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J.D. Rockefeller: From Oil Baron To Billionaire
John D. Rockefeller still ranks as one of the richest men in modern times. According to Forbes Magazines Most Wealthy Historical Figures 2008, his adjusted fortune of more than $300 billion rivals the relative wealth controlled by the Pharaohs of ancient Egypt or the Roman emperors. Rockefeller remains one of the great figures of Wall Street - reviled as a villain, applauded as an innovator and universally recognized as one of the most powerful men in history. Read on for a look at his life and achievements.
Son of a Peddler
Rockefeller was born on July 8, 1839. His father led a nomadic life selling goods across the country while his mother raised the children. Rockefeller received an unusually good education for his time and found work as a clerk at a commission house at the age of 16. He left thecommission house to form a partnership at the age of 24.
Oil Refiner
The first thing that distinguished Rockefeller from others was his understanding of risk. He knew that speculators in oil had the potential for huge profits if they hit a deposit, but they were also losing money when they didnt. Instead of getting into the speculation business, Rockefeller chose the refining business, where the profits were smaller but more stable
Putting all of his money into his first refining business, Rockefeller transformed it by emphasizing what we now call research and development (R
Introduction To International REITs
Investing in real estate investment trusts (REITS) has long been an excellent way for investors to diversify stock portfolios. In 2007, the global real estate market represented more than $900 billion of equity capitalization and was growing, according to the National Association of Real Estate Investment Trusts (NAREIT). For the longest time, publicly-traded real estate investment trusts were only available in the areas like the U.S. or Australia; now, more foreign countries are adopting similar structures.
Tutorial: Exploring Real Estate Investments
If youre an investor who owns U.S. REITs, you are only seeing part of the total picture. In fact, a shift toward an international REIT portfolio may be more suitable. Expanding an investment portfolio to include international real estate could open the door to potential return opportunities while further dampening portfolio risk. As is said in real estate, its all about location, location, location.
Breakdown of Global REIT Market
Before we begin to dissect the characteristics and benefits of investing in foreign REITs, let us first recap the REIT universe as a whole. A REIT is a corporation that purchases, owns and manages real estate properties and/or mortgage loans. The REIT structure is unique in that REITs are given special tax status that allows them to avoid corporate tax, as long as 90% of the income is distributed to investors. Although the REIT structure avoids double taxation to shareholders, tax losses cannot be passed through. (To read more REIT basics, see What Are REITs? and ourExploring Real Estate Investments tutorial.)
The global real estate securities market has grown significantly as both developed and developing countries move to create REIT or REIT-like corporate structures. Prior to 1990, however, only the U.S., the Netherlands, Australia and Luxembourg had adopted REIT-like structures. In 2007, according to Dimensional Fund Advisors, the global REIT market was dominated by the U.S. (55%), Australia, Great Britain and Japan. Therefore, non-U.S. REITS make up almost half of the global REIT market. The global REIT universe continues to expand; therefore, investors who limit their REIT positions to U.S.-only funds will also likely limit their opportunities. (Keep reading on this subject in The Emergence Of Global Real Estate.)
Benefits of REITs
One of the benefits of REITs when compared to direct equity real estate investments is that investors have the ability to more effectively and efficiently diversify their real estate portfolios because REITs tend to be more liquid. Of course, the biggest advantage offered by REITs is the diversification benefit. Investors strive to locate asset classes that offer low correlations to other positions in their portfolios. The lower the correlation, the lower the idiosyncratic risk. (To learn more about the benefits of diversification, see Introduction To Diversification and Risk And Diversification.)
The chart below illustrates the low correlation that REITs have to other U.S. core indexes over an extended period of time.
Monthly Return Correlation Coefficient: January 1979 to December 2006
-- Equity REIT Index S
Investing In Russia: A Risky Game?
Russia has never been the easiest country to understand. Winston Churchill described the country as a riddle, wrapped in a mystery inside an enigma, and today a lot of investors would share his viewpoint.
