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Archive for the ‘Economics’ Category

Exchange Traded Funds (ETFs) have been growing in popularity with investors and their advisers.  They offer low costs and opportunities to more precisely create an asset allocation or take advantage of trading and hedging ideas.

Currency Exchange Traded Funds have grown popular over the course of 2011 to investors who are attempting to gain exposure to foreign currency while avoiding the cost and complexity of the foreign exchange (Forex) market. Investing in foreign stocks and bonds can be a good investment when looking for a financial diversification and also offer the potential of producing substantial returns.

Up until recently, an investor’s only choice to hedge foreign exposure has been through the Forex markets. These markets can be complex for most investors and require substantial capital at risk.  Investing in Forex is promoted by some as a speculative way to make profits.  But an investment in foreign currency comes with the risk of losing money through exchange rates.

ETF’s that focus on currencies are a less complex way to hedge an overseas investment. They give the average investor the opportunity to invest away from the US dollar. ETF’s are also used as ideal instruments for investors to diminish the loss of money due to exchange rates.

Why Invest in Currency Exchange Traded Funds?

Investing in an ETF is much less complex than investing in the Forex market. Although the Forex is the most liquid market (trillions are traded each day), it can be difficult for the average investor to get a seat at the table considering the capital that may be needed and the trading costs incurred. ETF’s offer a simpler way to invest in foreign markets.

If an investor feels as though there is potential economic growth overseas or in an emerging market, ETF’s are a perfect vehicle for international exposure.  Buying individual stocks overseas may be difficult for US investors and may be costly as well.  Mutual funds are a great way to gain access but they have higher costs compared to ETFs.

Why invest in currencies?  Consider this:  Living in the US means that your source of income and most of your investments are denominated in US dollars.  If your portfolio is loaded with domestic investments (and most investors tend to be woefully under-allocated in foreign equity positions), adding a currency ETF to your portfolio can help balance your investments and add diversity to your portfolio away from the US dollar.

Let’s say you are investing overseas through mutual funds in your 401(k) or brokerage account.  Most of these portfolio managers tend to not hedge their exposure to currency changes.  This can turn a positive fund return into a loss when converting back to the US dollar.

Now an investor may want to hedge by holding a position in a foreign currency.  But investing in foreign markets can be risky because of the constant fluctuation of currency and exchange rates. The currency market never closes and is open twenty-four hours of everyday. For the average investor, constantly keeping up with the currencies to figure out the best times to sell and buy may not be worthwhile and result in a loss in money (as well as sleep).   ETF’s offer a more efficient opportunity to manage these risks of foreign investments.

Why bother?  Well, just look at the news headlines.  There continues to be debt crises in foreign and US markets.  This tends to lead to potentially higher interest rates as investors demand a higher return for attracting their money to a particular country.  Higher interest rates in turn will negatively impact the value of the currency and lead to a “weaker” currency. (The upside, on the other hand, is that a weak dollar, for example, will make our exports more competitively priced and help those business dealing overseas).

Investors may be interested in “safe haven” currencies during poor financial times. Countries with strong political stability, low inflation, and stable monetary and fiscal policies tend to be magnets for money in tough times. While that doesn’t necessarily describe the US right now, we are still considered the best option out there as a “safe haven.”

Hedging Examples

According to this article appearing on Investopedia, “a weakening currency can drag down positive returns or exacerbate negative returns in an investment portfolio. For example, Canadian investors who were invested in the S&P 500 from January 2000 to May 2009 had returns of -44.1% in Canadian dollar terms (compared with returns for -26% for the S&P 500 in U.S. dollar terms), because they were holding assets in a depreciating currency (the U.S. dollar, in this case).”

Disadvantages of ETF’s

No investment comes without risks and ETFs and currency ETFs in particular are no different. As is the case with many ETFs, there is always the issue of liquidity of the ETF.  (An ETF without a deep market or volume can produce exaggerated and volatile price changes). And in the case of currency ETFs there is the added issue of dealing with foreign taxes.

The Bottom Line

Whether or not a currency ETF makes sense for your particular situation is something that only you with the help of a qualified professional can determine.

