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An Inside Look At ETF Construction
Some people are happy to simply use a range of devices like wrist watches and computers and trust that things will work out. Others want to know the inner workings of the technology they use, and understand how it was built. If you fall into the latter category and as an investor have an interest in the benefits that exchange-traded funds (ETFs) offer, youll definitely be interested in the story behind their construction.
How an ETF Is Created
The creation and redemption process for ETF shares is almost the exact opposite of that of mutual fund shares. When investing in mutual funds, investors send cash to the fund company, which then uses that cash to purchase securities and in turn issue additional shares of the fund. When investors wish to redeem their mutual fund shares, the shares are returned to the mutual fund company in exchange for cash. The creation of an ETF, however, does not involve cash.
The process begins when a prospective ETF manager (known as a sponsor) files a plan with the SEC to create an ETF. Once the plan is approved, the sponsor forms an agreement with an authorized participant, generally a market maker, specialist or large institutional investor, who is empowered to create or redeem ETF shares. (In some cases, the authorized participant and the sponsor are the same).
The authorized participant borrows shares of stock, often from a pension fund, places those shares in a trust, and uses them to form creation units of the ETF. Creation units are bundles of stock varying from 10,000 to 600,000 shares, but 50,000 shares is whats commonly designated as one creation unit of a given ETF. Then, the trust provides shares of the ETF - which are legal claims on the shares held in the trust (the ETFs represent tiny slivers of the creation units) - to the authorized participant. Because this transaction is an in-kind trade - that is, securities are traded for securities - there are no tax implications. Once the authorized participant receives the ETF shares, they are then sold to the public on the open market just like shares of stock.
When ETF shares are bought and sold on the open market, the underlying securities that were borrowed to form the creation units remain in the trust account. The trust generally has little activity beyond paying dividends from the stock held in the trust to the ETF owners and providing administrative oversight because the creation units are not impacted by the transactions that take place on the market when ETF shares are bought and sold.
Redeeming an ETF
When investors want to sell their ETF holdings, they can do so by one of two methods. The first is to sell the shares on the open market. This is generally the option chosen by most individual investors. The second option is to gather enough shares of the ETF to form a creation unit and then exchange the creation unit for the underlying securities. This option is generally only available to institutional investors due to the large number of shares required to form a creation unit. When these investors redeem their shares, the creation unit is destroyed and the securities are turned over to the redeemer. The beauty of this option is in its tax implications for the portfolio.
We can see these tax implications best by comparing the ETF redemption to that of a mutual fund redemption. When mutual fund investors redeem shares from a fund, all shareholders in the fund are affected by the tax burden. This is because to redeem the shares, the mutual fund may have to sell the securities it holds, realizing the capital gain, which is subject to tax. Also, all mutual funds are required to pay out all dividends and capital gains on a yearly basis. Therefore, even if the portfolio has lost value that is unrealized, there is still a tax liability on the capital gains that had to be realized because of the requirement to pay out dividends and capital gains.
ETFs minimize this scenario by paying large redemptions with shares of stock. When such redemptions are made, the shares with the lowest cost basis in the trust are given to the redeemer. This increases the cost basis of the ETFs overall holdings, minimizing its capital gains. It doesnt matter to the redeemer that the shares it receives have the lowest cost basis because the redeemers tax liability is based on the purchase price it paid for the ETF shares, not the funds cost basis. When the redeemer sells the shares of stock on the open market, any gain or loss incurred has no impact on the ETF. In this manner, investors with smaller portfolios are protected from the tax implications of trades made by investors with large portfolios.
The Role of Arbitrage
Critics of ETFs often cite the potential for ETFs to trade at a share price that is not aligned with the value of the underlying securities. To help us understand this concern, a simple representative example best tells the story.
Assume an ETF is made up of only two underlying securities:
• Security A, which is worth $1 per share
• Security B, which is also worth $1 per share
In this example, most investors would expect one share of the ETF to trade at $2 per share (the equivalent worth of Security A and Security B). While this is a reasonable expectation, it is not always the case. It is possible for the ETF to trade at $2.02 per share or $1.98 per share or some other value.
If the ETF is trading at $2.02, investors buying shares of the ETF are paying more for the shares than the underlying securities are worth. This would seem to be a dangerous scenario for the average investor, but in reality, it isnt a major problem because of arbitrage trading.
Heres how arbitrage sets the ETF back into equilibrium. The trading price of an ETF is established at the close of business each day, just like any other mutual fund. ETF sponsors also announce the value of the underlying shares on a daily basis. When the price of the ETF deviates from the value of the underlying shares, the arbitragers spring into action. If the underlying securities are trading at a lower price than the ETF shares, arbitragers buy the underlying securities, redeem them for creation units, and then sell the ETF shares on the open market for a profit. If underlying securities are trading at higher values than the ETF shares, arbitragers buy ETF shares on the open market, form creations units, redeem the creation units in order to get the underlying securities, and then sell the securities on the open market for a profit. The actions of the arbitrageurs set the supply and demand of the ETFs back into equilibrium to match the value of the underlying shares.
Because ETFs were used by institutional investors long before they were discovered by the investing public, active arbitrage among institutional investors has served to keep ETF shares trading at a range that is close to the value of the underlying securities.
The Bottom Line
In a sense, ETFs have a lot in common with wrist watches. Everybody wants their watch to tell the correct time, but they dont need to know how the watch was built in order to benefit from it. With ETFs, investors can enjoy the benefits associated with this unique and attractive investment product, without even being aware of the complicated series of events that make it work. But, of course, knowing how those events work makes you a more educated investor, which is the key to being a better investor.
Everything Investors Need To Know About Earnings
You cant get far in the stock market without understanding earnings. Everybody from CEOs to research analysts is infatuated with this often-quoted number. But what exactly do earnings represent? Why do they attract so much attention? Well answer these questions and more in this primer on earnings.
What Are Earnings?
A companys earnings are, quite simply, its profits. Take a companys revenue from selling something, subtract all the costs to produce that product, and, voila, you have earnings! Of course, the details of accounting get a lot more complicated, but underneath all the financial jargon what is really being measured is how much money a company makes.
Part of the confusion associated with earnings is caused by its many synonyms. The terms profit, net income, bottom line and earnings all refer to the same thing.
Earnings Per Share
To compare the earnings of different companies, investors and analysts often use the ratio earnings per share (EPS). To calculate EPS you take the earnings left over for shareholders and divide by the number of shares outstanding. You can think of EPS as a per-capita way of describing earnings. Because every company has a different number of shares owned by the public, comparing only companies earnings figures does not indicate how much money each company made for each of its shares, so we need EPS to make valid comparisons.
For example, take two companies: ABC Corp. and XYZ Corp. They both have earnings of $1 million but ABC Corp has 1 million shares outstanding while XYZ Corp. only has 100,000 shares outstanding. ABC Corp. has EPS of $1 per share ($1 million/1 million shares) while XYZ Corp. has EPS of $10 per share ($1 million/100,000 shares).
Earnings Season
Earnings season is Wall Streets equivalent to a school report card. It happens four times per year; publicly traded companies in the U.S. are required by law to report their financial results on a quarterly basis. Most companies follow the calendar year for reporting, but they do have the option of reporting based on their own fiscal calendars.
Although it is important to remember that investors look at all financial results, you might have guessed that earnings (or EPS) is the most important number released during earnings season, attracting the most attention and media coverage. Before earnings reports come out, stock analysts issue earnings estimates - what they think earnings will come in at. These forecasts are then compiled by research firms into the consensus earnings estimate.
When a company beats this estimate its called an earnings surprise, and the stock usually moves higher. If a company releases earnings below these estimates it is said to disappoint, and the price typically moves lower. All this makes it hard to try to guess how a stock will move during earnings season: its really all about expectations. (For more on this phenonmenon, see Surprising Earnings Results.)
Why Do Investors Care About Earnings?
Investors care about earnings because they ultimately drive stock prices . Strong earnings generally result in the stock price moving up (and vice versa). Sometimes a company with a rocketing stock price might not be making much money, but the rising price means that investors are hoping that the company will be profitable in the future - of course, there are no guarantees that the company will fulfill investors current expectations.
The dotcom boom and bust is a perfect example of company earnings coming in significantly short of the numbers investors imagined. When the boom started, everybody got excited about the prospects for any company involved in the internet, and stock prices soared. Over time, it became clear that the dotcoms werent going to make nearly as much money as many had predicted. It simply wasnt possible for the market to support these companies high valuations without any earnings; as a result, the stock prices of these companies collapsed.
When a company is making money it has two options. First, it can improve its products and develop new ones. Second, it can pass the money onto shareholders in the form of a dividend or a share buyback (see The Lowdown on Stock Buybacks). It really is this simple!
In the first case, you trust the management to re-invest profits in the hope of making more profits. In the second case, you get your money right away. Typically, smaller companies attempt to create shareholder value by reinvesting profits, while more mature companies pay out dividends. Neither method is necessarily better, but both rely on the same idea: in the long run, earnings provide a return on shareholders investments .
Summary
Earnings means profit; its the money a company makes. It is often evaluated in terms of earnings per share (EPS) - this is the most important indicator of a companys financial health. Earnings reports are released four times per year and are followed very closely by Wall Street. In the end, growing earnings are a good indication that a company is on the right path to providing a solid return for investors.
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An Introduction To Stock Market Indexes
June 04 2011| Filed Under » Index Fund, Investing Basics, Stocks
Its not unusual for people to talk about the market as if there were a common meaning for the word. But in reality, the many indexes of the differing segments of the market dont always move in tandem. If they did, there would be no reason to have multiple indexes. By gaining a clear understanding of how indexes are created and how they differ, you will be on your way to making sense of the daily movements in the marketplace. Here well compare and contrast the main market indexes so that the next time you hear someone refer to the market, youll have a better idea of just what they mean.
Tutorial: Stock Basics
The Dow
If you ask an investor how the market is doing, you might get an answer that is based on the Dow. The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known and most frequently used indexes in the world. It includes the stocks of 30 of the worlds largest and most influential companies. The DJIA is whats known as a price weighted index. It was originally computed by adding up the per-share price of the stocks of each company in the index and dividing this sum by the number of companies - thats why its called an average. Unfortunately, it is no longer this simple to calculate. Over the years, stock splits, spin-offs and other events have resulted in changes in the divisor, making it a very small number (less than 0.2).
The DJIA represents about a quarter of the value of the entire U.S. stock market, but a percent change in the Dow should not be interpreted as a definite indication that the entire market has dropped by the same percent. This is because of the Dows price-weighted function. The basic problem is that a $1 change in the price of a $120 stock in the index will have the same effect on the DJIA as a $1 change in the price of a $20 stock, even though one stock may have changed by 0.8% and the other by 5%.
A change in the Dow represents changes in investors expectations of the earnings and risks of the large companies included in the average. Because the general attitude toward large-cap stocks often differs from the attitude toward small-cap stocks, international stocks or technology stocks, the Dow should not be used to represent sentiment in other areas of the marketplace. On the other hand, because the Dow is made up of some of the most well-known companies in the U.S., large swings in this index generally correspond to the movement of the entire market, although not necessarily on the same scale. (For more information on this index, see Calculating The Dow Jones Industrial Average.)
The S
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Market Problems? Blame Investors
Sure, the economy sometimes hits a slump, whether because of a war or unforeseen natural disaster. Of course, these things are beyond an investors control. But turbulence in the market can often be linked not to any perceivable event but rather to investor psychology. A fair amount of your portfolio losses can be traced back to your choices and the reasons for making them, rather than unseen forces of evil that we tend to blame when things go wrong. Here we look at some of the ways investors unwittingly inflict problems on the market.
Following the Crowd
Humans are prone to a herd mentality, conforming to the activities and direction of others. This is a common mistake in investing. Imagine you and a dozen other people are caught in a theater thats on fire. The room is filled with smoke and flames are licking the walls. The people best qualified to get you out safely, such as the building owner or an off-duty firefighter, shy away from taking the lead because they fear being wrong and they know the difficulties of leading a smoke-blinded group.
Then the take-charge person steps up and everyone is happy to follow the leader. This person is not qualified to lead you to the local 7-11, let alone get you out of an unfamiliar burning building, so, sadly, you are more likely to end up as ash than find your way out. This tendency to panic and depend on the direction of others is exactly why problems arise in the stock market, except we are often following the crowd into the burning building rather than trying to get out. Here are two actions caused by herd mentality:
• Panic Buying - This is the hot-tip syndrome, whose symptoms usually show up in buzzwords such as revolution, new economy, and paradigm shift. You see a stock rising and you want to hop on for the ride, but youre in such a rush that you skip your usual scrutiny of the companys records. After all, someone must have looked at them, right? Wrong. Holding something hot can sometimes burn your hands. The best course of action is to do your due diligence. If something sounds too good to be true, it probably is.
• Panic Selling - This is the end of the world syndrome. The market (or stock) starts taking a downturn and people act like its never happened before. Symptoms include a lot of blaming, swearing, and despairing. Regardless of the losses you take, you start to get out before the market wipes out whats left of your retirement fund. The only cure for this is a level head. If you did your due diligence, things will probably be OK, and a recovery will benefit you nicely. Tuck your arms and legs in and hide under a desk as people trample their way out of the market. (For more on this kind of behaviour, check out our Behavioral Finance Tutorial.)
We Cant Control Everything
Although it is a must, due diligence cannot save you from everything. Companies that become entangled in scandals or lie on their balance sheets can deceive even the most seasoned and prudent investor. For the most part, these companies are easy to spot in hindsight (Enron), but early rumors were subtle blips on the radar screens of vigilant investors. Even when a company is honest with an investor, a related scandal can weaken the share price. Omnimedia, for example, took a severe beating for Martha Stewarts alleged insider activities. So bear in mind that it is a market of risk. (For more on stock scandals, check out The Biggest Stock Scams Of All Time.)
Holding Out for a Rare Treat
Gamblers can always tell you how many times and how much theyve won, but never how many times or how badly theyve lost. This is the problem with relying on rewards that come from luck rather than skill: you can never predict when lucky gains will come, but when they do, its such a treat that it erases the stress (psychological, not financial) youve suffered.
