue for investors. If you're getting paid well to take risks, they may make sense. But what if you're not?

2. The Fed is getting nervous. This week it warned that the economy had weakened, and it unveiled its latest weapon in the war against deflation: using the proceeds from the sale of mortgages to buy Treasury bonds. That should drive down long-term interest rates. Great news for mortgage borrowers. But hardly something one wants to hear when the Dow Jones Industrial Average is already north of 10000.

3. Too many people are too bullish. Active money managers are expecting the market to go higher, according to the latest survey by the National Association of Active Investment Managers. So are financial advisers, reports the weekly survey by Investors Intelligence. And that's reason to be cautious. The time to buy is when everyone else is gloomy. The reverse may also be true.

4. Deflation is already here. Consumer prices have fallen for three months in a row. And, most ominously, it's affecting wages too. The Bureau of Labor Statistics reports that, last quarter, workers earned 0.7% less in real terms per hour than they did a year ago. No wonder the Fed is worried. In deflation, wages, company revenues, and the value of your home and your investments may shrink in dollar terms. But your debts stay the same size. That makes deflation a vicious trap, especially if people owe way too much money.

5. People still owe way too much money. Households, corporations, states, local governments and, of course, Uncle Sam. It's the debt, stupid. According to the Federal Reserve, total U.S. debt -- even excluding the financial sector -- is basically twice what it was 10 years ago: $35 trillion compared to $18 trillion. Households have barely made a dent in their debt burden; it's fallen a mere 3% from last year's all-time peak, leaving it twice the level of a decade ago.

6. The jobs picture is much worse than they're telling you. Forget the "official" unemployment rate of 9.5%. Alternative measures? Try this: Just 61% of the adult population, age 20 or over, has any kind of job right now. That's the lowest since the early 1980s -- when many women stayed at home through choice, driving the numbers down. Among men today, it's 66.9%. Back in the '50s, incidentally, that figure was around 85%, though allowances should be made for the higher number of elderly people alive today. And many of those still working right now can only find part-time work, so just 59% of men age 20 or over currently have a full-time job. This is bullish?

(Today's bonus question: If a laid-off contractor with two kids, a mortgage and a car loan is working three night shifts a week at his local gas station, how many iPads can he buy for Christmas?)

7. Housing remains a disaster. Foreclosures rose again last month. Banks took over another 93,000 homes in July, says foreclosure specialist RealtyTrac. That's a rise of 9% from June and just shy of May's record. We're heading for 1 million foreclosures this year, RealtyTrac says. And naturally the ripple effects hurt all those homeowners not in foreclosure, by driving down prices. See deflation (No. 4) above.

8. Labor Day is approaching. Ouch. It always seems to be in September-October when the wheels come off Wall Street. Think 2008. Think 1987. Think 1929. Statistically, there actually is a "September effect." The market, on average, has done worse in that month than any other. No one really knows why. Some have even blamed the psychological effect of shortening days. But it becomes self-reinforcing: People fear it, so they sell.

9. We're looking at gridlock in Washington. Election season has already begun. And the Democrats are expected to lose seats in both houses in November. (Betting at InTrade, a bookmaker in Dublin, Ireland, gives the GOP a 62% chance of taking control of the House.) As our political dialogue seems to have collapsed beyond all possible hope of repair, let's not hope for any "bipartisan" agreements on anything of substance. Do you think this is a good thing? As Davis Rosenberg at investment firm Gluskin Sheff pointed out this week, gridlock is only a good thing for investors "when nothing needs fixing." Today, he notes, we need strong leadership. Not gonna happen.

10. All sorts of other indicators are flashing amber. The Institute for Supply Management's manufacturing index, while still positive, weakened again in July. So did ISM's new-orders indicator. The trade deficit has widened, and second-quarter GDP growth was much lower than first thought. ECRI's Weekly Leading Index has been flashing warning lights for weeks. Europe's industrial production in June turned out considerably worse than expected. Even China's steamroller economy is slowing down. Tech bellwether Cisco Systems (Nasdaq: CSCO - News) has signaled caution ahead. Individually, each of these might mean little. Collectively, they make me wonder. In this environment, I might be happy to buy shares if they were cheap. But not so much if they're expensive. See No. 1 above.