But you should at least be aware of the tools available that may help you protect your portfolio. At the very least, it makes sense to hedge overseas investments especially during volatile times.

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When you’re on an airplane and hit turbulence or rough weather, the flight crew tells you to stay seated and buckled.  Unfortunately, when the markets hit bad weather, there is rarely such a warning.

You might want to call it “Black Thursday.”

Yesterday, the markets around the world went into a tailspin reacting almost violently to the ongoing drumbeat of dour economic news.

On the radar, we’ve seen the storm clouds moving in for a while now:

  • lower than expected GDP in the US last quarter,
  • downward revisions of the GDP to a negligible 0.4% for the first quarter,
  • lower business and consumer confidence surveys,
  • sharply lower than expected new jobs created,
  • higher unemployment,
  • foreign debt crises weighing down our Eurozone trading partners.

There was a temporary distraction over the last couple of weeks as we in the US focused on the debt ceiling debate to the exclusion of all else.  Self-congratulatory press remarks by politicians aside, nothing done in Washington really changed the fact that we are still flying into a stiff head wind and storm clouds that threaten recovery prospects.

Eventually, though, the accumulation of downbeat news over the past few weeks seems to have finally come to a head yesterday.  No one thing seems to have caused it.  It just seems that finally someone said “the Emperor has no clothes” and everyone finally noticed the obvious: global economies are weak and burdened by debt and political crises.

All of this has been creating doubt in the minds of investors about the ability to find and implement policies or actions by governments or private sector companies.  And doubt leads to uncertainty.  And if there’s one thing we know for certain, it is that markets abhor uncertainty.

While many commentators may have thought that the “resolution” of the debt ceiling debate in Washington would have calmed the markets, it seems that upon further review of the details the markets are not so sure.  And in an “abundance of caution” market analysts who once were so OK with exotic bond and mortgage investments are now reacting overly negatively to any and all news and evidence of weakness by governments or companies.

What’s An Investor to Do?

Don’t panic.  It may be cliché but it’s still true.  If you hadn’t already put in place a hedging strategy, then what is past is past and move forward.

So the Dow has erased on its gains for 2011 and has turned the time machine back to December 2008.

If you sell now — especially without a plan in place — you’re setting yourself up for failure.

Here’s a simple plan to consider:

  1. Hold On:  You can’t lose anything if you sell.
  2. Hedge: As I’ve said before in this blog and in the ViewPoint Newsletter, you need to put in place a hedge.  There are lots of tools available to investors (and advisers) to help:  Exchange Traded Funds (ETFs) on the S&P 500, for instance, can be hedged with options or you can use “trailing stop-loss” instructions to limit the market downside; another option – inverse ETFs that move opposite the underlying index. These aren’t buy-hold types of ETFs but can be used to provide short-term (daily) hedges.
  3. Rebalance:  If you’re not already diversified among different asset classes, then now’s the time to look at that. You may be able to pick up on some great bargains right now that will position you better for the long-term.  Yes, every risky asset got hit in the downdraft but that’s still no reason to be bulked up on one company stock or mutual fund type.
  4. Keep Your Powder Dry and in Reserve:  Cash is king – an oft-repeated phrase still holds true now.  Take a page from my retirement planning advice and make sure you have cash to cover your fixed overhead for a good long time.  With cash in place, you won’t be forced to sell out at fire sale prices now or during other rough times. This is part of what I refer to as “Buy and Hold Out.”
  5. Seek Professional Help:  Research reported in the Financial Planning Association’s Journal of Financial Planning shows that those with financial advisers and a plan are more satisfied and overall have more wealth.  Avoiding emotional mistakes improves an investor’s bottom line.

As a side note:  The old stockbroker’s manual still says “Sell in May and Go Away.”  Probably for good reason.  Historically, the summer months are filled with languid or down markets and volatile ups and downs.

 

While it’s tempting to give in to the emotional “flight” survival response that you’re feeling right now, don’t give in.  Stand and fight instead.  But fight smart. Have a plan and consider a professional navigator.

If you are seeking a second opinion or need some help in implementing a personal money rescue plan, please consider the help of a qualified professional.