Investors can fall prey to both the desire to have something to show for their time and the aversion to admitting they were wrong. Thus, some investors hold onto stock that is losing, praying for a reversal for their falling angels; other investors, settling for limited profit, sell stock that has great long-term potential. The more an investor loses, however, the larger the gain must be to meet expectations.
One of the big ironies of the investing world is that most investors are risk averse when chasing gains but become risk lovers when trying to avoid a loss (often making things much worse). If you are shifting your non-risk capital into high-risk investments, youre contradicting every rule of prudence to which the stock market ascribes and asking for further problems. You can lose money on commissions by overtrading and making even worse investments. Dont let your pride stop you from selling your losers and keeping your winners.
Xenophobia
People with this psychological disorder have an extreme fear of foreigners or strangers. Even though most people consider these fears irrational, investors engage in xenophobic behavior all the time. Some of us have an inborn desire for stability and the most seemingly stable things are those that are familiar to us and close to home (country or state).
The important thing about investing is not familiarity but value. If you look at a company that happens to look new or foreign but its balance sheet looks sound, you should not eliminate the stock as a possible investment. People constantly lament that its hard to find a truly undervaluedstock, but they dont look around for one; furthermore, when everyone thinks domestic companies are more stable and try to buy in, the stock market goes up to the point of being overvalued, which ironically assures people theyre making the right choice, possibly causing a bubble. Dont take this as a commandment to quit investing domestically; just remember to scrutinize a domestic company as closely as you would a foreign one. (For ideas on how to get involved with foreign stocks, check out Go International With Foreign Index Funds.)
Concluding with a Handy List
Some problems investors face are not isolated to the investing world. Lets look at the seven deadly sins of investing that often lead investors to blindly follow the herd:
1. Pride - This occurs when you are trying to save face by holding a bad investment instead of realizing your losses. Admit when you are wrong, cut your losses, and sell your losers. At the same time, admit when you are right and keep the winners rather than trying to over-trade your way up.
2. Lust – Lust in investing makes you chase a company for its body (stock price) instead of its personality (fundamentals). Lust is a definite no-no and a cause of bubbles and crazes.
3. Avarice – This is the act of selling dependable investments and putting that money into higher-yield, higher-risk investments. This is a good way to lose your shirt--the world is cold enough without having to face it naked.
4. Wrath – This is something that always happens after a loss. You blame the companies, brokerages, brokers, advisors, the CNBC news staff, the paperboy - everyone but yourself and all because you didnt do your due diligence. Instead of losing your cool, realize that you now know what you have to do next time.
5. Gluttony – A complete lack of self-control or balance, gluttony causes you to put all your eggs in one basket, possibly an over-hyped basket that doesnt deserve your eggs (Enron, anyone?). Remember balance and diversification are essential to a portfolio. Too much of anything is exactly that: TOO MUCH!
6. Sloth – You guessed it, this means being lazy and not doing your due diligence. On the flip side, a little sloth can be OK as long as its in the context of portfolio activity. Passive investors can profit with less effort and risk than over-active investors.
7. Envy – Coveting the portfolios of successful investors and resenting them for it can eat you up. Rather than cursing successful investors, why not try to learn from them? There are worse people to emulate than Warren Buffett. Try reading a book or two: knowledge rarely harms the holder.
Conclusion
Humans are prone to herd mentality, but if you can recognize what the herd is doing and examine it rationally, you will be less likely to follow the stampede when its headed in an unprofitable direction.
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Evaluating A Companys Capital Structure
For stock investors that favor companies with good fundamentals, a strong balance sheet is an important consideration for investing in a companys stock. The strength of a companys balance sheet can be evaluated by three broad categories of investment-quality measurements: working capital adequacy, asset performance and capital structure. In this article, well look at evaluating balance sheet strength based on the composition of a companys capital structure.
A companys capitalization (not to be confused with market capitalization) describes the composition of a companys permanent or long-term capital, which consists of a combination of debt and equity. A healthy proportion of equity capital, as opposed to debt capital, in a companys capital structure is an indication of financial fitness.
Clarifying Capital Structure Related Terminology
The equity part of the debt-equity relationship is the easiest to define. In a companys capital structure, equity consists of a companys common and preferred stock plus retained earnings, which are summed up in the shareholders equity account on a balance sheet. This invested capital and debt, generally of the long-term variety, comprises a companys capitalization, i.e. a permanent type of funding to support a companys growth and related assets.
A discussion of debt is less straightforward. Investment literature often equates a companys debt with its liabilities. Investors should understand that there is a difference between operational and debt liabilities - it is the latter that forms the debt component of a companys capitalization - but thats not the end of the debt story.
Among financial analysts and investment research services, there is no universal agreement as to what constitutes a debt liability. For many analysts, the debt component in a companys capitalization is simply a balance sheets long-term debt. This definition is too simplistic. Investors should stick to a stricter interpretation of debt where the debt component of a companys capitalization should consist of the following: short-term borrowings (notes payable), the current portion of long-term debt, long-term debt, two-thirds (rule of thumb) of the principal amount of operating leases and redeemable preferred stock. Using a comprehensive total debt figure is a prudent analytical tool for stock investors.
Its worth noting here that both international and U.S. financial accounting standards boards are proposing rule changes that would treat operating leases and pension projected-benefits as balance sheet liabilities. The new proposed rules certainly alert investors to the true nature of these off-balance sheet obligations that have all the earmarks of debt.
Is There an Optimal Debt-Equity Relationship?
In financial terms, debt is a good example of the proverbial two-edged sword. Astute use of leverage (debt) increases the amount of financial resources available to a company for growth and expansion. The assumption is that management can earn more on borrowed funds than it pays in interest expense and fees on these funds. However, as successful as this formula may seem, it does require that a company maintain a solid record of complying with its various borrowing commitments.
A company considered too highly leveraged (too much debt versus equity) may find its freedom of action restricted by its creditors and/or may have its profitability hurt as a result of paying high interest costs. Of course, the worst-case scenario would be having trouble meeting operating and debt liabilities during periods of adverse economic conditions. Lastly, a company in a highly competitive business, if hobbled by high debt, may find its competitors taking advantage of its problems to grab more market share .
Unfortunately, there is no magic proportion of debt that a company can take on. The debt-equity relationship varies according to industries involved, a companys line of business and its stage of development. However, because investors are better off putting their money into companies with strong balance sheets, common sense tells us that these companies should have, generally speaking, lower debt and higher equity levels.
Capital Ratios and Indicators
In general, analysts use three different ratios to assess the financial strength of a companys capitalization structure. The first two, the so-called debt and debt/equity ratios, are popular measurements; however, its the capitalization ratio that delivers the key insights to evaluating a companys capital position.
The debt ratio compares total liabilities to total assets . Obviously, more of the former means less equity and, therefore, indicates a more leveraged position. The problem with this measurement is that it is too broad in scope, which, as a consequence, gives equal weight to operational and debt liabilities. The same criticism can be applied to the debt/equity ratio, which compares total liabilities to total shareholders equity. Current and non-current operational liabilities, particularly the latter, represent obligations that will be with the company forever. Also, unlike debt, there are no fixed payments of principal or interest attached to operational liabilities.
The capitalization ratio (total debt/total capitalization) compares the debt component of a companys capital structure (the sum of obligations categorized as debt total shareholders equity) to the equity component. Expressed as a percentage, a low number is indicative of a healthy equity cushion, which is always more desirable than a high percentage of debt.
Additional Evaluative Debt-Equity Considerations
Companies in an aggressive acquisition mode can rack up a large amount of purchased goodwill in their balance sheets. Investors need to be alert to the impact of intangibles on the equity component of a companys capitalization. A material amount of intangible assets need to be considered carefully for its potential negative effect as a deduction (or impairment) of equity, which, as a consequence, will adversely affect the capitalization ratio.
Funded debt is the technical term applied to the portion of a companys long-term debt that is made up of bonds and other similar long-term, fixed-maturity types of borrowings. No matter how problematic a companys financial condition may be, the holders of these obligations cannot demand payment as long the company pays the interest on its funded debt. In contrast, bank debt is usually subject to acceleration clauses and/or covenants that allow the lender to call its loan. From the investors perspective, the greater the percentage of funded debt to total debt disclosed in the debt note in the notes to financial statements, the better. Funded debt gives a company more wiggle room.
Lastly, credit ratings are formal risk evaluations by credit-rating agencies - Moodys, Standard
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Introduction To Institutional Investing
Institutional investors are entities that pool together funds on behalf of others, and invest those funds in a variety of different financial instruments and asset classes. Institutional investors control a significant amount of all financial assets in the United States, and exert considerable influence in all markets.
TUTORIAL: Advanced Financial Statement Analysis
Influence
This influence has grown over time and can be confirmed by examining the concentration of ownership by institutional investors in the equity of the top 50 publicly traded corporations. The average institutional ownership in these companies was about 64% at the end of 2009, compared to 49% at the end of 1987. As the size and importance of institutions continues to grow, so does their relative holdings and influence on the financial markets.
Advantages
Institutional investors are generally considered to be more proficient at investing due to the assumed professional nature of operations and greater access to companies and managements because of size. These advantages may have eroded over the years as information has become more transparent and accessible, and regulation has limited the amount and method of disclosure by public companies. (These vehicles have gotten a bad rap in the press. Find out whether they deserve it. See Are Derivatives Safe For Retail Investors?)
Types of Institutional Investors
Institutional investors include public and private pension funds, insurance companies, savings institutions, closed- and open-end investment companies, and foundations.
By the Numbers
Institutional investors controlled $25.3 trillion, or 17.4% of all U.S. financial assets as of 12/31/2009, according to the Conference Board. This percentage has been declining over the last decade and peaked in 1999 at 21.5% of total assets. The gradual percentage decline arises due to the massive value increases in total outstanding assets which are available for investment purposes.
Asset Allocation
Institutional investors invested these assets in a variety of classes, the standard allocation is approximately 40% of assets to equity and 40% to fixed income. Another 20% of total assets were allocated to real estate, cash and other areas. However, these figures drastically vary from institution to institution. Equities have experienced the fastest growth over the last generation, and in 1980 only 18% of all institutional assets were invested in equities. (Your portfolios asset mix is a key factor in whether its profitable. Find out how to get this delicate balance right. Refer to 6 Asset Allocation Strategies That Work.)
Pension Funds
Pension funds are the largest part of the institutional investment community and control over $10 trillion, or approximately 40% of all professionally managed assets. Pension funds receive payments from individuals and sponsors, either public or private, and promise to pay a retirement benefit in the future to the beneficiaries of the fund.
The large pension fund in the United States, California Public Employees Retirement System (CalPERS), reported total assets of $239 billion at as of 2011. Although pension funds have significant risk and liquidity constraints, they are often able to allocate a small portion of their portfolios to investments which are not easily accessible to retail investors such as private equity and hedge funds.
Most pension fund operational requirements are discussed in the Employee Retirement Income Security Act (ERISA) passed in 1974. This law established the accountability of the fiduciaries of pension funds and set minimum standards on disclosure, funding, vesting and other important components of these funds.
Investment Companies
Investment companies are the second largest institutional investment class and provide professional services to banks and individuals looking to invest their funds.
Most investment companies are either closed- or open-end mutual funds, with open end funds continually issuing new shares as it receives funds from investors. Closed end funds issue a fixed number of shares and typically trade on an exchange.
Open end funds have the majority of assets within this group, and have experienced rapid growth over the last few decades as investing in the equity market became more popular. In 1980, investment companies comprised only 2.9% of all institutional assets, but this share more than tripled to 9.4% by 1990, and reached 28.4% by the end of 2009. However, with the rapid growth of ETFs many investors are now turning away from mutual funds.
The Massachusetts Investors Trust came into existence in the 1920s and is generally recognized as the first open-end mutual fund to operate in the United States. Others quickly followed and by 1929 there were 19 more open-end mutual funds and nearly 700 closed-end funds in the United States.
Investment companies are regulated primarily under the Investment Company Act of 1940, and also come under other securities laws in force in the United States. (Flying high one day but not the next - see the stories behind some spectacular meltdowns. Check out Massive Hedge Fund Failures.)
Insurance Companies
Insurance companies are also part of the institutional investment community and controlled almost the same amount of funds as investment firms. These organizations, which include property and casualty insurers and life insurance companies, take in premiums to protect policy holders from various types of risk. The premiums are then invested by the insurance companies to provide a source of future claims and a profit.
Savings Institutions
Savings institutions control over $1 trillion in assets. These organizations have seen a huge drop in assets over the last generation, with the percentage of assets held by savings institutions declining from 32.6% in 1980 to only 4.9% in 2009.
Foundations
Foundations are the smallest institutional investor as they are typically funded for pure altruistic purposes. These organizations are typically created by wealthy families or companies and are dedicated to a specific public purpose.
The largest foundation in the United States is the Bill and Melinda Gates Foundation, which held $36.7 billion in assets at the end of 2010. Foundations are usually created for the purpose of improving the quality of public services such as accessibility to education funding, healthcare and research grants.
Conclusion
Institutional investors remain an important part of the investment world despite a flat share of all financial assets over the last decade, and still have considerable impact on all markets and asset classes.
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5 Ways To Protect Your Portfolio From Volatility
Is it possible to gauge the level of anxiety in the investment markets? Certainly, and The Chicago Board of Exchange Volatility Index (VIX) measures it. The VIX reacts in real time - just as a stock does - and measures the level of volatility in the U.S. markets over the next 30 days. When the VIX is at 30, in the next 30 days the market could move as much as 2.5% in either direction, (30% divided by 12 months equals 2.5%). The VIX has hovered around 30 for the latter part of 2011, indicating that the market is still highly volatile.
Although short-term traders may call periods of high volatility great times to make money, the truth is that traders of all skill levels will face challenges in this market. What can you do to protect your portfolio against the wild stock market swings? Though it may not sound exciting to the average active trader, the best defense is to stick with conservative, boring strategies.