Its still hard for many investors to shake their memories of the Soviet era. Blame it on the heavy-handed government and crony capitalism. Nonetheless, in Russia it is still possible to generate returns. The trick for investors is to understand Russias opportunities and its risks.
Bust to Boom
For investors, Russia has ample economic and market growth opportunities. Since devaluation of the rouble and Russias financial crisis in 1998, growth in Russia has increased steadily to keep relatively on par with other dominant emerging markets such as Brazil, India and China. Equity markets in the country have soared. Between 2005 and 2010, the Russian stock exchange has delivered steady double-digit returns to investors, and the countrys performance is expected to continue showing sign of improvement.
Russia has one of the largest populations in the world - around 150 million people - many of whom have been getting slowly wealthier for the past decade and are spending an increasing amount of their income on luxury goods, services and holidays. A 2010 per capita GDP of approximately $16,000 puts it in the higher reaches of upper middle-income countries. As Russia makes significant strides to tap into its natural resource pool and implements policies to reduce disparity, per capita growth is likely to show improvement as well. A GDP growth rate averaging 7% between the crises of 1998 and 2008 made it not only a large market, but a large market that was growing rapidly. While Russia has been the laggard of the so-called BRIC economies (Brazil, Russia, India and China), Russia has enjoyed plenty of foreign investment. (Emerging markets provide new investment opportunities, but there are risks - both to residents and foreign investors. Check out What Is An Emerging Market Economy?)
Natural Resources
Plentiful natural resources represent Russias biggest draw for investors. Oil and gas play a major part in the Russian economy in terms of production for internal purposes and exports. In 2010 the country had nearly 80 billion barrels of proven oil reserves and tops the worlds rankings for natural gas. Russia also has exposure to the energy industry through a number of key joint ventures throughout Africa and other energy producing nations. But oil and gas are not the only natural resources that are plentiful in Russia. The mining and production of precious and non-precious metals is an enormous industry in the country, with great promise.
That being said, energy and minerals are part blessing, part curse. Russias heavy dependence on resources represents a risk. When you invest in Russia, you have to keep in mind the direction of commodity prices.
It is a very resource rich country, not only in hydrocarbons and minerals, but also in terms of human capital, talent and education, Russias Soviet tradition of education - superb in math and the hard sciences, excellent in languages - still produces plenty of brainy workers. Russia has an astounding 99% literacy rate and approximately half of the countrys citizens have some sort of post secondary education.
Politics
Russian politics may represent the biggest investment risk. Take Yukos, arguably one of Russias biggest and most successful oil companies. In 2003 its CEO, Mikhail Khodorkovsky, ran afoul of then-president Vladimir Putin and Russias courts convicted him on trumped-up charges that resulted in an eight-year jail sentence. Yukos was forced into bankruptcy, and its pieces were sold off at a discount to Putins allies for fractions of the actual market value. Yukos shareholders lost their shirts in the affair.
Russia has at times even made it difficult for foreign investors to operate in a environment free from bureaucratic pressures. For example, in an attempt to persuade shareholders to sell their stake in the TNK-BP joint venture, police raided BPs Moscow office in 2008. Various other barriers on international corporations such as Carrefour and DeBeers have forced them to withdraw their operations in Russia. The Russian government has a record of putting pressure on foreign energy companies as part of its effort to consolidate control over the countrys largest and most important hydrocarbon deposits.
Corruption and Lack of Governance
Corruption and weak corporate transparency is another major ongoing risk for investors. Many analysts admit say that this is a big problem - particularly among some of the smaller companies, whose accounts are not particularly transparent.
Even well-known and respected companies like Ikea which heavily focus on practicing ethical businesses activities declared a moratorium on subsequent Russian investments due to the ongoing concerns of corruption. Based on the Corruption Perception Index, Russia has a lot of obstacles to fair and efficient business practices. Even Iran, Libya and Pakistan are perceived as having less corruption.