 

Let’s Make A Plan Together:  978-388-0020

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Bonds are not the stodgy, boring things that most investors think of even though there’s no army of talking heads on financial news shows talking about them.

They are a huge market (about double the value of stocks as noted in my last post). They are an essential part of our economy.  Most companies cannot function without easy access to credit.  In fact, the shock and uncertainty that followed the collapse of some of the largest banks pretty much brought the economy to a standstill and contributed mightily to the Great Recession.

But that doesn’t mean that there isn’t money to be made in this asset class. Savvy investors of all stripes need to consider the value of bonds in a well-diversified portfolio.  And how you build that portfolio will help lower risks and costs and ultimately mean more money in an investor’s personal bottom line.

Whether someone is retired or not, bonds can provide income and potential capital appreciation (and depreciation if not hedged properly).

Bonds are a key part of an income-producing strategy (dividend-paying stocks are another asset class useful for this as well).

What is a Bond Ladder?

Essentially, a bond ladder describes a strategy to manage fixed-income investments by staggering the maturity dates of the various investments.

Some may be familiar with CD ladders: You select a series of bank certificates of deposit and stagger their maturity dates so that every six months, for example, a CD matures and you can reinvest the proceeds.

The advantage of this is that in a rising interest rate environment the investor is not locked out  of getting a higher rate on new money.

As with any fixed income investment, the disadvantage is that in a falling rate environment money that matures gets reinvested at a lower rate.

To minimize this impact professionals focus on the concept of “duration” which is a measure of how sensitive a bond (or any fixed income investment) is to changes in interest rates:  The lower the duration, the less sensitive and vice versa.

Mutual funds may publish an implied “duration” measure but it is not accurate because the fund, unlike the bonds themselves, is perpetual.

So to minimize risk to a fixed income portfolio, an investor (with the help of a competent financial professional) can create a custom portfolio.  And unlike a passive index fund, this custom portfolio can be built using bank CDs of staggering maturities for the near-term money coupled with a variety of bonds (corporate, US Government and municipal issues) with their own staggered maturity dates.

To mitigate the risks posed by higher interest rates caused by inflation or other political influences, the mix can also include “floating rate” bank notes. These are essentially bank loans to companies that adjust. Think of them like adjustable rate mortgages but to fund company operations  instead of real estate.

To add diversification to the mix, one can add closed-end funds that can be bought at a discount. These funds are professionally managed and offer an opportunity for price appreciation but at an expense ratio that is typically far lower than a conventional open-ended bond mutual fund.

By combining these elements, an investor may be able to lower the overall risk from interest rate movements, from default risk of individual components and from the impact of a “run on the bank” when others are selling (NAV risk).

And the overall cost of putting this together is cheaper than many mutual funds.  The cost to buy or trade an individual bond is typically included in the yield offered without any additional charge.  CDs do not have any added cost.  And for US Treasurys there may be a nominal fee (less than $3 per bond or example).

A knowledgeable financial professional can have access to hundreds of bond brokers.  By being independent and not beholden to any one broker’s inventory, an adviser can access offerings from multiple sources, find the best price and terms and lower an investor’s costs.

Depending on the total assets in the bond portfolio, the cost for professional management to monitor and make changes can typically run between 0.4% and 0.7% of the portfolio which is well under the cost of many mutual fund options.

For help putting your personal portfolio together, call Steve Stanganelli at Clear View at 978-388-0020 or 617-398-7494.

 

 

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June 2011 ViewPoint Newsletter

The current issue of the ViewPoint Newsletter from Steve Stanganelli, CFP(R) and Clear View Wealth Advisors is available for download from the SlideShare.net website.  A copy can also be found at the Clear View website newsletter archive.

In this issue, I focus on the key themes of the newsletter:  Retirement, College, Investing Strategy and Taxes.

  1. Retirement:  Using an “endowment” strategy to sustain withdrawals in retirement
  2. Investing: The value of dividend investing strategies for a total return investor and a discussion of how dividend payouts may predict future stock prices
  3. Taxes:  Real estate owners and especially those going through divorce may find these tips useful.
  4. College Planning:  On Thursday, June 9 there will be another free webinar with this one focused on Paying for College – Debunking Financial Aid Myths.