Hedge
Think of hedging as an insurance policy. Lets assume that you own Bank of America stock and it is now in a market decline. One way to hedge would be to purchase a put option, with a strike price below where you purchased the stock. You wont lose money on any move below your strike price. Other hedging options include short selling a stock and purchasing put options on index funds, like popular exchange traded fund SPDR S
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Conglomerates: Cash Cows Or Corporate Chaos?
Conglomerates are companies that either partially or fully own a number of other companies. Not long ago, sprawling conglomerates were a prominent feature of the corporate landscape. Vast empires, such as General Electric (NYSE:GE) and Berkshire Hathaway (NYSE:BRK.A), were built up over many years with interests ranging from jet engine technology to jewelry. Corporate hodgepodges like these pride themselves on their ability to avoid bumpy markets. In some cases, they have produced impressive long-term shareholder returns - but this doesnt mean that corporate conglomerates are always a good thing for investors. If youre interested in investing in these behemoths, there are a few things you should know. Here we explain what conglomerates are and give you an overview of the pros and cons of investing in them.
The Case for Conglomerates
The case for conglomerates can be summed up in one word: diversification. According to financial theory, because the business cycle affects industries in different ways, diversification results in a reduction of investment risk. A downturn suffered by one subsidiary, for instance, can be counterbalanced by stability, or even expansion, in another venture. In other words, if Berkshire Hathaways brick-making division has a bad year, the loss might be offset by a good year in its insurance business.
At the same time, a successful conglomerate can show consistent earnings growth by acquiring companies whose shares are more lowly rated than its own. In fact, GE and Berkshire Hathaway have both promised - and delivered - double-digit earnings growth by applying this investment growth strategy.
The Case Against Conglomerates
However, the prominent success of conglomerates such as GE and Berkshire Hathaway is hardly proof that conglomeration is always a good idea. There are plenty of reasons to think twice about investing in these stocks , particularly in 2009, when both GE and Berkshire suffered as a result of the economic downturn, proving that size does not make a company infallible.
Investment guru Peter Lynch uses the phrase diworsification to describe companies that diversify into areas beyond their core competencies. A conglomerate can often be an inefficient, jumbled affair. No matter how good the management team, its energies and resources will be split over numerous businesses, which may or may not be synergistic.
For investors, conglomerates can be awfully hard to understand, and it can be a challenge to pigeonhole these companies into one category or investment theme. This means that even managers often have a hard time explaining their investment philosophy to shareholders. Furthermore, a conglomerates accounting can leave a lot to be desired and can obscure the performance of the conglomerates separate divisions. Investors inability to understand a conglomerates philosophy, direction, goals and performance can eventually lead to share underperformance.
While the counter-cyclical argument holds, there is also the risk that management will keep hold of businesses with poor performance, hoping to ride the cycle. Ultimately, lower-valued businesses prevent the value of higher-valued businesses from being fully realized in the share price . (For further reading, see The Ups And Downs Of Investing In Cyclical Stocks.)
Whats more, conglomerates do not always offer investors an advantage in terms of diversification. If investors want to diversity risk, they can do so by themselves, by investing in a few focused companies rather than putting all of their money into a single conglomerate. Investors can do this far more cheaply and efficiently than even the most acquisitive conglomerate can.
The Conglomerate Discount
The case against conglomerates is a strong one. Consequently, the market usually applies a haircut to the piecewise, or sum-of-parts, value - that is, it frequently values conglomerates at a discount to more focused companies. This is known as the conglomerate discount. According to a 2001 article in CFO Magazine, academic studies have suggested in the past that this discount could be as much as 10-12%, but more recent academic inquiries have concluded that the discount is closer to 5%. Of course, there are some conglomerates that command a premium but, in general, the market ascribes a discount.
The conglomerate discount gives investors a good idea of how the market values the conglomerate as compared to the sum value of its various parts. A deep discount signals that shareholders would benefit if the company were dismantled and its divisions left to run as separate stocks.
Lets take a shot at calculating the conglomerate discount using a simple example. Well use a fictional conglomerate called DiversiCo, which consists of two unrelated businesses: a beverage division and a biotechnology division.
DiversiCo has a stock market valuation of $2 billion and total debt of $0.75 billion. Its beverage division has balance sheet assets of $1 billion, while its biotechnology division has $0.75 billion worth of assets. Focused companies in the beverage industry have median market-to-book values of 2.5, while pure play biotech firms have market-to-book values of 2. DiversiCos divisions are fairly typical companies in their industries. From this information, we can calculate the conglomerate discount:
Example - Calculating the Conglomerate Discount
Total Market Value DiversiCo:
= Equity Debt
= $2 billion $0.75 billion
= $2.75 billion
Estimated Value Sum of the Parts:
= Value of Biotech Division Value of Beverage Division
= ($0.75 billion X 2) ($1 billion X 2.5)
= $1.5 billion $2.5 billion
= $4.0 billion
So, the conglomerate discount amounts to:
= ($4.0 billion - $2.75 billion)/$4.0 billion
= 31.25%
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DiversiCos conglomerate discount of 31.25% seems unusually deep. Its share price does not reflect the true value of its separate divisions. It becomes clear that this multibusiness company could be worth significantly more if it were broken up into individual businesses. Consequently, investors may push for divesting or spinning off its beverage and biotech divisions to create more value. If that were to happen, Diversico might be worth closer examination as a buying opportunity.
What to Look For
The big question is whether investing in conglomerates makes sense. The conglomerate discount suggests it does not. But there may be a silver lining. If you invest in conglomerates that break up into individual pieces through divestitures and spinoffs, you could capture an increase in value as the conglomerate discount disappears. As a general rule, you stand to get greater returns when conglomerates break up than when they are built.
That said, some conglomerates do command a valuation premium - or at least a slim conglomerate discount. These are extremely well-run companies. They are managed aggressively, with clear targets set for divisions. Underperforming companies are quickly sold, or divested. More importantly, successful conglomerates have financial rather than strategic or operating objectives, adopting strict approaches to portfolio management .
If you choose to invest in conglomerates, look for ones with financial discipline, rigorous analysis and valuation, a refusal to overpay for acquisitions and a willingness to sell off existing businesses. As with any investment decision , think before you buy and dont assume that big companies always come with big returns.
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The Wall Street Animal Farm: Getting To Know The Lingo
Many people are intimidated by the business news because they dont understand the vernacular. Bull? Bear? Ostrich?!! What does this have to do with money? But theres good news: Wall Street language isnt only for business elites with advanced degrees from Ivy League schools. In fact, you may be surprised to find out that most Wall Street lingo is neither sophisticated nor esoteric. Yes, the truth is that investment bankers and brokers typically use words you probably mastered in kindergarten. Lets take a look at these barnyard words from a financiers perspective - youll be fluent in no time.
A Dog With Fleas
Depending on your movie knowledge, you may remember this classic line in the 1987 movie Wall Street : Its a dog with fleas, kid. That was how Gordon Gekko described a stock tip from a young, ambitious stockbroker named Bud Foxx. A dog is an underperforming stock or asset. Most Wall Street investors think of dog as a four-letter word, but a few are attracted to the dogs of the market. An investment philosophy called the dogs of the Dow theory advocates purchasing the most beaten-down stocks in the Dow Jones Industrial Average (DJIA) each year. According to this theory, by purchasing the stocks with the highest dividend yields in the Dow 30, investors can expect returns in the 13% range over a 15-year period.
Bear
The term bear refers to the given market conditions. Bull and bear are probably the most familiar terms on Main Street. Bear markets are rife with pessimism and negative sentiment. Typically, a bear market is one that has experienced declines of at least 15-20% and lasts more than two months. Probably the most famous bear markets occurred in 1929, which some believe caused the Great Depression. Unfortunately, economic indicators in 2008 have drawn comparisons to the Great Depression of 1929. The severe housing and credit bubbles originating in the first decade of the new millennium in the United States burst abruptly in 2007, and this credit unwinding, or deleveraging had a negative ripple effect on economies and markets worldwide. Venerable institutions, such as Bear Sterns and Lehman Brothers were wiped out by this bear market . Stock markets across the globe also experienced severe downturns. Governments engineered financial rescue packages for many large banks and insurance giants to avoid global financial markets meltdowns.
While there is no clear-cut strategy for investors in terms of surviving a bear market, many financial advisors suggest that bear markets occur as part of the normal economic and business cycle. For longer-term investors, these bear markets could be viewed as buying opportunities. Other advisors may recommend selling stocks and raising cash until a clear direction or bottom of the market begins to appear. (To learn more, read Adapt To A Bear Market.)
Bull
The term bull refers to a very positive stock market environment in which stock prices are increasing and money is flowing into stocks. Investor confidence is high in bull markets. During the 1990s and through early 2000, the U.S. stock market experienced a sustained bull market in stocks. Perhaps the poster child for the technology bull market of the 1990s was Cisco Systems (Nasdaq:CSCO). Cisco was experiencing tremendous growth due to the internet boom, and the stock returned nearly 75,000% from 1990 to 2000. Similarly, America Online (AOL) returned 480% in just six months. Bull markets can be very powerful creators of wealth for the average investor as well as Wall Street gurus. (For related reading about stock returns during bull markets, see The All Equities Portfolio Fallacy.)
Ostrich
An ostrich is an investor who fails to react to critical situations or events that are likely to impact his or her investment. For example, if the Securities and Exchange Commission (SEC) is launching an investigation into a company, an action that could be detrimental to the companys stock price, the ostrich will simply ignore this news. The ostrich effect is one in which investors bury their heads in the sand, hoping for better days ahead. Ostriches appear (or disappear) most frequently during bear markets, when people tend to experience the most financial stress.
Pig
A pig is any investor who puts greed ahead of his or her investment principles or sound strategies. Anyone who watches investment guru Jim Cramer knows one of his most famous expressions: Bulls make money, bears make money and pigs get slaughtered. A pig tends to think that a 100% return over a 12-month period is not good enough. As a result, the pig may then go and borrow money on margin or mortgage his or her home to buy more of a stock at a higher price with the hope of making more money on the investment. The pig can get slaughtered if the stock drops and all the original gains are lost.
Smart investors are disciplined investors. Professional investors know when to take profits as well as when to cut their losses. Their primary concern is the preservation of capital and not necessarily hitting a home run every time they step up to the plate.
Sheep
A sheep is an investor who has no strategy or focus in mind. This type of person simply listens to others for financial advice, and often misses out on the most meaningful moves in the market as a result. For example, sheep investors who had a philosophy of only buying value stocks in the 1990s missed one of the greatest bull markets of our time. In other words, a sheep can be eaten by a bull or bear if he or she isnt in the right place in the market.
Conclusion
Dont assume that you cant learn trader-talk or Wall-Street-speak just because you dont work there. In fact, picking up the lingo may be more of an exercise of your animal knowledge instead of your investment savvy. Learning these terms can help you gain some insight into the world of words on Wall Street. Surprisingly, youll find that they arent different much from the words heard on Main Street - or in kindergarten classrooms across America.
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Is Your Portfolio Overweight?
Over time, the makeup of your portfolio changes as various sectors and stocks perform better or worse than the market. Your original well-planned portfolio allocation evolves to one where the best performing stocks or ETFs become a more heavily-weighted part of your portfolio. Then the stocks that have underperformed make up less of the total allocation of your portfolio. This is a very unappealing - and unhealthy - shape for a portfolio to be in and it signals that its time to make some adjustments.
Get On the Scale
As time passes, it will become necessary for investors to re-examine their portfolios allocation. Being overweight in some sectors may not be the best strategy going forward. Stocks do not increase in value at the same rate. One asset category might appreciate more, causing an imbalance in your original allocation. In a 2000 study by Ibbotson and Kaplan, asset allocation was found to explain 93.6% of the variability of an assets performance. Placing your assets in the right sector leads to overweighting that sector in your portfolio.
Over time, one sector will become the leader and another will lag. For example, during the height of the dotcom boom, technology returned 66.69%, while consumer staples lost 14.49%. In this case, your portfolio would have been overweight in the technology sector. In 2000, as the dotcom boom ended, consumer staples delivered a 26.04% return and technology lost 42.04%. If you adjusted the weight of technology and increased the weight of consumer staples, your portfolio would have thanked you. Adjusting your portfolio to reduce its overweight condition usually leads to success. (Learn more about the dotcom boom and bust in our Market Crashes Tutorial.)
So how can you tell if your portfolio is out of balance? The best place to begin is with your original assessment of the market that led you to form your current portfolio allocation . Some questions to ask are:
• What has changed since your evaluation of the economy, the business cycle and the market? If your assessment has changed, then the weighting of your portfolio needs to change.
• What is the current level of risk in your portfolio and how has it changed since your last assessment? If the risk has increased beyond your comfort level, it is time to adjust your allocation to bring your risk back to levels that are more normal. Often when a sector has risen dramatically, it increases the risk that you might lose much or all of what you have gained. Reducing this overweight condition by selling part of these securities can help to lower the risk in the portfolio.
• Has the splendid performance of one or more stocks caused your portfolio to be less diversified, increasing its dependence on the performance of a few stocks? Diversification is a way to spread the risk across asset classes. As your portfolio over weighs toward one or a few stocks, your first-rate diversification has fallen off. (Find out how to find the right balance of diversification in Introduction To Diversification.)
If answering any of these questions leads you to conclude your portfolio is overweight, it is time to reallocate by selling some of the shares of the securities that have performed well and putting that money to work in stocks or ETFs that have the best potential to outperform in the future.
When to Make an Adjustment
An overweight portfolio requires you to address underperforming stocks or ETFs as well as those that are your best performers. Stocks and ETFs do not grow at the same rate. One asset category might appreciate more causing an imbalance from your original allocation.
When you make an adjustment, recognize that you will be dealing with underperforming stocks or ETFs as well as your best performing stocks or ETFs.
For your underperforming stocks or ETFs, the following are some of the questions you should ask:
• Are there problems with the company missing its earnings or revenue expectations?