The Bottom Line
As they seek investment opportunities around the world, investors need knowledge of the national risks that may threaten their investment. We all know that the high returns come from high risk investments and emerging markets are the likely area to find returns that outperform those of the developed nations. While Russia offers high returns, it is dominated by energy companies, the state of regulations still under development, and there are political risks that are larger in that country than others. The striking feature of investing in Russia - the risks and rewards are both high. (Get the full story on this asset class before you write it off as too risky.
Earnings Power Drives Stocks
Equity investors are primarily interested in the earnings power of the companies in which they invest . Other things being equal, the greater the earning potential of the issuer, the greater the upside potential of the stock.
A good way to analyze earnings power is to assess return on assets (ROA) and return on equity (ROE) - two financial ratios that compare a companys earnings to certain balance sheet components. An even better way is to break out these simple ratios into their component parts to see whats really driving earnings power over time. In this article, well show you how to calculate this number and make it work for you.
Return On Assets
ROA is simply earnings available for the common shareholder divided by average total assets over a time period (usually one fiscal year). ROA measures the earnings power of a companys assets - how well the company generates earnings from its asset base. As demonstrated by a simple example, ROA is a very easy ratio to calculate.
Looking at the 2006 financial statements for General Electric, we note that earnings were $20.8 billion, the beginning total asset line was $673.3 billion and the ending total asset line was $697.2 billion.
So, ROA is $20.8/(($673.3 $697.2)/2) or 3.03%.
You can use this tool to compare the current ROA to GEs historic numbers as well as to comparable companies. This is to assess whether GEs earnings power is increasing or decreasing over time. Remember that numbers dont just move on their own - if this number is increasing or decreasing, there must be a reason.
Return On Equity
ROE is the companys earnings the are available for common shareholders divided by average equity. ROE is similar to ROA except that it measures the earnings power of a companys net assets (assets minus debt or other items that arent common equity). It is a more direct measure of how well the company generates earnings from a shareholders investments (or the book value of the shareholders investment). It is therefore the more applicable and more widely used measure for equity analysis compared to ROA. Continuing with GEs financials, we note that in the beginning period, equity was $109.4 billion and the ending period equity was $112.3 billion. ROE is GEs $20.8 billion in earnings divided by average equity, or 18.8%. Just like for ROA, you would then take the ROE and check for any changes in trends and what reasons there could be for those changes. (For more on this, see Keep Your Eyes On The ROE.)
Analyzing Du Ponts ROE Theory
Years ago, the smart people at E.I. Du Pont de Nemours and Company realized they could better analyze the returns of their business by breaking out ROE into a few component parts. Called Du Pont identity or Du Pont ROE decomposition, it is a widely used technique for analyzing ROE. There are a few ways to do this, but well look at a simple version of it here.
Where:
EAT = earnings after tax or net earnings for the common shareholders
EBIT = operating income (which doesnt consider interest expenses and taxes)
Notice how the numerator and denominators of the four terms cancel each other out:
The first term (EAT/EBIT) could be described as interest and tax burden. It measures the proportion of operating income that is left over for the common shareholders after paying interest on debt and taxes. Other things being equal, profit-loving common shareholders want this number to be as high as possible. In the GE example, EAT for 2006 was $20.8 billion and EBIT was $43.9 billion, so the interest and tax burden was 0.474. In other words, about 47.4% of operating income flowed through to the shareholders after the company paid interest and taxes.
The second term (EBIT/Sales) is described as operating margin. Operating margin is an important accounting measure of revenues less operating expenses (like the cost of goods sold and corporate overhead). Again, business owners love big operating margins, so they prefer this number to be as high as possible. Continuing with GEs financials, operating margin for 2006 was $43.9 billion divided by revenue of $163.4 billion, or 26.9%.
Sales/Average Assets is called asset turnover. Asset turnover is a measure of how efficiently the company uses its assets to produce revenues. Investors want this number to be as high as possible, all other things being equal. Continuing with GE, asset turnover is $163.4 billion/$685.25 billion, or 0.239.