CLICK BELOW to VIEW the NEWSLETTER

Make Sense of Your Money with the ViewPoint Newsletter

Click Here to Download June 2011 ViewPoint Newsletter

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A key component of a diversified income-oriented portfolio is dividends. This is what I have noted in the past during my presentations, blogs and online musings. They are a key part of a solid retirement income strategy.

The total return from stocks is derived from two key components:  price appreciation and the cash flow from dividends.

Most investors are certainly familiar with the concept of price appreciation (or depreciation as was evident during the financial crisis and Flash Crash for instance).  This is what the media each night focuses on when they report on “The Market.”

But less noticed is the value of dividends to the longer-term success of an investor.

The Value of Dividends to An Investor

Below is a chart of various recent periods of stock market performance compiled by Thornburg Investment.

The “Dividend Aristocrats Index” refers to an index of companies that consistently lead the market in paying dividends and regularly increasing their dividends.

Annualized Total Return Period Dividend Aristocrats Index S&P 500
1990-94 12.58% 10.4%
1995-99 19.48% 28.54%
2000-04 9.79% -2.29%
2005 – 9/2009 2.32% -0.08%
1990 – 9/2009 10.97% 8.41%

Dividend-paying stocks have shown these positive attributes over this period:

  1. Historically higher yields than bonds
  2. Historically higher total returns compared to bonds because of the stock appreciation potential of the dividend-payers.
  3. Higher income, capital appreciation and total return compared to the S&P 500 Index in almost all of the periods noted above and a near 20-year annualized total return of nearly 11% versus 8.4.

Dividend-paying stocks are probably not as sexy as most aspects of the stock market.  They are part of “value investing.” They are the stuff of “conservative” portfolios built for “widows and orphans.”  They are the basic building blocks used by Benjamin Graham, the author of Intelligent Investing and the principles on which Warren Buffet built Berkshire-Hathaway.

But for an income-oriented investor (such as a retiree) looking at ways to manage income in retirement, they should not be overlooked.  In fact, recent research reveals that those companies that pay out higher dividends also tend to have higher stock prices because they also have higher earnings growth. And earnings growth is another key component in valuing stocks.  This research indicates this as a global tendency.

Searching for Yield

Unfortunately, seeking out high dividend-paying companies in the US is not so easy.  Unlike managements of Euro-based companies where paying dividends is a sort of badge of honor, US companies tend to be much more stingy in paying back earnings to owners of the company (the stockholders).

And the trend in dividend yields is one that continues to decline. A research note by Vanguard (May 2011) shows this trend.  From 1928 through 1945, the average dividend yield was around 5.6% and dividends represented about 67% of company earnings (aka dividend payout ratio). From 1945 to 1982 the average yields dropped to 4.2% and the payout ratio to 53%.  In the more recent period from 1983 through 2010, the average dividend yield has dropped to 2.5% with a payout ratio of about 46%.

As you can see finding “Aristocrats” that pay out higher than these averages makes a big difference.  And the higher payouts may also portend higher future earnings as well as stock price appreciation.

But even those companies which are “stingier” will still help out a portfolio.

Do Lower Dividends Mean Lower Stock Prices?

The question that investors may be asking themselves now is “will these lower dividend yields (historically and compared to Europe for instance) be an indicator of lower stock prices?” Because the market’s dividend yield is below its historical norm, is that an indicator of lower total returns in the future?

While the stock market is certainly not without bubbles and crashes, it is unlikely that this is a factor in possible future stock price levels. Lower dividend yields are not necessarily an indicator of lower total returns.

There are other reasons that are more likely the cause of this trend toward lower yield payouts.  Part of this is based on US tax policy.  Another is the culture of US corporate management that has opted toward share repurchases instead.

In the US, there is a bias in favor of long-term capital gains over receiving dividends and paying income taxes.

When dividends are paid out all stock holders receive the income and are subject to tax. When management opts for a “share repurchase” program, only those who tender their shares are paid out.  So this may be more agreeable to investors who are trying to manage their tax bill from investing. For those who are longer-term stock holders, they may receive more favorable capital gains treatment by holding the stock and waiting simply for appreciation.