• Are there changes in management that raise concern?
• Is the sector likely to continue to perform poorly over the next year?
For your better performing stocks or ETFs, here are some of the questions you should ask:
• Has the stock or ETF performed as expected?
• Has the growth in revenues and earnings slowed or are the prospects for growth still in place?
• How does the stock compare to its peers in terms of growth in revenues, margin, free cash flow and profit?
• Will the sector continue to outperform over the next year or is another sector about to take over? Buying in a bad year can lead to better performance in the next year. Selling after a good year captures profit should the sector have a bad year. It is a good strategy to capture some of your profits by selling your best performing shares.
Most successful long-term investors review their portfolios on a regular basis. While you do not have to make changes every quarter, it is a good idea to reassess your original assumptions and analysis. Moreover, evaluate the risk of a reversal in the course of the market. You goal is to avoid incurring unexpected losses and confirm your current allocation reflects your view of the market.
When to Stay the Course
So far, we have discussed when to make adjustments in your portfolio as the weighting of the stocks or ETFs changes. However, sometimes it is best to stay the course.
During your assessment of your best performing stocks or ETFs, you continue to believe they represent the best opportunities going forward. Often the underlying trend lasts for several years. In this case, should the trend continue, you and your portfolio will continue to benefit from the current overweighting.
Maybe your portfolio is weighted to sectors , funds or stocks that have underperformed. In this case, you might be properly positioned for a rebound. After all, you could have been early. In this case, it makes sense to stay the course or even add to your underperforming segments.
The tax man always has a say on when you can make changes in your portfolio. Capital gains on stocks or funds held for one year or less receive regular income tax treatment, whereas, securities held for more than one year receive more favorable tax treatment. While you should not make a decision to hold or sell a security only for tax reasons, it is one of the factors to consider.
The Bottom Line
A portfolio that is overweight in a sector, fund or stock should cause you to assess whether you should rebalance your portfolio. Simple allocation steps can help you to decide if you should rebalance or stay the course. Being proactive in your assessment will help to keep your portfolio properly aligned with the market, and is a lot better than sitting back and hoping everything will work out.
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Contemplating Collectible Investments
If you have much space for storage, your attic and garage might be stuffed with old furniture, books and other items youve held onto over the years. If this is the case, you may be sitting on a few valuable collectibles just waiting to make you money. That said, you are just as likely to be looking at little more than a pile of junk. In this article well take a look at collectibles as an investment and help you decide whether this emotional market is a good place to park your money.
All Things Old Made New Again
140,000,000 B.C: A young Allosaurus missteps and finds itself mired in a sink hidden beneath the underbrush. Millions of geological ages later, an amateur paleontologist helps him out - or at least what was left of his head. In 2005, the Allosaurus restored skull sells for the high price of $600.
1908: Honus Wagner of the Pittsburgh Pirates hits his tenth home run and ends the year with a .354 batting average, marking one of the best years of his career. The next year, the American Tobacco Company commemorates Wagner by putting a trading card inside its cigarette packages. Less than 60 make it into stores before it is discovered that Honus is vehemently against smoking. In 2000, Wagners cigarette trading card is sold on EBay for $1.1 million.
1962: Stan Lee creates a superhero who has to worry about rent, his ailing aunt and passing his next test - all in addition to saving the world. Peter Parkers misadventure with a radioactive spider hit the stands with a $0.12 cover price. And, in 2006, the first edition of The Amazing Spider-Man is among the most valuable comics with a price around $6,000 or more, according to Wizard: The Guide To Comics pricing guide.
These are all examples of the strange and wonderful world of collectibles. While there is no denying the thrill of owning a juvenile Allosaurus skull, is collecting really a form of investment?
All That Glitters ...
The reason we began by discussing a fossil, a comic and a baseball card is that people have no qualms about calling them collectibles. However, when you speak about diamonds, gold and other precious materials, people tend to call theminvestments . In theory, these materials - and even stocks - could be termed collectibles because their price is based more on what people are willing to pay for them (or market value) than on their actual intrinsic value. But in the practical world, precious metals and stocks have an intrinsic value. For metals, this value is based on rarity and the fact that if you melt it, burn it or bend it, you still have the same atomic substance in the end. For stocks, the value is produced by the underlying brick and mortar company that the share represents - a company that is generating earnings to justify the prices you pay for its stock.
What makes collectibles different is that even a little damage can erase all of a collectibles value. This is because a collectibles value is based on emotional factors like nostalgia. These emotional factors can be as erratic as they are powerful. If you were asked whether people would be willing to pay more for a dinosaur skull or a baseball card, even if you chose one over the other you would give them both a higher value than, say, a torn up baseball card or a box of bone fragments. Those items you would probably call worthless (unless you are an archaeologist or a fan of papier-mâché).
The 20-Year Itch
It is said that nostalgia runs in 20-year cycles. In other words, the things that are popular now will become collectibles in 20 years when people want to reconnect with their past. This doesnt mean that you can buy the top 10 items from consumer polls, incubate them for 20 years and then sell them for a fortune. It means that some items this year will become collectibles if they meet two conditions: rarity and appeal.
Rarity is becoming a harder thing to find as mass production methods allow companies to (over)fill demand without incurring that much extra cost. Beanie Babies have devalued as more and more product lines are introduced. It is profitable for a company to sell as many products as it takes to satiate demand, and that mentality destroys a future collectors profits. (For more on this concept, check out Economics Basics.)
Appeal is also a difficult thing to nail down. To make money at collecting, you have to predict what will become popular in retrospect - perhaps something that is not in high demand now will become popular in the future, either because they are rare or they were not fully appreciated at the time. For example, in the 1950s and 1960s, wing-tipped plastic sun glasses with glass lenses were sold for a few dollars in drugstores, but they can now fetch hundreds of dollars in collectors markets.
Reasons Not To Buy Collectibles
Mark-ups
When you buy a collectible from a dealer, that dealer is usually marking up the price to make a profit. Unlike collectors, dealers do not have the luxury of holding an item for years and years while the value may or may not increase - they have sales to make and a business to run.
Maintenance
Many collectibles require special care to keep them in top condition. These can range in cost from the $1 plastic cover used to keep hockey cards safe to a special room with moisture, heat and light monitors to lengthen a paintings life. On top of the storage costs, there are the added costs of buying insurance for the more valuable types of collectibles as well as paying to have professionals, appraisers, restorers and dealers look at the collectible before you sell it. A collectible doesnt produce income while you hold it, and it may actually eat income while you wait for it to increase in value.
Wear
Most categories of collectibles - from Pokemon cards to antique plumbing fixtures - have a manual classifying how much an item is worth in pristine condition and what sorts of damage degrades it by what percentage of value. For example, a well-read copy of the aforementioned Amazing Spiderman #1 may only be worth 30-60% of the $6,000 list price, depending on what type and what degree of wear it shows.
Counterfeiting
Most museums display dinosaur fossils models - not the real thing. Can you tell the difference between an Allosauras skull made of plaster and cement and one made of fossilized bone? No matter how experienced the appraiser, forgeries do make it to the dealers and then through to the collectors, which could leave you holding a very expensive piece of criminal art.
Low Returns
Collectibles tend to have lower returns than a stock market index fund, a money market account and most bond funds. If you took an average of the returns on all collectibles – which is practically impossible to do given some have little or no market to measure – it would be dismal compared to the S
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Uncovering The Securities Firm
December 31 2011| Filed Under » Brokers, Careers, Investing Basics, Portfolio Management
As individual investors, many of us trust our money to large securities firms or investment dealers. Typically employing tens of thousands of employees, the most recognized firms give investors confidence that their investment funds are managed by a seasoned team of professionals. However, we usually interact with these large businesses only by means of a single intermediary, such as our investment advisor or broker. So how does a large securities house really work? In this article, we will look at a typical securities firm, including its different departments and the roles of various employees. (To learn more about financial planners read Financial Planners: Practice What You Preach.)
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Departments and Divisions
Typically, a large firm has the following departments: sales, underwriting and financing, trading, research and portfolio, and administration. There are many small boutique firms that may serve only a single department of a business (i.e. retail sales), but even in this limited operation, their activities might resemble those of the respective department of a larger firm.
Sales
Sales is likely the department employing the largest number of people in the firm and it is the area that individual retail investors interact with the most. Within the retail sales force, investment advisors may focus on servicing a specific area of the investment industry, or they may provide a one-stop-shop for all retail investment needs. For example, an investment advisor may perform only those services that are associated with a stock broker, or offer other services as well, such as stock and mutual fund transactions, bond trading, life insurance sales and so forth. In a small firm, the activities of the investment advisor are likely to be more diverse.
A second division within the sales department is institutional sales. It is primarily involved in selling new securities issues to traders working at institutional client firms, such as pension funds and mutual funds. If a hot new securities issue generates so much interest that it quickly becomes oversubscribed, the job of institutional sales is as simple as allocating shares to the best clients (as a reward for their ongoing business).
Due to the large dollar volume of transactions and the commissions from both new issues and existing accounts, the institutional sales department often generates a significant portion of the firms profits (making institutional salespeople some of the best-paid personnel in the entire firm). The institutional sales department works closely with the firms trading department (discussed below) to maintain accounts in good standing.
Underwriting / Financing
The firms institutional sales division also works closely with the underwriting or financing department, which coordinates new securities issues and/or follow-up securities issues on the secondary market. The underwriting or finance department negotiates with the companies or governments issuing the securities, establishing their type of security, its price, an interest rate (if applicable) and other special features and protective provisions.
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The firms underwriting or financing department may be split into two divisions: the first relating to matters of corporate finance and the second to those of government finance. In a fully-integrated firm, these departments would be quite distinct, as the needs of corporations and governments vary widely. For example, the corporate finance department would require familiarity with stocks, bonds, and other securities, while the government department might be more geared toward bond and Treasury bill issues.
Trading
The firms trading department also has separate divisions, most likely according to the type of securities being traded: bonds, stocks and various other specialized financial instruments. Traders in the bond division may have sub-specializations, such as government or corporate money market instruments or bonds, or even such instruments as debentures.
The stock-trading department executes orders from retail and institutional sales staff. Stock traders maintain close links with traders on the floor of stock exchanges; although, with the rise of electronic trading, the interaction may be with a trading computer instead of a human being.
The firms trading department may also include a division geared toward various other specialized instruments, perhaps mutual funds or exchange-traded options, or commodity and financial futures contracts.
Research and Portfolio
The research department supports all other departments. Its securities analysts provide vital analysis and data to aid traders, salespeople and underwriters. This data is necessary for the selling and pricing of existing securities trades and new issues. The firms research department may consist of economists, technical analysts, and research analysts who specialize in specific types of securities or specific industries (within the equities specialization).
The research department may be further divided into retail and institutional divisions, although if the firm has only one research department, research reports geared to institutional clients may also be made available to retail investors. If the firm hosts a single institutional research department, it would be geared toward analyzing potential new issues, takeovers, and mergers, in addition to providing ongoing coverage of securities held by institutional clients. Together with the retail department, analysts may be further involved in structuring portfolios for individual and small-business accounts.
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Administration
The administration department is a vital component of the firms organization. It not only maintains proper paperwork and accounting for all trades and transactions, but also ensures compliance with securities legislation and oversees internal human resources matters. All trades made by the firm must be accounted for, and all incoming and outgoing funds and securities must be continually balanced. Securities must be checked for registration, and delivery requirements and dividend payments must be credited to accounts as received.
In the credit and compliance division, client accounts are constantly monitored for industry and firm compliance, ensuring that payments and securities are received by their due dates and that margin accounts fulfill applicable margin requirements. The financial division oversees accounting matters such as payroll, budgeting, and financial reports and statements. Minimum capital levels are maintained according to industry requirements, ensuring that the various departments within the firm hold sufficient funds to accommodate changes in the firms business.
The Bottom Line
Despite their importance to the investment industry and the economy at large, securities firms are still somewhat of a mystery to the average investor. Securities firms tend to maintain a rather secretive culture of inner-circle participants, due largely to the players specialized roles and occupations. Many retail investors interact with only their personal financial advisor or broker, and therefore lack insight into the larger set of roles within the firm. It benefits every investor to know whos who behind that set of magnificent oak doors, as each of the employees in a securities firm affects the real returns of ones investment portfolio.
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4 Signs A Private Company Is Going Public
When a private company makes plans to go public, there is rarely any fanfare or advance notice. Some of the radio silence is due to SEC requirements in relation to official filings of notices and the prospectus, and some is simply due to the fact that a company going public is often big news and puts the corporation under a magnifying glass. It is easier for a company to make preparations in the relative solitude of anonymity. There are, however, several signs, prior to the official notification and filing, that can indicate that a company is about to make the big leap.
SEE: IPO Basics
Corporate Governance Upgrades
Public companies that trade on U.S. stock exchanges are required under the Sarbanes-Oxley Act of 2002 (SOX) to maintain certain standards in the management of the corporation. These standards include having an external board of directors, developing and assessing an effective set of internal controls over the financial management of the company, and creating a formal process where employees and others can have direct access to the audit committee to report on illegal activities, as well as those that violate company policy. A sudden flurry of new policies and procedures could be an indication of a move towards an initial public offering (IPO).
Big Bath Write-Downs
Public companies, and those that are about to go public, have their annual and quarterly financial statements scrutinized by investors and analysts. Private companies considering going public often assess their own financial statements and take any write-offs they are allowed under GAAPall at once, to present better income statements in the future.
For example, accounting rules require that companies write down inventory that is unsalable or worth less than its original cost. However, there is substantial leeway in making that determination. Companies often keep inventory on their balance sheets as long as possible to ensure that they are meeting asset ratios for banks and other lenders . Once a company contemplates going public, it often makes sense to write off the inventory sooner rather than later, when it would impact shareholder profitability.
Sudden Changes in Senior Management
Once a company contemplates going public, it has to think about how qualified its current management is and whether it is need of some spring cleaning. To attract investors , a public company needs to have officers and managers who are experienced and have a track record of leading companies to profitability. If there is a full scale overhaul in the upper echelons of a company, it may be a signal that it is trying to improve its image in advance of going public.