Lastly, Average Assets/Average Equity is called financial leverage. The number is higher if the company has a lot of debt and smaller if the company is more conservatively financed. Other things being equal, the higher this number, the higher the ROE. However, using a lot of debt is risky and common shareholders do not always want their companies to use a lot of debt to finance operations.
Debt can cause a lot of burden on cash flows, not just from interest expense (which hits the income statement directly) but also from principal repayments (which hits the cash flow statement). Also note the relationship between financial leverage and the tax and interest burden. A high debt load increases financial leverage but decreases the income flow after taxes and interest, causing a combination effect on ROE. In our example, financial leverage is $685.25 billion/$110.9 billion or 6.2-times.
Buy-And-Hold Investing Vs. Market Timing
If you were to ask 10 people what long-term investing meant to them, you might get 10 different answers. Some may say 10 to 20 years, while others may consider five years to be a long-term investment . Individuals might have a shorter concept of long term, while institutions may perceive long term to mean a time far out in the future. This variation in interpretations can lead to variable investment styles.
For investors in the stock market , it is a general rule to assume that long-term assets should not be needed in the three- to five-year range. This provides a cushion of time to allow for markets to carry through their normal cycles.
However, whats even more important than how you define long term is how you design the strategy you use to make long-term investments . This means deciding between passive and active management. Read on to learn more.
Long-Term Strategies
Investors have different styles of investing, but they can basically be divided into two camps: active management and passive management. Buy-and-hold strategies - in which the investor may use an active strategy to select securities or funds but then lock them in to hold them long term - are generally considered to be passive in nature. Figure 1 shows the potential benefits of holding positions for longer periods of time. According to research conducted by Charles Schwab Company in 2012, between 1926 and 2011, a 20-year holding period never produced a negative result.
Source: Schwab Center for Financial Research
Figure 1: Range of S
Financial Statement Manipulation An Ever-Present Problem For Investors
Financial statement manipulation is an ongoing problem in corporate America. Although the Securities and Exchange Commission (SEC) has taken many steps to mitigate this type of corporate malfeasance, the structure of management incentives, the enormous latitude afforded by theGenerally Accepted Accounting Principles (GAAP) and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity. Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warning signs and the tools that are at their disposal in order to mitigate the adverse implications of these problems.
Factors That Contribute to Financial Statement Manipulation
There are three primary reasons why management manipulates financial statements. First, in many cases the compensation of corporate executives is directly tied to the financial performance of the company. As a result, management has a direct incentive to paint a rosy picture of the companys financial condition in order to meet established performance expectations and bolster their personal compensation.
Second, it is relatively easy to manipulate corporate financial statements because the Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude in the accounting provisions that are available to be used by corporate management. For better or worse, these GAAP standards afford a significant amount of flexibility, making it very easy for corporate management to paint a favorable picture of the financial condition of the company.
Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep their client happy. Moreover, auditors typically receive a significant amount of money from the companies that they audit. Therefore, there is implicit pressure to certify the financial statements of the company in order to retain their business.
How Financial Statements Are Manipulated
There are two general approaches to manipulating financial statements. The first approach is to inflate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.
The second approach to financial statement manipulation requires the exact opposite tactic, which is to deflate current period earnings on the income statement by deflating revenue or by inflating current period expenses. The reason behind this approach may not be as obvious as in the previous example because it may seem counterintuitive to make the financial condition of a company look worse than it actually is. However, there are many reasons to engage in such activity, such as making a company look bad in order to dissuade potential acquirers, pulling all of the bad financial information surrounding the company into one period so that the company will look stronger going forward, pulling all of the bad financial information into the current period when the poor performance can be attributed to the current macroeconomic environment or to postpone good financial information to a future period when it is more likely to be recognized.
According to Dr. Howard Schilit, in his famous book Financial Shenanigans (2002), there are seven primary ways in which corporate management manipulates the financial statements of a company. Lets look at these seven general categories of financial statement manipulation and the typical accounting processes that facilitate the manipulation.