Tuesday, 10 August 2010

Not-So-Happy Talk at Happy Hour

by Michael Santoli

Meet enough traders and page fund managers for lunches, coffees and happy hours, and some themes start to emerge about what's confusing them at a given moment. Here are a couple of market riddles in heavy rotation:

Professional investors seem to be in a persistent state of reverse sticker shock regarding Big Tech stocks. The marquee names of the go-go tech market of the '90s look "too cheap" by most measures, and have for a couple of years, and yet the stocks just sit there.

Take the representative "big five" of Microsoft (Nasdaq: MSFT - News), Intel (Nasdaq: INTC - News), Oracle (Nasdaq: ORCL - News), IBM (NYSE: IBM - News) and Hewlett-Packard (NYSE: HPQ - News). They all trade at between 70% and 90% of the broad market's price/earnings multiple based on the next 12 months' forecasts, after having spent a decade or more at often wild premiums to the average stock, without even accounting for the tens of billions in collective cash on their balance sheets. This is jarring to a generation of investors accustomed to thinking of tech as the market's version of a luxury good—expensive because it was somehow better, and better because it was expensive.

There are a few ways to explain this reality. One is that the market has finally figured out that tech companies are...just companies, and their stocks mere stocks, and their products, many of them impressive and indispensable, are subject to all the familiar economic and competitive forces. Are Intel chips better than Cheerios or unleaded regular? Investors are collectively saying "not to us" based on the similar-to-higher valuations of General Mills (NYSE: GIS - News) and ExxonMobil (NYSE: XOM - News).

There's also a certain limbo state reserved for "cheap" tech stocks. Growth investors aren't turned on by good but mature and moderately growing businesses. Some value investors are happy to step in, but the companies' resistance to paying generous dividends and the way they report profits, excluding crucial stock-based employee compensation, rankle many.

These stocks all have huge weights in the overall indexes. There is virtually no money entering long-only vehicles such as index mutual funds. And hedge funds, the setters of the marginal price in today's market, avoid most such benchmark-dominating names. (Google (Nasdaq: GOOG - News) and Apple (Nasdaq: APPL - News), however, are fair game for hedgies, embodying as they do a secular "story" they can play.)

In this way, Big Tech is illustrative of all the large-cap stocks, which can be made to look cheap based on expected results, lack sponsorship and are generally held back by an abidingly high-risk premium being assigned by a skeptical, shock-wary market. If tech stays cheap for as long as the sector stayed expensive beginning in the mid-'90s, the cheapness should last quite a while, even if it also reduces the risk of owning it at today's prices.

Another big topic of trader talk: How will this nervous market handle the notoriously treacherous September-October period? Many investors aren't waiting to find out. They are sidelining themselves. Or, to a notable degree, they are placing a bet that volatility will surge as summer wanes into fall.

One way to show this is the large premium that has persisted in futures on the CBOE Volatility Index (VIX) that will pay off if the market gets panicky by late September. This means traders are willing to pay what appear to be aggressively high prices for defense against a volatility storm.

It's possible to read this in a contrarian manner and conclude that too many are too fearful and thus the market is insulated against a truly damaging market shock. And it's true that last year under similar conditions we got a couple of volatility pops and sharp pullbacks, though nothing that even threatened the July 2009 lows. But traders who study these patterns also say a steep premium in the futures simply implies the market is "overbought."

What's sure, though, is that the current market volatility and the levels implied by the futures must converge before too long, either by the market getting skittish again or the forward volatility futures coming down.

This volatility argument aside, the market for the moment seems to have allowed a few plausible reasons to crack pass it by—not least the soft GDP and employment numbers the past two Fridays. Volume remains light, participation thin, conviction levels low. The trading-range idea remains dominant for now, but it's the sort of climate that is conducive to air pockets in either direction, just as the recent data and the bond-market's deflation alarm will inject some drama into Tuesday's Federal Reserve meeting.

Monday, 9 August 2010

How rich is rich?

By Steve Hargreaves

NEW YORK ( -- How much money do you need to feel rich?

Wealth is a subjective concept, but one thing is universal in most definitions: being able to live a comfortable life without having to work.