Selling-Off Non-Core Business Segments
A company that springs up from scratch can often have some business units attached to it that are ancillary to its core, or main, business purpose. An example of this is an office supplies company that has a payroll processing business; the secondary business does not connect directly to the main business. In order to market a company in an initial public offering, the prospectus is expected to show a clear business direction. If a company is shedding its non-core operations, it may be a sign that it is getting lean and mean in preparation for a public share offering.
The Bottom Line
Because of the ability of a private company to keep quiet on its intentions to go public until the formal SEC-required filings and announcements, it can be difficult to assess whether a company is heading in that direction. However, there are always more subtle signals for those seeking them out.
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Understanding Stock Splits
Say you had a $100 bill and someone offered you two $50 bills for it. Would you take the offer? This might sound like a pointless question, but the action of a stock split puts you in a similar position. In this article we will explore what a stock split is, why its done and what it means to the investor.
What Is a Stock Split?
A stock split is a corporate action that increases the number of the corporations outstanding shares by dividing each share, which in turn diminishes its price. The stocks market capitalization, however, remains the same, just like the value of the $100 bill does not change if it is exchanged for two $50s. For example, with a 2-for-1 stock split, each stockholder receives an additional share for each share held, but the value of each share is reduced by half: two shares now equal the original value of one share before the split.
Lets say stock A is trading at $40 and has 10 million shares issued, which gives it a market capitalization of $400 million ($40 x 10 million shares). The company then decides to implement a 2-for-1 stock split. For each share shareholders currently own, they receive one share, deposited directly into their brokerage account . They now have two shares for each one previously held, but the price of the stock is split by 50%, from $40 to $20. Notice that the market capitalization stays the same - it has doubled the amount of stocks outstanding to 20 million while simultaneously reducing the stock price by 50% to $20 for a capitalization of $400 million. The true value of the company hasnt changed one bit.
The most common stock splits are, 2-for-1, 3-for-2 and 3-for-1. An easy way to determine the new stock price is to divide the previous stock price by the split ratio. In the case of our example, divide $40 by 2 and we get the new trading price of $20. If a stock were to split 3-for-2, wed do the same thing: 40/(3/2) = 40/1.5 = $26.6.
It is also possible to have a reverse stock split: a 1-for-10 means that for every ten shares you own, you get one share. Below we illustrate exactly what happens with the most popular splits in regards to number of shares, share price and market cap of the company splitting its shares.
Whats the Point of a Stock Split?
So, if the value of the stock doesnt change, what motivates a company to split its stock? Good question. There are several reasons companies consider carrying out this corporate action.
The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more attractive level. The effect here is purely psychological. The actual value of the stock doesnt change one bit, but the lower stock price may affect the way the stock is perceived and therefore entice new investors. Splitting the stock also gives existing shareholders the feeling that they suddenly have more shares than they did before, and of course, if the prices rises, they have more stock to trade.
Another reason, and arguably a more logical one, for splitting a stock is to increase a stocks liquidity, which increases with the stocks number of outstanding shares. You see, when stocks get into the hundreds of dollars per share, very large bid/ask spreads can result (see Why the Bid/Ask Spread Is So Important.). A perfect example is Warren Buffetts Berkshire Hathaway, which has never had a stock split. At times, Berkshire stock has traded at nearly $100,000 and its bid/ask spread can often be over $1,000. By splitting shares a lower bid/ask spread is often achieved, thereby increasing liquidity.
None of these reasons or potential effects that weve mentioned agree with financial theory, however. If you ask a finance professor, he or she will likely tell you that splits are totally irrelevant - yet companies still do it. Splits are a good demonstration of how the actions of companies and the behaviors of investors do not always fall into line with financial theory. This very fact has opened up a wide and relatively new area of financial study called behavioral finance (see Taking A Chance On Behavorial Finance.).
Advantages for Investors
There are plenty of arguments over whether a stock split is an advantage or disadvantage to investors. One side says a stock split is a good buying indicator, signaling that the companys share price is increasing and therefore doing very well. This may be true, but on the other hand, you cant get around the fact that a stock split has no affect on the fundamental value of the stock and therefore poses no real advantage to investors. Despite this fact the investment newsletter business has taken note of the often positive sentiment surrounding a stock split. There are entire publications devoted to tracking stocks that split and attempting to profit from the bullish nature of the splits. Critics would say that this strategy is by no means a time-tested one and questionably successful at best.
Factoring in Commissions
Historically, buying before the split was a good strategy because of commissions that were weighted by the number of shares you bought. It was advantageous only because it saved you money on commissions. This isnt such an advantage today because most brokers offer a flat fee for commissions, so you pay the same amount whether you buy 10 shares or 1,000 shares. Some online brokers have a limit of 2,000 or 5,000 shares for that flat rate, but most investors dont buy that many shares at once. The flat rate therefore covers most trades, so it does not matter if you buy pre-split or post-split.
Conclusion
The most important thing to know about stock splits is that there is no effect on the worth (as measured by market capitalization) of the company. A stock split should not be the deciding factor that entices you into buying a stock. While there are some psychological reasons why companies will split their stock, the split doesnt change any of the business fundamentals. In the end, whether you have two $50 bills or one $100 bill, you have the same amount in the bank.
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The Two Sides Of Dual-Class Shares
It sounds too good to be true: own a small portion of a companys total stock, but get most of the voting power. Thats the truth behind dual-class shares. They allow shareholders of non-traded stock to control terms of the company in excess of the financial stake. While many investors would like to eliminate dual-class shares, there are several hundred companies in the United States with dual A and B listed shares, or even multiple class listed shares. So, the question is, whats the impact of dual-class ownership on a companys fundamentals and performance? (To learn more, see The ABCs Of Mutual Fund Classes.)
What Are Dual-Class Shares?
When the Internet company Google went public, a lot of investors were upset that it issued a second class of shares to ensure that the firms founders and top executives maintained control. Each of the Class B shares reserved for Google insiders would carry 10 votes, while ordinary Class A shares sold to the public would get just one vote. (To learn more, see When Insiders Buy, Should Investors Join Them?)
Designed to give specific shareholders voting control, unequal voting shares are primarily created to satisfy owners who dont want to give up control, but do want the public equity market to provide financing. In most cases, these super-voting shares are not publicly traded and company founders and their families are most commonly the controlling groups in dual-class companies.
Who Lists Them?
The New York Stock Exchange allows U.S. companies to list dual-class voting shares. Once shares are listed, however, companies cannot reduce the voting rights of the existing shares or issue a new class of superior voting shares. (For more information, see The NYSE And Nasdaq: How They Work.)
Many companies list dual-class shares. Fords dual-class stock structure, for instance, allows the Ford family to control 40% of shareholder voting power with only about 4% of the total equity in the company. Berkshire Hathaway Inc., which has Warren Buffett as a majority shareholder, offers a B share with 1/30th the interest of its A-class shares, but 1/200th of the voting power. Echostar Communications demonstrates the extreme power that can be had through dual-class shares: founder and CEO Charlie Ergen has about 5% of the companys stock, but his super-voting class-A shares give him a whopping 90% of the vote.
Good or Bad?
Its easy to dislike companies with dual-class share structures, but the idea behind it has its defenders. They say that the practice insulates managers from Wall Streets short-term mindset. Founders often have a longer term vision than investors focused on the most recent quarterly figures. Since stock that provides extra voting rights often cannot be traded, it ensures the company will have a set of loyal investors during rough patches. In these cases, company performance may benefit from the existence of dual-class shares.
With that said, there are plenty of reasons to dislike these shares. They can be seen as downright unfair. They create an inferior class of shareholders and hand over power to a select few, who are then allowed to pass the financial risk onto others. With few constraints placed upon them, managers holding super-class stock can spin out of control. Families and senior managers can entrench themselves into the operations of the company, regardless of their abilities and performance. Finally, dual-class structures may allow management to make bad decisions with few consequences.
Hollinger International presents a good example of the negative effects of dual-class shares. Former CEO Conrad Black controlled all of the companys class-B shares, which gave him 30% of the equity and 73% of the voting power. He ran the company as if he were the sole owner, exacting huge management fees, consulting payments and personal dividends. Hollingers board of directors was filled with Blacks friends who were unlikely to forcefully oppose his authority. Holders of publicly traded shares of Hollinger had almost no power to make any decisions in terms of executive compensation, mergers and acquisitions, board construction poison pills or anything else for that matter. Hollingers financial and share performance suffered under Blacks control. (To learn more, see Mergers And Acquisitions: Understanding Takeovers.)
Academic research offers strong evidence that dual-class share structures hinder corporate performance. A Wharton School and Harvard Business School study shows that while large ownership stakes in managers hands tend to improve corporate performance, heavy voting control by insiders weakens it. Shareholders with super-voting rights are reluctant to raise cash by selling additional shares--that could dilute these shareholders influence. The study also shows that dual-class companies tend to be burdened with more debt than single-class companies. Even worse, dual-class stocks tend to under-perform the stock market.
The Bottom Line
Not every dual-class company is destined to perform poorly--Berkshire Hathaway, for one, has consistently delivered great fundamentals and shareholder value. Controlling shareholders normally have an interest in maintaining a good reputation with investors. Insofar as family members wield voting power, they have an emotional incentive to vote in a manner that enhances performance. All the same, investors should keep in mind the effects of dual-class ownership on company fundamentals.
How To Outperform The Market
All investors must reevaluate and refine their investing styles and strategies from time to time. As we gain investing experience and knowledge, our view of the market is likely to change and most likely broaden how we envision the extent of our investing capacity. Those who want to try to outperform the market - that is, realize returns greater than the market average - might consider an active trading strategy, even if only for a portion of their portfolio. Here we explain what active trading is, how active traders view the market, their tools and investment vehicles and finally, the risks associated with their style.
What Is Active Trading?
The best way to understand active trading is to differentiate it from buy-and-hold investing, which is based on the belief that a good investment will be profitable in the long term. This means ignoring day-to-day market fluctuations. Using a buy and hold strategy, this kind of investor is indifferent to the short-term for two reasons: first, because he or she believes any momentary effects of short-term movements really are minor compared to the long-term average, and second, because short-term movements are nearly impossible to exactly predict.
An active trader, on the other hand, isnt keen on exposing his or her investments to the effect of short-term losses or missing the opportunity of short-term gains. Its not surprising then, that active traders see an average long-term return not as an insurmountable standard but as a run-of-the-mill expectation. To exceed the standard, or outperform the market, the trader realizes that he or she must look for the profit potential in the markets temporary trends, which means trying to perceive a trend as it begins and predict where it will go in the near future.
Below is a chart that demonstrates the difference between the long and short-term movements of the market. Note that even though the security moves upward over time, it experiences many smaller trends in both directions along the way.
Performance and the Short Term
Traders are active because for them the importance of the markets short-term activity is magnified - these market movements offer opportunity for accelerated capital gains. A traders style determines the time frame within which he or she looks for trends. Some look for trends within a span of a few months, some within a few weeks, and some within a few hours. Because a shorter period will see more definitive market movements, a trader analyzing a shorter time frame will be more active, executing more trades.
A greater number of trades doesnt necessarily equal greater profits. Outperforming the market doesnt mean maximizing your activity, but maximizing your opportunities with a strategy. An active trader will strive to buy and sell (or vice versa in the case of shorting) at the two extremes of a trend within a given time frame. When buying a stock, a trader may try to buy it at the lowest point possible (or an upwards turning point, otherwise known as a bottom) and then sell it when there are signs that it has hit a high point. These signs are generally discerned by means of technical analysis tools, which we discuss below. The more the trader strives to buy and sell at the extremes, the more aggressive - and risky - is his or her strategy.
Maximizing returns or outperforming the market isnt just about reaping profits, its also about avoiding losses. In other words, the trader will keep an eye out for any signs that the security is about to take a surprising turn in an undesirable direction. When these signs occur, the trader knows that it is time to exit the investment and seek profits elsewhere. A long-term trader, on the other hand, stays invested in the security if he or she has confidence in its value, even though it may be experiencing a downward shift - the buy and hold investor must tolerate some losses that the trader believes are possible to avoid.
Technical Analysis
You need particular analytical techniques and tools to discern when a trend starts and when it will come to an end. Technical analysis specializes in interpreting price trends, identifying the best time to buy and sell a security with the use of charts. Unlike fundamental analysis, technical analysis sees price as an all-important factor that tells the direction a security will take in the short term. Here are three principles of technical analysis:
• For the most part, the current price of a stock already reflects the forces influencing it - such as political, economic and social changes - as well as peoples perception of these events.
• Prices tend to move in trends.
• History repeats itself.
From these three principles emerges a complicated discipline that designs special indicators to help the trader determine what will happen in the future. Indicators are ways in which price data is processed (usually by means of a calculation) in order to clarify price patterns, which become apparent when the results of the indicators calculation are plotted on a chart. Displayed together with plotted historical prices, these indicators can help the trader discern trend lines and analyze them, reading signals emitted by the indicator in order to choose entry into or exit from the trade. Some examples of the many different types of indicators are moving averages, relative strength and oscillators.
Fundamental analysis can be used to trade, but most traders are well trained and experienced in the techniques of charting and technical analysis. It is a blend of science and art that requires patience and dedication. Because timing is of the utmost importance in active trading, efficiency in technical analysis is a great determiner of success.
Leverage
The short term approach of investing offers opportunities to realize capital gains not only by means of trend analysis, but also through short-term investing devices that amplify potential gains given the amount invested. One of these techniques is leveraging, which is often implemented by something called margin.
Margin is simply the use of borrowed money to make a trade. Say you had $5,000 to invest: you could, instead of simply investing this amount, open a margin account and receive an additional, say, $5,000 to invest. This would give you a total of $10,000 with which to make a trade. So, if you invested in a stock that returned 25%, your $10,000 investment turns into $12,500. Now, when you pay back the original $5,000, youd be left with $7,500 (well assume interest charges are zero), giving you a $2,500 profit or a return of 50%. Had you invested only $5,000, your profit wouldve been only $1,250. In other words, margin doubled your return.