1. Recording Revenue Prematurely or of Questionable Quality
o Recording revenue prior to completing all services
o Recording revenue prior to product shipment
o Recording revenue for products that are not required to be purchased
2. Recording Fictitious Revenue
o Recording revenue for sales that did not take place
o Recording investment income as revenue
o Recording proceeds received through a loan as revenue
3. Increasing Income with One-Time Gains
o Increasing profits by selling assets and recording the proceeds as revenue
o Increasing profits by classifying investment income or gains as revenue
4. Shifting Current Expenses to an Earlier or Later Period
o Amortizing costs too slowly
o Changing accounting standards to foster manipulation
o Capitalizing normal operating costs in order to reduce expenses by moving them from the income statement to the balance sheet
o Failing to write down or write off impaired assets
5. Failing to Record or Improperly Reducing Liabilities
o Failing to record expenses and liabilities when future services remain
o Changing accounting assumptions to foster manipulation
6. Shifting Current Revenue to a Later Period
o Creating a rainy day reserve as a revenue source to bolster future performance
o Holding back revenue
7. Shifting Future Expenses to the Current Period as a Special Charge
o Accelerating expenses into the current period
o Changing accounting standards to foster manipulation, particularly through provisions for depreciation, amortization and depletion
Investors should understand that there are a host of techniques that are at managements disposal. However, what investors also need to understand is that while most of these techniques pertain to the manipulation of the income statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of cash flows . Moreover, even the semantics of the management discussion and analysis section of the financials can be manipulated by softening the action language used by corporate executives from will to might, probably to possibly, and therefore to maybe. Taken collectively, investors should understand these issues and nuances and remain on guard when assessing a companys financial condition.
Financial Manipulation via Corporate Merger or Acquisition
Another form of financial manipulation can be found during the merger or acquisition process. A classic approach to this type of manipulation occurs when management tries to persuade all parties involved in the decision-making process to support a merger or acquisition based primarily on the improvement in the estimated earnings per share of the combined companies. Lets look at the table below in order to understand how this type of manipulation takes place.
Proposed Corporate Acquisition Acquiring Company Target Company Combined Financials
Common Stock Price
$100.00
$40.00
-
Shares Outstanding
100,000
50,000
120,000
Book Value of Equity
$10,000,000
$2,000,000
$12,000,000
Company Earnings
$500,000
$200,000
$700,000
Earnings Per Share $5.00 $4.00 $5.83
Based on the data in the table above, the proposed acquisition of the target company appears to make good financial sense because the earnings per share of the acquiring company will be materially increased from $5 per share to $5.83 per share. However, the earnings per share of the acquiring company will increase by a material amount for only two reasons, and neither reason has any long-term implications.
Following the acquisition, the acquiring company will experience an increase of $200,000 in company earnings due to the addition of the income from the target company. Moreover, given the high market value of the acquiring companys common stock, and the low book value of the target company, the acquiring company will only have to issue an additional 20,000 shares in order to make the $2 million acquisition. Taken collectively, the significant increase in company earnings and the modest increase of 20,000 common shares outstanding will lead to a more attractiveearning per share amount. Unfortunately, a financial decision based primarily on this type of analysis is inappropriate and misleading, because the future financial impact of such an acquisition may be positive, immaterial or even negative.
How to Guard Against Financial Statement Manipulation
There are a host of factors that may affect the quality and accuracy of the data at an investors disposal. As a result, investors must have a working knowledge of financial statement analysis, including a strong command of the use of internal liquidity solvency analysis ratios, externalliquidity marketability analysis ratios, growth and corporate profitability ratios, financial risk ratios and business risk ratios. Investors should also have a strong understanding of how to use market multiple analysis, including the use of price/earnings ratios, price/book value ratios, price/sales ratios and price/cash flow ratios in order to gauge the reasonableness of the financial data .
Finally, investors should keep in mind that the independent auditors responsible for providing the audited financial data may very well have a material conflict of interest that is distorting the true financial picture of the company and that the information provided to them by corporate management may be disingenuous, and therefore should be taken with a grain of salt.