"I'd like to have enough money so my family and I wouldn't have to work anymore or worry about the necessities, and maybe travel a bit," said Deborah Veale, a Southern California resident visiting New York City.

Veale said she'd need about $10 million to consider herself set.

One woman from Seattle put it at a "couple thousand dollars a month." Another from New York City wanted a billion (although she'd still fly coach.)
Does $250,000 make you rich?

Experts peg the figure to be somewhere around $2 million to $12 million in savings.

On the high end of that range, a single person living in an expensive part of the country (say, New York City), wanting to retire at 35 would need at least $300,000 a year to feel rich, according to Steven Kaye, president of Watchung, N.J.-based wealth management firm American Economic Planning Group. He based that number on real-life figures his clients tell him they need.

A yearly income of $300,000 would allow for taxes, a $3,800-a-month apartment (the average price in Manhattan), and a monthly spending allowance of around twelve grand, he said. Not too bad, especially since you could do this all without a pesky job.

To generate $300,000 a year beginning at age 35, you'd need a nest egg of just under $12 million. That assumes a conservative investment portfolio generating a return of 5% a year, an inflation rate of 2.5% a year and Social Security benefits of $25,000 a year starting at age 62.

Over time, the shape of your nest egg would resemble a bell curve, growing in the early years, and then declining as inflation required you to withdraw more money to maintain a lifestyle equivalent to $300,000 in 2010. The $12 million would finally dwindle to $934 when you turned 100.
0:00 /1:21Considering yourself 'rich'

If you live in a low cost part of the country, $100,000 a year should be enough, said Kaye. In that case, you would need savings of about $4 million to retire at 35.

But if you're willing to stay in the workforce until age 65, a mere $2 million would be enough.

Jon Duncan, a financial planner at Tacoma, Wash.-based Seneschal Advisors, gave numbers similar to Kaye's, and agreed that for most people, the figure would be somewhere in the multi-millions.

"I'm from an era when we'd talk about millionaires and say 'Whoa, he's got it made for life,'" said Duncan. "But that's not the case anymore."

Indeed, few experts think a million is enough to quit your day job.

"Don't retire at 35," he advised this reporter, "you'll need a ton of money."
Keeping up with the Joneses

Of course, there are other ways of determining wealth besides just what you'll need to live well in retirement.

Although decidedly not recommended by financial planners, one is relativity. Basically, you're rich if you're making more than your brother-in-law.

That appears to be how the government measures affluence. The Obama administration wants to extend tax cuts for all but the wealthiest Americans, which it defines to be those families making more than $250,000.

But that only includes about 2% of the population, according to the Census Bureau.

Kaye cautions not to confuse wealth with income. Some people can make a million a year, but be spending a million and a half. They are not rich, said Kaye.

"Income relates to lifestyle," he said. "Wealth relates to balance sheets."

Three Years on, Is the Financial Crisis Over?

Three years ago to the day, BNP Paribas, the French banking giant, suspended redemptions on three funds, marking the beginning of the credit crunch.

The collapse of the US subprime market and its knock-on effects of the mortgage-backed securities market began a series of crisis that have come close to bringing the global economy to its knees.

Three years later, it appears the world remains clouded by uncertainty. Unprecedented actions by central banks and governments across the world have averted a melt-down in the global economy but commentators say we are not out of the woods yet.

"The crisis will be over when bank lending returns to normal, equities rise and risks come down, this has not yet happened," Brendan Brown, head of research at Mitsubishi UFJ Securities, said.

"The major problem is that quantitative easing has been counter-productive. The central banks have stopped prices from falling. When prices fall, people buy but by shoring up asset prices the central bankers have stood in the way of recovery," he added.

The Federal Reserve starts a meeting Tuesday to decide on rates and speculation is mounting over whether the Federal Open Market Committee (FOMC) will announce further quantitative easing to help shore up confidence.

"The big risk is that the Fed reacts to its own depression. The Fed could over-react and would be better off going on holiday rather than announcing yet more QE," Brown said.

Banking Sector Still Fragile

The banking crisis is far from over, according to Robin Bew, chief economist of the Economist Intelligence Unit.

"There is a short-term need to make sure banks do not take risks that could lead to problems and a long-term need to get banks lending to small and medium sized businesses," Bew said.