However, as the upside potential is exacerbated, so is the downside risk. If the above investment instead experienced a 25% decline, you would have suffered a loss of 50%, and if the investment experienced a 50% decline, you wouldve lost 100%. You may have already guessed that, with leverage, a trader can lose more than his or her initial investment! As such it is a trading tool that should be used only by experienced traders who are skilled at the art of timing entry into and exit from investments. Also, since margin is borrowed money, the less time you take to pay it back, the less interest you pay on it. If you take a long time to try to reap profits from a trade, the cost of margin can eat into your overall return.
The Risks
Active trading offers the enticing potential of above-average returns, but like almost anything else thats enticing, it cannot be achieved successfully without costs and risks.
The shorter time frame to which traders devote themselves offers a vast potential but, because the market can move fast, the trader must know how to read it and then react. Without skill in discerning signals and timing entries and exits, the trader may not only miss opportunities but also suffer the blow of rapid losses - especially if, as we explained above, the trader is riding on high leverage. Thus, learning to trade is both time consuming and expensive. Any person thinking of becoming an active trader should take this into account.
Also the higher frequency of transactions of active trading doesnt come for free: brokerage commissions are placed on every trade and, since these commissions are an expense, they eat into the traders return. Because every trade costs money, a trader must be confident in his or her decision: to achieve profits, the return of a trade must be well above the commission. If a trader is not sure of what he or she is doing and ends up trading more frequently because of blunders, the brokerage costs will add up on top of any losses.
Finally, because securities are being entered and exited so often, the active trader will have to pay taxes on any capital gains realized every year. This could differ from a more passive investor who holds investments for numerous years and does not pay capital gains tax on a yearly basis. Capital gains tax expense must also be factored in when an active trader is calculating overall return.
Conclusion
As you gain more education and experience as an investor, you may become curious about the different ways to reach returns. It is important to be willing to learn about different strategies and approaches, but it is equally important to know what suits your personality, skills and risk tolerance. You may have guessed that active trading is best suited to those who are committed to taking control over their portfolio and pursuing their goals quickly and aggressively. All of this requires a willingness to not only take risks, but also keep up skills and efficiency. If this sounds like you, it may be time to start learning more!
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Bailout Acronyms 101
The government has been launching stimulus programs, financial entities and other programs designed to lead us out of recession nearly as fast as lawmakers and bureaucrats can come up with acronyms. As soon as the media begins to tout a new one, theres another on its heels. (For a comprehensive review of the current crisis, refer to The 2007-2008 Financial Crisis In Review.)
From TAF to PPPIP
It all began in December of 2007, when the United States Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank (ECB) and the Swiss National Bank took coordinated action to address the developing credit crisis. More than two years later, the bailout efforts continue. The primary flavors of the alphabet soup in the United States include:
• TAF
The Term Auction Facility was launched on December 12, 2007. It permitted banks to use securities as collateral to take short-term loans from the federal government for periods of either 28 or 84 days. In the Feds words, TAF is a credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction. The first auction took place on December 17.
• TSLF
The Term Securities Lending Facility was launched on March 11, 2008. Like TAF, which made credit available to depository institutions, TSFL made $200 billion in credit available to other financial institutions (brokerage firms and other entities such as Fannie Mae, Freddie Mac, Citigroup, Countrywide Financial) for 28-day periods as opposed to the traditional overnight loans. These entities use securities as collateral to borrow money. Weekly auctions began on March 27, 2008.
• PDCF
On March 17, 2008, the Federal Reserve announced the creation of the Primary Dealer Credit Facility. Unlike TAF and TSLF, which were designed to address long-term funding needs, PDCF provides daily access to cash to the same entities that borrow from TAF and TSLF. The institutions pay an interest rate equal to the Feds primary credit rate for short-term (overnight) loans. (Learn more in Top 6 U.S. Government Financial Bailouts.)
• AMLF
In September, 2008, the Federal Reserve Board announced the creation of the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, which loans money to banks and bank holding companies to help them meet redemptions in money market funds. They do this by lending funds to borrowers to purchase eligible ABCPs from the money market fund. Because the market for commercial paper dried up, the government feared that investors would be unable to redeem their assets from money-market funds. This could have been a major financial meltdown, as money-market funds have been touted as cash-like, safe investments.
• TARP
While previous programs were designed to thaw the frozen credit markets, the serious attempts at economic salvation really started with the Troubled Assets Relief Program. TARP, also known as the bailout, entered the world on October 3, 2008. It was $700 billion program conceived in response to financial institutions struggling under the weight of sub-prime loan defaults. The greed-driven lenders gave money to foolish borrowers that were obviously unable to repay it, so the government agreed to use tax-payer money to take the bad loans off of the lenders books in order to thaw the credit markets.
• TALF
TALF came next. In March of 2009, the Term Asset-Backed Securities Lending Facility, or bailout number two, tossed $200 billion more into the bailout pool by printing new money. The government launched TALF after the asset-backed securities (ABS) market froze over in October, causing consumers and small business owners to be unable to access credit.
TALF was supposed to help market participants meet the credit needs of households and small businesses by supporting the issuance of ABS collateralized by student loans, auto loans, credit card loans , and loans guaranteed by the Small Business Administration (SBA). This effort also wasnt enough.
• FSP
Bailout number three, the Financial Stabilization Plan, grew TALF to a trillion dollars. It also permits commercial-mortgage backed securities (CMBS) to be used as collateral.
• CPFF
The Commercial Paper Funding Facility came along in October of 2008, as commercial paper fell victim to illiquid credit markets. It was designed to provide a market for commercial paper by purchasing commercial paper from eligible issuers. The facility would use a special purpose vehicle (SPV) to buy and hold these commercial paper to maturity and use the proceeds at maturity to repay the funds they borrowed from the Fed.
• PPIP
The Public-Private Investment Program , rolled out in March 2009, was created to buy bad assets in order to get them off of banks books. It was funded with a combination of TARP money and money from private investors. The programs main purpose was to provide price discovery in the market for toxic assets and to remove these assets from the balance sheets of financial institutions.
When Will the Madness End?
The long, complicated saga can be summarized as the result of a consumption-crazed society willing to borrow more than it can afford to repay from lenders that were all too willing to dole out the cash in the name of ever-increasing profits. After the loans were made, they were packed into structured products and sold to investors who didnt understand what they were buying and didnt want to as long as the investments generated hefty returns. When the borrowers failed to repay the loans, the fancy investments fell apart, leaving the taxpayers to fund the cleanup.
The increasingly complex array of structured products form an alphabet soup of their own:
• mortgage-backed securities (MBS)
• collateralized mortgage-backed obligations (CMBO)
• collateralized debt obligation (CDO)
• collateralized bond obligation (CBO)
• collateralized loan obligation (CLO)
Lessons Learned
While the alphabet soup of investments and programs designed to clean up after them is a deep and messy brew, the lessons from the debacle are far clearer and apply to lenders, borrowers, businesses and individuals alike, include those that created the mess and those that got caught up in it. First, dont lend or borrow more that you can afford to repay, and second, dont buy or sell anything that you dont understand.
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Dissecting Declarations, Ex-Dividends And Record Dates
Have the workings of dividends and dividend distributions mystified you too? Chances are its not the concept of dividends that confuses you; the ex-dividend date and date of record are the tricky factors. In this article well sort through the dividend payment process and explain on what date the buyer of the stock gets to keep the dividend.
Before we explain how it all works, lets go over some of the basics to ensure we have the proper foundation to understand the more complex issues. Some investment terms are thrown around more often than Frisbees on a hot summer day, so its important that we define exactly what were talking about.
Different Types of Dividends
The decision to distribute a dividend is made by a companys board of directors. There is nothing requiring a company to pay a dividend, even if the company has paid dividends in the past. However, many investors view a steady dividend history as an important indicator of a good investment, so most companies are reluctant to reduce or stop their dividend payments. (For more information on buying dividend paying stocks , see the articles How Dividends Work for Investors and The Importance of Dividends.
Dividends can be paid in various different forms, but there are two major categories: cash and stock. The most popular are cash dividends. This is money paid to stockholders , normally out of the corporations current earnings or accumulated profits.
For example, suppose you own 100 shares of Corys Brewing Company (ticker: CBC). Cory has made record sales this year thanks to an unusually high demand for his unique peach flavored beer. The company therefore decides to share some of this good fortune with the stockholders and declares a dividend of $0.10 per share. This means that you will receive a check from Corys Brewing Company for $10.00 ($0.10*100). In practice, companies that pay dividends usually do so on a regular basis of four times a year. A one-time dividend such as the one we just described is referred to as an extra dividend.
The stock dividend, the second most common dividend paying method, pays additional shares rather than cash. Suppose that Corys Brewing Company wishes to issue a dividend but doesnt have the necessary cash available to pay everyone. He does, however, have enough Treasury stock to meet the requirements of the dividend payout. So instead of paying cash, Cory decides to issue a dividend of 0.05 new shares of CBC for every existing one. This means that you will receive five shares of CBC for every 100 shares that you own. If any fractional shares are left over, the dividend is paid as cash (because stocks cant trade fractionally).
Another type of dividend is the property dividend, but it is used rarely. This type of allocation is a physical transfer of a tangible asset from the company to the investors. For instance, if Corys Brewing Company was still insistent on paying out dividends but didnt have enough Treasury stock or enough money to pay out all investors, the company could look for something physical (property) to distribute. In this case, Cory might decide that his unique peach beer would be the best substitute, so he could distribute a couple of six-packs to all the shareholders.
The Important Dates of a Dividend
There are four major dates in the process of a company paying dividends:
• Declaration date - This is the date on which the board of directors announces to shareholders and the market as a whole that the company will pay a dividend.
• Ex-date or Ex-dividend date - On (or after) this date the security trades without its dividend. If you buy a dividend paying stock one day before the ex-dividend you will still get the dividend, but if you buy on the ex-dividend date, you wont get the dividend. Conversely, if you want to sell a stock and still receive a dividend that has been declared you need to sell on (or after) the ex-dividend day. The ex-date is the second business day before the date of record.
• Date of record - This is the date on which the company looks at its records to see who the shareholders of the company are. An investor must be listed as a holder of record to ensure the right of a dividend payout.
• Date of payment (payable date) - This is the date the company mails out the dividend to the holder of record. This date is generally a week or more after the date of record so that the company has sufficient time to ensure that it accurately pays all those who are entitled.
Why All These Dates?
Ex-dividend dates are used to make sure dividend checks go to the right people. In todays market, settlement of stocks is a T 3 process, which means that when you buy a stock , it takes three days from the transaction date (T) for the change to be entered into the companys record books.
As mentioned, if you are not in the companys record books on the date of record, you wont receive the dividend payment. To ensure that you are in the record books, you need to buy the stock at least three business days before the date of record, which also happens to be the day before the ex-dividend date.
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As you can see by the diagram above, if you buy on the ex-dividend date (Tuesday), which is only two business days before the date of record, you will not receive the dividend because your name will not appear in the companys record books until Friday. If you want to buy the stock and receive the dividend, you need to buy it on Monday. (When the stock is trading with the dividend the term cum dividend is used). But, if you want to sell the stock and still receive the dividend, you need to sell on or after Tuesday the 6th.
*Note: Different rules apply if the dividend is 25% or greater of the value of the security. In this case, the Financial Industry Regulatory Authority (FINRA) indicates that the ex-date is the first business day following the payable date. For further details on dividend issues, search FINRAs website.
A Money Machine?
Now that we understand that a dividend can be received by purchasing the stock before the ex-date, can we make more money? Nope, its not that easy. Remember, everybody knows when the dividend is going to be paid, and the market sees the dividend payout as a time when the company is giving out a part of its profits (reducing its cash). So the price of the stock will drop approximately by the amount of the dividend on the ex-dividend date. The word approximately is crucial here. Due to tax considerations and other happenings in the market, the actual drop in price may be slightly different. In any case, the point is that you cant make free profits on the ex-dividend date.
Conclusion
The reasons for and effects of all these dates are by no means easy to grasp. Its important to clear up any confusion between ex-dividend and record dates. But always keep in mind that when youre investing in a dividend paying stock, its more crucial to consider the quality of the company than the date on which you buy in.
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Breaking Down The Balance Sheet
A companys financial statements - balance sheet, income and cash flow statements - are a key source of data for analyzing the investment value of its stock. Stock investors, both the do-it-yourselfers and those who follow the guidance of an investment professional, dont need to be analytical experts to perform a financial statement analysis. Today, there are numerous sources of independent stock research, online and in print, which can do the number crunching for you. However, if youre going to become a serious stock investor, a basic understanding of the fundamentals of financial statement usage is a must. In this article, we help you to become more familiar with the overall structure of the balance sheet.
The Structure of a Balance Sheet
A companys balance sheet is comprised of assets, liabilities and equity. Assets represent things of value that a company owns and has in its possession, or something that will be received and can be measured objectively. Liabilities are what a company owes to others - creditors, suppliers, tax authorities, employees, etc. They are obligations that must be paid under certain conditions and time frames. A companys equity represents retained earnings and funds contributed by its shareholders, who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.
The relationship of these items is expressed in the fundamental balance sheet equation:
Assets = Liabilities Equity
The meaning of this equation is important. Generally, sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables and fixed assets (plant, property and equipment). As a companys assets grow, its liabilities and/or equity also tends to grow in order for its financial position to stay in balance.
How assets are supported, or financed, by a corresponding growth in payables, debt liabilities and equity reveals a lot about a companys financial health. For now, suffice it to say that depending on a companys line of business and industry characteristics, possessing a reasonable mix of liabilities and equity is a sign of a financially healthy company. While it may be an overly simplistic view of the fundamental accounting equation, investors should view a much bigger equity value compared to liabilities as a measure of positive investment quality, because possessing high levels of debt can increase the likelihood that a business will face financial troubles.