The Bottom Line
The known prevalence and magnitude of the material issues associated with the compilation of corporate financial statements should remind investors to use extreme caution in their use and interpretation. There are many cases of financial manipulation that date back over the centuries, and recent examples such as Enron, Worldcom, Tyco International, Adelphia, Global Crossing, Cendant, Freddie Mac and AIG should remind investors of the potential land mines that they may encounter. Investors should also remember the corporate malfeasance recently conducted by the now defunct auditing firm Arthur Anderson, as well as the disingenuous information provided to the general public by the corporate executives of 360 Networks, Lehman Brothers and General Motors leading up to their bankruptcies. Extreme caution should be used while conducting financial statement analysis.
Finally, given the prevalence and magnitude of the material issues surrounding financial statement manipulation in corporate America, a strong case can be made that most investors should stick to investing in low-cost, diversified, actively-managed mutual funds in order to mitigate the likelihood of investing in companies that suffer from such corporate financial malfeasance. Simply put, financial statement analysis should be left to investment management teams that have the knowledge, background and experience to thoroughly analyze a companys financial picture before making an investment decision. Unfortunately, very few investors have the necessary time, skills and resources to engage in such activity, and therefore the purchase of individual securities by most investors is probably not a wise decision.
6 Misconceptions About Investing Young
Investing is seen by many as an arduous task - one that is complicated, risky and best left to other people. It is often easier to avoid investing altogether, than confront it head on. A natural human reaction is to create excuses that rationalize why one has chosen to avoid an activity. Investing at a young age is no exception: a variety of misconceptions about investing young perpetuates the idea that investing is best left to older people and experts. This article will examine several of these misconceptions that are often used as an excuse to delay or avoid investment activity.
SEE: Young Investors: What Are You Waiting For?
I dont have enough money.
While it is true that young adults are usually inundated with debt - from student loans, car payments and mortgages - many can find at least a small amount of money to invest on a monthly or yearly basis. Contributing to employer-sponsored plans, such as 401(k)s, can allow a small investment to grow over time, particularly when matched by the employer. The power of compounding creates a golden opportunity for young investors, even those on a tight budget. It is important to keep in mind that investing does not have to involve huge positions; it is possible to invest in a very small number of stock shares.
I dont know anything about investing.
Ignorance is not an excuse to avoid investing. Young investors have many years to study, research and develop proficiency in investing techniques and strategies. A wealth of information is available to tech-savvy young adults, from financial and education websites, to social media pages, webinars and the many advanced trading platforms that are available for free or for a limited monthly fee.
Investing is too risky.
Many young adults are keenly aware of the economic crisis and the resulting chaos that ensued. While investing can be risky, it can be managed in a way that keeps it from being too risky, however that is defined for each individual. Young investors with a low risk tolerance can select more conservative portfolios, like blue-chip stocks and bonds. Investors with a higher tolerance for risk can enter more aggressive positions with higher reward potential.
Investing can wait till Im older.
Young investors have to contribute less to make more money over time than older investors. This is due to the power of compounding. A person who starts at age 20 and invests $100 per month until age 65 (a total contribution of $54,000) will have more than $200,000 when he or she reaches age 65, assuming a 5% return. If the person delays investing until age 40, he or she will have to contribute $334 each month (a total contribution of $100,200) to arrive at the same $200,000 by age 65.
Investing is for old people and Wall Street types.
While the media do portray many investors either as wizened old men or young, power-hungry Wall Street types, most investors are ordinary people, both young and old, wealthy and not. Even though we often hear You are never too old to start investing (or saving for retirement), the opposite is true as well: people are never too young to start investing.
My 401(k) should be all I need.
Depending on social security and 401(k)s can be risky. It is difficult to predict where social security will be in future years, and many investors learned the hard way in the last decade that employee-sponsored retirement plans dont always work out. Starting young and diversifying through a variety of investment vehicles is the best way to secure ones financial future.