Global trade has recovered sharply since the height of the crisis and firms are now correcting an inventory overhang that is helping boost corporate numbers, he added.

"It is important no to get too gloomy, as a cyclical recovery is underway in the rich world," Bew said. "Fiscal consolidation is needed but China will boost domestic demand boosting a number of other economies."

But the banking crisis is still running, as the US commercial property market "looks sickly" with $1.4 trillion worth of loans maturing between 2011 and 2014 and a dearth of borrowers, "like Japan in the 1990s," he explained.

However bad things look, the world's top 150 banks are out of the crisis, according to Ralph Silva, director of Silva Research Network and a banking analyst.

"The top 150 banks globally have spent a fortune getting into better shape but big problems remain further down the food chain," Silva told CNBC. "I am very concerned by the banks between 300 and 1000 in the global rankings. There is no transparency and debt ratings are a concern, if we do have a problem it will be here."

"Not even smaller banks will be left to collapse in Europe and there is a lot of uncollateralized debt on the smaller banks balance sheets," he added.

It will take more than three years to get out of the crisis, other analysts say.

"Banks lend over long-term horizons like 25 years, the financial crisis will take longer to unwind itself than three years," Peter Hemington, a corporate finance partner at BDO, told CNBC.

"The ECB is still lending 700 billion euros ($931 billion) to banks and refinancing remains a major problem," Hemington added.

Tuesday, 3 August 2010

5 Ways to Retire Before Age 40

by Luke Landes

Voluntary early retirement before the age of forty is not typical. Leaving work behind as early as possible to focus on other aspects of life is a popular goal, but most people will not achieve it.

In order to retire in your forties and still have the funds you need to finance all that you'd like to do, you need to create the right environment to foster extraordinary results with your money. Don't count on winning the lottery or selling the company you built in your basement to Google.

Those who leave the workforce before age forty compose a small percentage of the working population, just as Olympic-level swimmers are a small percentage of everyone who competes in the sport. To achieve in the Olympic Games you need to take several extreme actions. To retire early, you will have to do the same. These tips may help you generate enough money to retire before age forty.

Ignore what other people think. You'll need the right mindset. As you make choices that could lead you to extreme early retirement, you may face resistance from family and friends. The decisions you will need to make are often directly opposed with others' expectations. Find like-minded individuals whose advice and encouragement will help move you in the right direction.

More from Yahoo! Finance:

• The Millionaire's Retirement Plan

• How Behind Are Your Retirement Savings?

• Tax Changes and Your Retirement
Visit the Retirement Center

Save as much as possible as soon as possible. This is the first of your unpopular decisions. You will need to sacrifice your spending at the beginning of your career in order to have a better chance of living the way you want when you want, with financial freedom, for a longer amount of time. To you, frugality should be elevated to an art form. Your friends may call you cheap, but you won't care because you are focused on your goal without distraction.

Earn as much as possible as quickly as possible. With more income, you can keep more money in high-yield savings accounts and investments. Those funds will be ready for your early retirement. While it's the amount you save that matters, you can significantly extend those savings by earning more. Work more hours or take an additional job or two. Olympic athletes train and practice constantly and this is the same intensity you need to achieve an early retirement.

Avoid fees while investing. While this concept is one part of saving as much as possible, it deserves its own mention. Most investments underperform index funds and you'll pay higher fees for those lackluster results. While some investments do beat the market, you won't know which investments will skyrocket until it's too late. Invest in index funds and make sure you have a sensible mix of asset classes that present a good chance of protecting you from down markets when you need the money you've invested.

Consider a new definition of retirement. You may still want to work in retirement to earn additional money, particularly if you can do work you enjoy. Consider a part-time job or even a full-time job with a non-profit organization aligned with your interests and values. Leaving the corporate world to work for an organization you care about can be exhilarating and you will enjoy the work. Extreme early retirement is an achievement most people will not accomplish, even if you put forth a good effort. Leaving the workforce behind before the age of forty is an extraordinary accomplishment and it requires dedication, intensity, and a willingness to live differently.

Luke Landes writes for Consumerism Commentary, where he encourages discussions about money and consumer issues. Consumerism Commentary regularly tracks and reviews the best online savings accounts and other financial products and other financial products.

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