Balance Sheet Formats
Standard accounting conventions present the balance sheet in one of two formats: the account form (horizontal presentation) and the report form (vertical presentation). Most companies favor the vertical report form, which doesnt conform to the typical explanation in investment literature of the balance sheet as having two sides that balance out. (For more information on how to decipher balance sheets, see Reading The Balance Sheet.)
Whether the format is up-down or side-by-side, all balance sheets conform to a presentation that positions the various account entries into five sections:
Assets = Liabilities Equity
• Current assets (short-term): items that are convertible into cash within one year
• Non-current assets (long-term): items of a more permanent nature
As total assets these =
• Current liabilities (short-term): obligations due within one year
• Non-current liabilities (long-term): obligations due beyond one year
These total liabilities
• Shareholders equity (permanent): shareholders investment and retained earnings
Account Presentation
In the asset sections mentioned above, the accounts are listed in the descending order of their liquidity (how quickly and easily they can be converted to cash). Similarly, liabilities are listed in the order of their priority for payment. In financial reporting, the termscurrentand non-current are synonymous with the terms short-term and long-term, respectively, and are used interchangeably. (For related reading, see The Working Capital Position.)
It should not be surprising that the diversity of activities included among publicly-traded companies is reflected in balance sheet account presentations. The balance sheets of utilities, banks, insurance companies, brokerage and investment banking firms and other specialized businesses are significantly different in account presentation from those generally discussed in investment literature. In these instances, the investor will have to make allowances and/or defer to the experts.
Lastly, there is little standardization of account nomenclature. For example, even the balance sheet has such alternative names as a statement of financial position and statement of condition. Balance sheet accounts suffer from this same phenomenon. Fortunately, investors have easy access to extensive dictionaries of financial terminology to clarify an unfamiliar account entry.
The Importance of Dates
A balance sheet represents a companys financial position for one day at its fiscal year end, for example, the last day of its accounting period, which can differ from our more familiar calendar year. Companies typically select an ending period that corresponds to a time when their business activities have reached the lowest point in their annual cycle, which is referred to as their natural business year.
In contrast, the income and cash flow statements reflect a companys operations for its whole fiscal year - 365 days. Given this difference in time, when using data from the balance sheet (akin to a photographic snapshot) and the income/cash flow statements (akin to a movie) it is more accurate, and is the practice of analysts, to use an average number for the balance sheet amount. This practice is referred to as averaging, and involves taking the year-end (2004 and 2005) figures - lets say for total assets - and adding them together, and dividing the total by two. This exercise gives us a rough but useful approximation of a balance sheet amount for the whole year 2005, which is what the income statement number, lets say net income, represents. In our example, the number for total assets at year-end 2005 would overstate the amount and distort the return on assets ratio (net income/total assets). The Bottom Line
Since a companys financial statements are the basis of analyzing the investment value of a stock, this discussion we have completed should provide investors with the big picture for developing an understanding of balance sheet basics.
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Getting Into The Gold Market
From ancient civilizations through the modern era, gold has been the worlds currency of choice. Today, investors buy gold mainly as a hedge against political unrest and inflation. In addition, many top investment advisors recommend a portfolio allocation in commodities, including gold, in order to lower overall portfolio risk.
Well cover many of the opportunities for investing in gold, including bullion (i.e. gold bars), mutual funds, futures, mining companies and jewelry. With few exceptions, only bullion, futures and a handful of specialty funds provide a direct investment opportunity in gold. Other investments gain part of their value from other sources. (For background reading, see Does It Still Pay To Invest In Gold?)
Gold Bullion
This is perhaps the best-known form of direct gold ownership. Many people think of gold bullion as the large gold bars held at Fort Knox. Actually, gold bullion is any form of pure, or nearly pure, gold that has been certified for its weight and purity. This includes coins, bars, etc., of any size. A serial number is commonly attached to gold bars as well, for security purposes.
While heavy gold bars are an impressive sight, their large size (up to 400 troy ounces) makes them illiquid, and therefore costly to buy and sell. After all, if you own one large gold bar worth $100,000 as your entire holding in gold and then decide to sell 10%, you cant exactly saw off the end of the bar and sell it. On the other hand, bullion held in smaller-sized bars and coins have much more liquidity, and is a very common method of holding bullion.
Gold Coins
For decades, large quantities of gold coins have been issued by sovereign governments around the world. For investors, coins are commonly bought from private dealers at a premium of about 1-5% above their underlying gold value.
The advantages of bullion coins are:
• Their prices are conveniently available in global financial publications.
• Gold coins are often minted in smaller sizes (one ounce or less), making them a more convenient way to invest in gold than the larger bars.
• Reputable dealers can be found with minimal searching and are located in many large cities.
Caution: Older, rare gold coins have what is known as numismatic or collectors value above and beyond the underlying value of the gold. To invest strictly in gold, focus on widely circulated coins and leave the rare coins to collectors.
Some of the widely circulated gold coins include the South African krugerrand, the U.S. eagle and the Canadian maple leaf.
The main problems with gold bullion are that the storage and insurance costs, and the relatively large markup from the dealer both hinder profit potential. Also, investing in gold bullion is a direct investment in golds value, and each dollar change in the price of gold will proportionally change the value of ones holdings. Other gold investments, such as mutual funds, may be made in smaller dollar amounts than bullion, and also may not have as much direct price exposure as bullion does.
Gold ETFs and Mutual Funds
One alternative to a direct investment in gold bullion is to invest in one of the gold-based exchange-traded funds (ETFs). Each share of these specialized instruments represents a fixed amount of gold, such as one-tenth of an ounce. These funds may be purchased or sold in any brokerageor IRA account just like stocks. This method is therefore easier and more cost effective than owning bars or coins directly, especially for small investors, as the minimum investment is only the price of a single share of the ETF. The annual expense ratios of these funds are often less than 0.5%, much less than the fees and expenses on many other investments, including most mutual funds.
Many mutual funds own gold bullion and gold companies as part of their normal portfolios, but investors should be aware that only a few mutual funds focus solely on gold investing; most own a number of other commodities. The major advantages of the gold-only oriented mutual funds are:
• Low cost and low minimum investment required
• Diversification among different companies
• Ease of ownership in a brokerage account or an IRA
• Require no individual company research
Some funds invest in the indexes of mining companies, others are tied directly to gold prices, while still others are actively managed. Read their prospectuses for more information. Traditional mutual funds tend to be actively managed, while ETFs adhere to a passive index-tracking strategy, and therefore have lower expense ratios. For the average gold investor, however, mutual funds and ETFs are now generally the easiest and safest way to invest in gold.
Gold Futures and Options
Futures are contracts to buy or sell a given amount of an item, in this case gold, on a particular date in the future. Futures are traded in contracts, not shares, and represent a predetermined amount of gold. As this amount can be large (for example, 100 troy ounces x $1,000/ounce = $100,000), futures are more suitable for experienced investors. People often use futures because the commissions are very low, and the margin requirements are much lower than in traditional equity investments. Some contracts settle in dollars while others settle in gold, so investors must pay attention to the contract specifications to avoid having to take delivery of 100 ounces of gold on the settlement date. (For more on this, read Trading Gold And Silver Futures Contracts.)
Options on futures are an alternative to buying a futures contract outright. These give the owner of the option the right to buy the futures contract within a certain time frame at a preset price. One benefit of an option is it both leverages your original investment and limits losses to the price paid. A futures contract bought on margin can require more capital than originally invested if losses mount quickly. Unlike with a futures investment, which is based on the current value of gold, the downside to options is that the investor must pay a premium to the underlying value of the gold to own the option. Because of the volatile nature of futures and options, they may be unsuitable for many investors. Even so, futures remain the cheapest (commissions interest expense) way to buy or sell gold when investing large sums.
Gold Mining Companies
Companies that specialize in mining and refining will also profit from a rising gold price. Investing in these types of companies can be an effective way to profit from gold, and can also carry lower risk than other investment methods.
The largest gold mining companies operate extensive global operations; therefore, business factors common to many other large companies influence their investment success. As a result, these companies can still show profit in times of flat or declining gold prices. One way they do this is by hedging against a fall in gold prices as a normal part of their business. Some do this and some dont. Even so, gold mining companies may provide a safer way to invest in gold than through direct ownership of bullion. However, the research and selection of individual companies requiresdue diligence on the investors part. As this is a time consuming endeavor, it may not be feasible for many investors.
Gold Jewelry
Most of the global gold production is used to make jewelry. With global population and wealth growing annually, demand for gold used in jewelry production should increase over time as well. On the other hand, gold jewelry buyers are shown to be somewhat price sensitive, buying less if the price rises swiftly.
Buying jewelry at retail prices involves a substantial markup – up to 400% over the underlying gold value. Better jewelry bargains may be found at estate sales and auctions. The advantage of buying jewelry this way is that there is no retail markup; the disadvantage is the time spent searching for valuable pieces. Nonetheless, jewelry ownership provides the most enjoyable way to own gold, even if it is not the most profitable from an investment standpoint. As an art form, gold jewelry is beautiful. As an investment, it is mediocre - unless you are the jeweler.
Conclusion
Larger investors, who wish to have direct exposure to the price of gold, may prefer to invest in gold directly through bullion. There is also a level of comfort found in owning a physical asset instead of simply a piece of paper. The downside is the slight premium to the value of gold paid on the initial purchase, as well as the storage costs.
For investors who are a bit more aggressive, futures and options will certainly do the trick. But, buyers should beware: these investments are derivatives of golds price and can see sharp moves up and down, especially when done on margin. On the other hand, futures are probably the most efficient way to invest in gold, except for the fact that contracts must be rolled over periodically as they expire.
The idea that jewelry is an investment is quaint, but naive. There is too much of a spread between the price of most jewelry and its gold value for it to be considered a true investment. Instead, the average gold investor should consider gold oriented mutual funds and ETFs, as these securities generally provide the easiest and safest way to invest in gold.
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Five Things To Know About Asset Allocation
With literally thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. However, starting to build a portfolio with stock picking might be the wrong approach. Instead, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold - this is referred to as your asset allocation.
What is Asset Allocation?
Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a settlement for mediocrity, but for most investors its the best protection against major loss should things ever go amiss in one investment class or sub-class.
The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines.
We must emphasize that there is no simple formula that can find the right asset allocation for every individual - if there were, we certainly wouldnt be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation:
Risk vs. Return
The risk-return tradeoff is at the core of what asset allocation is all about. Its easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest potential (stocks and derivatives) isnt the answer. The crashes of 1929, 1981, 1987, and the more recent declines of 2000-2002 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. Its time to face the truth: every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you cant keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. (To learn more about bond investing , see Bond Basics Tutorial.
Dont Rely Solely on Financial Software or Planner Sheets
Financial planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan. For example, one rule of thumb that many advisors use to determine the proportion a person should allocate to stocks is to subtract the persons age from 100. In other words, if youre 35, you should put 65% of your money into stock and the remaining 35% into bonds, real estate and cash.
But standard worksheets sometimes dont take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that dont capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because its best for you, but because its easy for them. Rules of thumb and planner sheets can give people a rough guideline, but dont get boxed into what they tell you.
Determine your Long and Short-Term Goals
We all have our goals. Whether you aspire to own a yacht or vacation home, to pay for your childs education, or simply to save up for a new car , you should consider it in your asset allocation plan. All of these goals need to be considered when determining the right mix.
For example, if youre planning to own a retirement condo on the beach in 20 years, you need not worry about short-term fluctuations in the stock market . But if you have a child who will be entering college in five to six years, you may need to tilt your asset allocation to safer fixed-income investments.
Time is your Best Friend
The U.S. Department of Labor has said that for every 10 years you delay saving for retirement (or some other long-term goal), you will have to save three times as much each month to catch up. Having time not only allows you to take advantage of compounding and the time value of money, it also means you can put more of your portfolio into higher risk/return investments, namely stocks. A bad couple of years in the stock market will likely show up as nothing more than an insignificant blip 30 years from now.
Just Do It!
Once youve determined the right mix of stocks, bonds and other investments, its time to implement it. The first step is to find out how your current portfolio breaks down. Its fairly straightforward to see the percentage of assets in stocks vs. bonds, but dont forget to categorize what type of stocks you own (small, mid, or large cap). You should also categorize your bonds according to their maturity (short, mid, long-term). Mutual funds can be more problematic. Fund names dont always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested.
There is no one standardized solution for allocating your assets. Individual investors require individual solutions. Furthermore, if a long-term horizon is something you dont have, dont worry. Its never too late to get started. Its also never too late to give your existing portfolio a face-lift: asset allocation is not a one-time event, its a life-long process of progression and fine-tuning.
How To Dispute A Credit Card Charge
What happens when the brand-new digital camera you brought home turns out to be a bust? Or the DVD player you got for your spouses birthday gets stuck permanently on rewind? Or, when youve been double-charged for something youre sure you only came home with one of?
SEE: Check out our credit card comparison tool and find out which credit card is right for you.
If youve made these purchases on a credit card - and these days, thats a near certainty - youre in luck. Thanks to the Fair Credit Billing Act, consumers have a good deal of protection for their credit card purchases. This law allows consumers to withhold payment on poor-quality, damaged merchandise or incorrectly billed items they bought with a credit card until the matter is resolved. Read on as we show you how to dispute a credit card charge and actually come out on the winning side.
Retrace Your Steps
Your first move is always to go back and attempt to resolve the problem with the merchant. If you give them a chance to address your complaint, they very often will; especially if you approach them with politeness and courtesy. Most large retailers have customer service policies in place that err strongly on the side of being generous, at least within a certain period of time, and under ordinary circumstances.
Bottom line is, if you act promptly and reasonably, youre likely to get the full benefit of the doubt. If you dont have luck with the first representative you speak with, ask to talk with the manager or supervisor on duty. Be sure to keep records of each interaction, the person you spoke with as well as the date and time, so you can refer back to them if needed.
Put It In Writing
If the merchant wont budge, its time to put your complaint in writing. Draft a short, detailed letter outlining your particular dispute, and address it to the merchant via certified mail. Before you send it, make a few copies, so you can save one for your records and send another copy to your credit card company, as proof of your efforts to resolve this dispute.