The Bottom Line
Young adults often have so many distractions that it is difficult to set aside the time to think about investing. In addition to being busy with friends, work and hobbies, this age group is often burdened by a significant amount of debt, making investing seem like something that will have to wait. Despite these common misconceptions about investing young, those who do start studying, researching and investing young, have many advantages over those who wait, including the power of compounding and the ability to weather a certain degree of risk.
An Introduction To Depositary Receipts
A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.
Tutorial: ADR Basics
Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in euros.
How Does the DR Work?
The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:
Example
Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list its publicly traded shares on the NYSE in the form of an ADR. Before the gas companys shares are traded freely on the exchange, a U.S. broker, through an international office or a local brokerage house in Russia, would purchase the domestic shares from the Russian market and then have them delivered to the local (Russian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. In this example, the depository bank is the Bank of New York. Once the Bank of New Yorks local custodian bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by informing the Bank of New York that the shares can now be issued in the United States. The Bank of New York then delivers the ADRs to the broker who initially purchased them.
Based on a determined ADR ratio, each ADR may be issued as representing one or more of the Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from the equivalent Russian price of the shares being held by the depository bank. The ADRs now represent the local Russian shares held by the depository, and can now be freely traded equity on the NYSE.
After the process whereby the new ADR of the Russian gas company is issued, the ADR can be traded freely among investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. All ADR transactions of the Russian gas company will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.
Pricing and Cross-Trading
When any DR is traded, the broker will aim to find the best price of the share in question. He or she will therefore compare the U.S. dollar price of the ADR with the U.S. dollar equivalent price of the local share on the domestic market. If the ADR of the Russian gas company is trading at US$12 per share and the share trading on the Russian market is trading at $11 per share (converted from Russian rubles to dollars), a broker would aim to buy more local shares from Russia and issue ADRs on the U.S. market. This action then causes the local Russian price and the price of the ADR to reach parity. The continual buying and selling in both markets, however, usually keeps the prices of the ADR and the security on the home market in close range of one another. Because of this minimal price differential, most ADRs are traded by means of intramarket trading. (Learn more about ADRs in ADRs: Invest Offshore Without Leaving Home.)
A U.S. broker may also sell ADRs back into the local Russian market. This is known as cross-border trading. When this happens, an amount of ADRs is canceled by the depository and the local shares are released from the custodian bank and delivered back to the Russian broker who bought them. The Russian broker pays for them in roubles, which are converted into dollars by the U.S. broker.
The Benefits of Depositary Receipts
The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad. (Learn more about investing in emerging markets in Equity Valuation In Emerging Markets.)
Lets take a closer a look at the benefits:
For the Company
A company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the shares liquidity while boosting the companys prestige on its local market (the company is traded internationally). Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a DR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face.
For the Investor
Buying into a DR immediately turns an investors portfolio into a global one. Investors gain the benefits of diversification while trading in their own market under familiar settlement and clearance conditions. More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.
Conclusion
Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. As with any security, however, investing in ADRs requires an understanding of why they are used, and how they are issued and traded.
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!
The Importance Of Diversification
Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk. Here, we look at why this is true, and how to accomplish diversification in your portfolio. (To learn more, see Diversification: Protecting Portfolios From Mass Destruction.)
Different Types of Risk
Investors confront two main types of risk when investing:
• Undiversifiable - Also known as systematic or market risk, undiversifiable risk is associated with every company. Causes are things like inflation rates, exchange rates, political instability, war and interest rates. This type of risk is not specific to a particular company or industry, and it cannot be eliminated, or reduced, through diversification; it is just a risk that investors must accept.
• Diversifiable - This risk is also known as unsystematic risk, and it is specific to a company, industry, market, economy or country; it can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so that they will not all be affected the same way by market events.
Why You Should Diversify
Lets say you have a portfolio of only airline stocks. If it is publicly announced that airline pilots are going on an indefinite strike, and that all flights are canceled, share prices of airline stocks will drop. Your portfolio will experience a noticeable drop in value. If, however, you counterbalanced the airline industry stocks with a couple of railway stocks, only part of your portfolio would be affected. In fact, there is a good chance that the railway stock prices would climb, as passengers turn to trains as an alternative form of transportation.