Admittedly, there may also be an incentive by management not to declare dividends so that they can hold onto the capital to “reinvest” in the business – which may or may not be a good thing.  (The same argument can also be seen in political terms in Washington when both parties are arguing about whether or not to have tax cuts).

And management may also have an incentive to repurchase stock because such programs provide the company with flexibility to change the terms – something that is frowned upon if management were to lower or cancel a declared dividend.

How to Use Dividends in Your Portfolio

In any event, using dividend-paying stock is something that makes sense in retirement portfolios.  To provide tax efficiency, it makes sense to include these in your qualified accounts (like IRAs).  And to boost income, it makes sense to add global dividend-paying stocks which tend to have higher yields and payouts.  Nothing in these current research notes indicates that the lower US yields and payouts are an indicator for lower future stock prices.  There are enough other things going on in the economy locally and globally that can impact do that.

To Build a Better Mousetrap or Get More Information

For more ways to build a retirement income portfolio, please feel free to give me a call directly at 978-388-0020 and stay tuned to the company website for upcoming webinars that will cover this topic too.

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Lately, the media has been dominated by the compromise on US federal tax policy that has been brokered by President Obama that will lead to an extension of current income tax rates, lower estate and payroll tax rates and an extension of unemployment benefits.  It is very likely to pass almost intact and free up the logjam that has hampered this lame duck session of Congress.

Uneven Recovery

From the point of view of a resident of Main Street, the economy is still ailing.  Consumer demand is still off.  A stubbornly high unemployment rate persists.  Real estate values continue to drop in most markets and at best have settled in at levels not seen in nearly a decade. In general, it’s not a pretty picture.

On the other hand, business profits, productivity and cash (now sitting at about $2 Trillion) are up. And this has been reflected on Wall Street by a healthy rise in most major indices.

So the prescription for getting out of this funk is a familiar one: Low taxes leads to growth.  Sometimes, though, conventional thinking can be dangerous.

Economic Theory

From a purely economic theory point of view, there are really only three participants in the economy who can spur demand and ultimately growth: consumers, businesses or government (at all levels).

With consumer spending hampered by unemployment and nervousness about what assets, income and jobs that they may have, you can’t really expect consumers to be leading us to growth.

While businesses have the cash and the profits, they seem to be in wait-and-see mode “keeping their powder dry.”

So that leaves governments at the local, state and federal level. Unfortunately, most local and state governments don’t have the resources or the legal authority to continue deficit spending so that leaves us dependent on the federal purse to help spur the economy.

Tax Package as Stimulus

The tax package compromise as proposed is not perfect.  Like any piece of legislation, it is a mash-up (though the versions seen on Glee are usually much more fun to watch).  It certainly provides the potential for much-needed economic stimulus.

By putting cash in the pockets of the persistent unemployed, it will help keep households running and bolster their local economies when cash is circulated.  By reducing payroll taxes on those who are working, it will also lead to direct spending in much the same way that the under-reported stealth “middle class tax cut” of 2010 did.

By patching the Alternative Minimum Tax (AMT) for another year, more than 21 million households were protected from an unexpected hike in their personal tax burden (estimated at around $3,000 to $5,000 for each family) which might have choked off funds available to circulate in the rest of the economy for goods and services.

The big question will be whether the upper income brackets will use their tax breaks on income and estate taxes to pump up the economy.  Certainly, it could help with high-end consumer goods, vacation homes, and furnishings.  But as much as these purchases will help jewelers, real estate agents, car salesmen and clothing retailers, there’s only so many shoes, watches, cars and homes that someone can consume.

Good Politics May Make for A Bad Economy Long-Term

But will this create jobs?  How quickly can an expected $100,000 cut in income taxes for the richest 1% of Americans translate to business investment that creates jobs?  And at the end of the day, does this potential added economic activity keep us on track for growth?

These are the kinds of questions that probably prompted credit analysts at Moody’s Investor Service, a credit rating company, to put out a cautionary note about the possible negative impact on federal finances with its ultimate impact on consumers.