Next youll draft a letter to your credit card company, to officially alert it of the disputed purchase amount. The Fair Credit Billing Act mandates that you do this in writing, within 60 days after the bill with the disputed charge was sent to you. In your letter, youll need to include your account number, the closing date of the bill on which the disputed charge appears, a description of the disputed item and the reason youre withholding payment. You should also enclose a copy of your complaint letter to the merchant, along with any other documentation that supports your position. This letter should also be sent via certified mail, return receipt requested; be sure you send it to the billing inquiries address at your credit card company, and not the regular address for payments (since these are often two separate departments).
Keep on Paying
Even though youre disputing an item on your current bill, its important to maintain your other payments. If youve charged anything else on your card during this cycle, youll need to send that payment and all financing charges to the regular address, otherwise youll incur interest and late-payment charges.
At this point, youre just waiting to hear the result of your challenge. Some card companies - especially the bigger firms, such as Capital One - will often give the benefit of the doubt to their consumers, and issue a temporary credit until the dispute is resolved. This isnt required by law, however, so dont assume you will get this consideration. Meanwhile, the card issuer will get in touch with the merchant to find out their side of the story. Basically, if they end up siding with you, you will enjoy a full refund. If not, youll have to pay for the disputed item, as well as any additional finance charges that may have accrued.
There are a few catches to the Fair Credit Billing Act. Technically, the sale must be for more than $50 and must have taken place in your home state or within 100 miles of your billing address, which means phone or internet orders may be immune. However, few issuers enforce these rules on purchases, because most credit card companies are eager to hold onto your business, given the highly competitive nature of the industry these days. But, theres still always a chance that your claim could be denied on these grounds.
You Have a Better Chance Than You Might Think
If you find yourself in the position of having to dispute a credit card charge, you may have more rights and advantages than you realize. The key is to act quickly and responsibly. Address the matter in a prompt and courteous fashion with the merchant in question, and if necessary, follow up with your credit card issuer. In most cases the whole matter can be resolved within a matter of weeks to your satisfaction.
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How To Invest In Private Equity
Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions or strengthen a companys balance sheet.
Unless you are willing to put up $250,000 or more, your choices in investing in the high-stakes world of private equity are very limited. In this article, well show you why and where you can invest in the private equity game.
SEE: Life-Cycle Funds: Can It Get Any Simpler?, Advantages Of Mutual Funds and The Dangers of Over-Diversification.)
Why Invest in Private Equity?
As you can see from the chart below, private equity is on the upswing, in spite of 2008s crisis:
U.S. Venture Capital Investment By Year
Year Number of Deals Total Investment (USD Mil)
2002 3,183 20,849.83
2003 3,004 18,613.83
2004 3,178 22,355.27
2005 3,262 22,945.71
2006 3,827 26,594.17
2007 4,124 30,826.31
2008 4,111 30,545.51
2009 3,065 19,745.81
2010 3,526 23,253.31
2011 3,673 28,425.08
Source: http://www.nvca.org/ffax.html
Institutional investors and wealthy individuals are often attracted to private-equity investments. This includes large university endowments, pension plans and family offices. Their money goes into pools that represent a source of funding for early-stage, high-risk ventures and plays a major role in the economy.
Often, the money will go into new companies believed to have significant growth possibilities in industries such as: telecommunications, software, hardware, healthcare and biotechnology. Private-equity firms try to add value to the companies they buy, with the goal of making them even more profitable. For example, they might bring in a new management team, add complementary companies, aggressively cut costs and then sell for big profits.
You probably recognize some of the companies below, which received private-equity funding over the years:
• A
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Achieving Optimal Asset Allocation
The important task of appropriately allocating your available investment funds among different assets classes can seem daunting, with so many securities to choose from. Here we will illustrate what asset allocation is, its importance and how you can determine your appropriate asset mix and maintain it.
What is Asset Allocation?
Asset allocation refers to the strategy of dividing your total investment portfolio among various asset classes, such as stocks, bonds and money market securities. Essentially, asset allocation is an organized and effective method of diversification.
To help determine which securities, asset classes and subclasses are optimal for your portfolio, lets define some briefly:
• Large-cap stock - These are shares issued by large companies with a market capitalization generally greater than $10 billion.
• Mid-cap stock - These are issued by mid-sized companies with a market cap generally between $2 billion and $10 billion.
• Small-cap stocks - These represent smaller-sized companies with a market cap of less than $2 billion. These types of equities tend to have the highest risk due to lower liquidity.
• International securities - These types of assets are issued by foreign companies and listed on a foreign exchange. International securities allow an investor to diversify outside of his or her country, but they also have exposure to country risk - the risk that a country will not be able to honor its financial commitments.
• Emerging markets - This category represents securities from the financial markets of a developing country. Although investments in emerging markets offer a higher potential return, there is also higher risk, often due to political instability, country risk and lower liquidity. (For further reading, see What Is An Emerging Market Economy?)
• Fixed-income securities - The fixed-income asset class comprises debt securities that pay the holder a set amount of interest, periodically or at maturity, as well as the return of principal when the security matures. These securities tend to have lower volatility than equities, and have lower risk because of the steady income they provide. Note that though payment of income is promised by the issuer, there is a risk of default. Fixed-income securities include corporate and government bonds.
• Money market - Money market securities are debt securities that are extremely liquid investments with maturities of less than one year. Treasury bills (T-bills) make up the majority of these types of securities.
• Real-estate investment trusts (REITs) - Real estate investment trusts (REITs) trade similarly to equities, except the underlying asset is a share of a pool of mortgages or properties, rather than ownership of a company.
Maximizing Return While Minimizing Risk
The main goal of allocating your assets among various asset classes is to maximize return for your chosen level of risk, or stated another way, to minimize risk given a certain expected level of return. Of course to maximize return and minimize risk, you need to know the risk-return characteristics of the various asset classes. Figure 1 compares the risk and potential return of some of the more popular ones:
Figure 1
Equities have the highest potential return, but also the highest risk. On the other hand, Treasury bills have the lowest risk since they are backed by the government, but they also provide the lowest potential return.
Figure 1 also demonstrates that when you choose investments with higher risk, your expected returns also increase proportionately. But this is simply the result of the risk-return tradeoff. They will often have high volatility and are therefore suited for investors who have a high risk tolerance(can stomach wide fluctuations in value), and who have a longer time horizon.
Its because of the risk-return tradeoff - which says you can seek high returns only if you are willing to take losses - that diversification through asset allocation is important. Since different assets have varying risks and experience different market fluctuations, proper asset allocation insulates your entire portfolio from the ups and downs of one single class of securities. So, while part of your portfolio may contain more volatile securities - which youve chosen for their potential of higher returns - the other part of your portfolio devoted to other assets remains stable. Because of the protection it offers, asset allocation is the key to maximizing returns while minimizing risk.
Deciding Whats Right for You
As each asset class has varying levels of return for a certain risk, your risk tolerance, investment objectives, time horizon and available capital will provide the basis for the asset composition of your portfolio.
To make the asset allocation process easier for clients, many investment companies create a series of model portfolios, each comprising different proportions of asset classes. These portfolios of different proportions satisfy a particular level of investor risk tolerance. In general, these model portfolios range from conservative to very aggressive:
Conservative model portfolios generally allocate a large percent of the total portfolio to lower-risk securities such as fixed-income and money market securities.
The main goal with a conservative portfolio is to protect the principal value of your portfolio. As such, these models are often referred to as capital preservation portfolios.
Even if you are very conservative and prefer to avoid the stock market entirely, some exposure can help offset inflation. You could invest the equity portion in high-quality blue chip companies, or an index fund, since the goal is not to beat the market. (For further reading, see the tutorialAll about Inflation.)
A moderately conservative portfolio is ideal for those who wish to preserve a large portion of the portfolios total value, but are willing to take on a higher amount of risk to get some inflation protection.
A common strategy within this risk level is called current income. With this strategy, you chose securities that pay a high level of dividends or coupon payments.
Moderately aggressive model portfolios are often referred to as balanced portfolios since the asset composition is divided almost equally between fixed-income securities and equities in order to provide a balance of growth and income.
Since these moderately aggressive portfolios have a higher level of risk than those conservative portfolios mentioned above, select this strategy only if you have a longer time horizon (generally more than five years), and have a medium level of risk tolerance.
Aggressive portfolios mainly consist of equities, so these portfolios value tends to fluctuate widely. If you have an aggressive portfolio, your main goal is to obtain long-term growth of capital. As such the strategy of an aggressive portfolio is often called a capital growth strategy.
To provide some diversification, investors with aggressive portfolios usually add some fixed-income securities.
Very aggressive portfolios consist almost entirely of equities. As such, with a very aggressive portfolio, your main goal is aggressive capital growth over a long time horizon.
Since these portfolios carry a considerable amount of risk, the value of the portfolio will vary widely in the short term.
Nothing is Set in Stone
Note that the above outline of model portfolios and the associated strategies offer only a loose guideline - you can modify the proportions above to suit your own individual investment needs. How you fine tune the models above can depend on your future needs for capital and on what kind of an investor you are. For instance, if you like to research your own companies and devote time to stock picking, you will likely further divide your equities portion of your portfolio among subclasses of stocks. By doing so, you can achieve a specialized risk-return potential within one portion of your portfolio. (For further reading, see the tutorial Guide to Stock-Picking Strategies.)
Also, the amount of cash and equivalents, or money market instruments you place in your portfolio will depend on the amount of liquidity and safety you need. If you need investments that can be liquidated quickly or you would like to maintain the current value of your portfolio, you might want to put a larger portion of your investment portfolio in money market or short-term fixed-income securities. Those investors who do not have liquidity concerns and have a higher risk tolerance will have a small portion of their portfolio within these instruments.
Maintaining Your Portfolio
Once you have chosen your portfolio investment strategy, it is important to conduct periodic portfolio reviews, as the value of the various assets within your portfolio will change, affecting the weighting of each asset class. For example, if you start with a moderately conservative portfolio, the value of the equity portion may increase significantly during the year, making your portfolio more like that of an investor practicing a balanced portfolio strategy , which is higher risk!
In order to reset your portfolio back to its original state, you need to rebalance your portfolio. Rebalancing is the process of selling portions of your portfolio that have increased significantly, and using those funds to purchase additional units of assets that have declined slightly or increased at a lesser rate. This process is also important if your investment strategy or tolerance for risk has changed.
Conclusion
Asset allocation is a fundamental investing principle, because it helps investors maximize profits while minimizing risk. The different asset allocation strategies described above can help any investor do this regardless of their risk tolerance and investment goals. In turn, choosing an appropriate asset allocation strategy and conducting periodic reviews will ensure you maintain your long-term investment goals and reach your desired return at the lowest amount of risk possible.
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Golden Opportunity For Real Estate Investors
In August 2011, the Federal Housing Finance Agency (FHFA) announced their mandate to reduce the volume of real estate owned (REO) properties, stabilize property values in areas hard-hit with foreclosures and increase the supply of affordable rental housing in those same markets. In February 2012, the FHFA launched the REO-to-Rental Pilot Initiative that will attract smaller investors and increase private investment in REO properties.
FHFA Overview
The FHFA has regulatory and supervisory oversight over Fannie Mae, Freddie Mac and the Federal Home Loan Bank System. The agency worked with the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), theFederal Housing Administration (FHA), the U.S. Department of Housing and Urban Development (HUD), the Treasury Department and many state and local governments to develop the REO-to-Rental Pilot Initiative to increase participation from smaller and private investors to purchase, rehabilitate, manage and rent REO properties in areas with declining market values and deteriorating conditions.
How the Pilot Program Works
Potential investors will register and complete a pre-qualification form online. This establishes eligibility to bid on pools of foreclosures held in REO status with Fannie Mae in the initial pilot phase. Future offerings will include REO holdings from Freddie Mac and the FHA. Qualified investors include partnerships, trusts and individuals along with banks, non-profit agencies and for-profit real estate businesses.
Investors are required to hold and rent the properties for a specified time. They must also provide affordable rents and lease-to-own options. This program is not for short-term investors, but rather those who are committed to long-term holdings and will operate under a business model that includes housing counseling for prospective tenant-buyers.
The target properties are in areas that have high numbers of foreclosed properties, and high rental demand. Most properties will be vacant single-family residences withnonperforming loans that failed the short-sale process. Many two- to four-family units in a foreclosure status will also be available. Some properties offered will be existing tenant occupied properties; others include owners who remained as renters after a foreclosure.
Traditionally, REO sales focused on large institutional investors and individual owner-occupant buyers. This pilot program allows small individual investors to bridge the gap, and fill an important niche missing in many depressed housing markets – that is, participation from local real estate investors who reside in or near communities they invest in.
Requirements for Individual Investors
1. Net worth of $1 million, individual or joint.
2. Net income of $200,000 individual, $300,000 joint.
3. Experience buying, selling, developing, managing real estate with emphasis on risk management ability.
Can the Program Work?
Either Fannie Mae or the FHFA will have to provide seller financing in order to make the pilot program successful. This reduces the role of these agencies in the housing market, something consumer advocates, market players and lawmakers are calling for. This also provides access to ablanket mortgage or other similar lines of financing traditionally not available to small investors in some areas. Structure and oversight should use strategies that worked well in the past, such as those the Resolution Trust Corporation used to solve the savings and loan failures of the past. Investors need tax advantages similar to those available through real estate investment trusts. Finally, regulatory controls must deter practices that helped fuel the current housing crisis such as inadequate renter-buyer income verification, property flipping and ownership/chain of title fraud.
The Bottom Line
This is an excellent opportunity for individual real estate investors, developers and property managers to enter or re-enter the buy-to-hold and rental real estate market under favorable conditions.
For more information about the Federal Housing Finance Agencys REO-to-Rental Pilot Initiative, visit the REO Asset Disposition page on the agencys website. Serious investors should also complete the Investor Pre-Qualification Process at Fannie Maes HomePath website.
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