From a purely political point of view, this may be a good deal.  From a short-term economic stimulus point of view, it provides some benefits.  In the long-term, though, there is a real risk that the nation’s strained finances will take a hit to its credit rating leading to higher borrowing costs for the government directly and for all consumers seeking credit as well.

The Rich (And The Government) Are Different

Why?  Well, ask any mortgage borrower.  When you have pristine credit, it’s easier to borrow money at the most favorable rates.  Over the long-term, borrowing $200,000 at 6% will cost you more than borrowing the same amount at 4.5%.

On the other hand, when a borrower’s credit score is lower – even by a little – then the options available can dry up or cost more.

This is what may happen as we move forward and digest the impact of this tax plan.  It ultimately is kicking the can down the road for others to deal with.  The estimated price tag on the plan is between $700-billion and $900-billion to be added on top of a trillion-dollar plus federal deficit. And the proposals for cutting the deficit prompted much gnashing of teeth and proclamations of lines in the sand indicating that there is no likely easy compromise on their recommendations especially in a grid-locked Congress next term.

US Credit Score on Watch List

Is there an immediate problem?  No.  As long as we still have investors who are confident that they will get paid back on the money that they lend us through their purchase of our government’s debt.  Unlike the mortgage borrower in my example, the government can vote to increase its credit limit and authorize the printing of cash. Not something that your typical consumer or state government can do.

And investor’s in the marketplace seem to be OK with that as seen by the cost of insuring against default through derivatives. An insurance contract to protect $13.-million worth of U.S. government debt currently costs €41,000 a year, according to data from credit-information firm Markit Group. That is down from €59,000 in February of this year, and far less than in early 2009, when it cost €100,000.

But this can turn on a dime.  Ask those folks in Greece.  They are painfully aware what can happen when investors and banks lose patience and pull the plug and the credit line.

Yes, Greece is not the US, which has the benefit of being the world’s reserve currency.  But that should not lead us to complacency and hubris.  We need more than conventional thinking and political party maneuvering.  We need the kind of shared sacrifice that the Greatest Generation exhibited which won the peace in a global conflict and pulled us out of the other greatest global economic calamity of the last century.

Either we need to make the tough choices now while we can or we will be forced to pretty much at gunpoint down the road.  That’s not a pretty picture nor a way to grow in the long-term.

Maybe we can get the folks from Glee to work on a musical mash-up of sorts that will make this happen.

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The clock is running out on this session of Congress.  While far from a sure thing, at least there is movement on the tax front.  Whether that movement is progress or a step back will depend on your point of view.

It’s been said many times:  Two things you don’t want to see being made are sausage and legislation.

This go-around with the recently negotiated tax bill is just such an example.  In the spirit of the holidays, there is just about something for everyone in this proposed compromise: tax cut extension, cut in payroll taxes, a fix to the AMT exemption, extension of unemployment benefits.

While the full impact is yet to be digested, it is certain that the debate is far from over.  And it is almost equally certain that in its present form it will likely add considerably to the federal budget deficit.

Since we are still in fragile economic territory, demand stimulus is still needed.  And at least this proposal, while far from perfect, will provide that in the form of funding for unemployment benefits, lower payroll taxes and

Now that there will be “tax certainty” let’s see if the job creation will follow.

I’m happy to see that there is a patch for the AMT so that millions of families won’t be unexpectedly hit by a stealth tax increase.  Unfortunately, a permanent fix of the AMT is not on the radar and we’ll be doing this again next year as well.

And from an estate planning point of view, there will finally be some certainty on this front – at least for now.

While ‘stimulus’ is a bad word, at least there will be some economically beneficial parts to the proposal.  The most direct positive impact on the economy and aggregate demand is having more cash in the hands of average consumers.  On this point, the extension of unemployment benefits, in addition to being just morally right, will put cash in the pockets of millions who will immediately circulate it for payment of needed goods and services – not to mention paying the mortgage to help avert more foreclosures.

I’m no fan of trickle down economics and don’t think that we can afford tax breaks that for the most part will not lead to job creation in the near term.

Now we’ll see how the proposal will fare in Congress.  In any event, let’s hope that the sound you hear in the background is only the clock ticking down to the end of the session and not the timer of a not-t00-distant debt time bomb counting down to a nasty explosion.

 

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