But, you could diversify even further because there are many risks that affect both rail and air, because each is involved in transportation. An event that reduces any form of travel hurts both types of companies - statisticians would say that rail and air stocks have a strong correlation. Therefore, to achieve superior diversification, you would want to diversify across the board, not only different types of companies but also different types of industries. The more uncorrelated your stocks are, the better.
Its also important that you diversify among different asset classes. Different assets - such as bonds and stocks - will not react in the same way to adverse events. A combination of asset classes will reduce your portfolios sensitivity to market swings. Generally, the bond and equity markets move in opposite directions, so, if your portfolio is diversified across both areas, unpleasant movements in one will be offset by positive results in another. (To learn more about asset class, see Five Things To Know About Asset Allocation.)
There are additional types of diversification, and many synthetic investment products have been created to accommodate investors risk tolerance levels; however, these products can be very complicated and are not meant to be created by beginner or small investors. For those who have less investment experience, and do not have the financial backing to enter into hedging activities, bonds are the most popular way to diversify against the stock market.
Unfortunately, even the best analysis of a company and its financial statements cannot guarantee that it wont be a losing investment. Diversification wont prevent a loss, but it can reduce the impact of fraud and bad information on your portfolio.
How Many Stocks You Should Have
Obviously owning five stocks is better than owning one, but there comes a point when adding more stocks to your portfolio ceases to make a difference. There is a debate over how many stocks are needed to reduce risk while maintaining a high return. The most conventional view argues that an investor can achieve optimal diversification with only 15 to 20 stocks spread across various industries. (To learn more about what constitutes a properly diversified stock portfolio, see Over-Diversification Yields Diminishing Returns. To learn about how to determine what kind of asset mix is appropriate for your risk tolerance, see Achieving Optimal Asset Allocation.)
Conclusion
Diversification can help an investor manage risk and reduce the volatility of an assets price movements. Remember though, that no matter how diversified your portfolio is, risk can never be eliminated completely. You can reduce risk associated with individual stocks, but general market risks affect nearly every stock, so it is important to diversify also among different asset classes. The key is to find a medium between risk and return; this ensures that you achieve your financial goals while still getting a good nights rest.
The Risks Of Investing In Emerging Markets
Investing is always risky business; corporate scandals regularly surface in the news, corporate bonds are frequently downgraded, accounting fraud is often revealed and market imperfections such as the flash crash continuously bring a level of uncertainty. Even the most stable domestic blue chip companies will face times of tremendous volatility.
Emerging markets offer numerous benefits to investors such as elevated economic growth rates, higher expected returns and diversification benefits. However, there are a number of important risks to consider before investing in regions outside of the developed world. (Emerging markets provide new investment opportunities, but there are risks - both to residents and foreign investors. See What Is An Emerging Market Economy?)
1) Foreign Exchange Rate Risk
Foreign investments in stocks and bonds will typically produce returns in the local currency of the investment. As a result, investors will have to convert this local currency back into their domestic currency. An American who purchases a Brazilian stock in Brazil will have to buy and sell the security using the Brazilian real. Therefore, currency fluctuations can impact the total return of investment. If, for example, the local value of a held stock increased by 5%, but the real depreciated by 10%, the investor will experience a net loss in terms of total returns when selling and converting back to U.S. dollars.
2) Non-Normal Distribution
North American market returns arguably follow a pattern of normal distributions. As a result, financial models can be used to price derivatives and make somewhat accurate economic forecasts about the future of equity prices. Emerging market securities, on the other hand, cannot be valuated using the same type of mean-variance analysis. Also, because emerging markets are undergoing constant changes, it is almost impossible to utilize historical information in order to draw proper correlations between events and returns.
3) Lax Insider Trading Restrictions
Although most countries claim to enforce strict laws against insider trading, none have proved to be as rigorous as America in terms of prosecuting unfair trading practices. Insider trading and various forms of market manipulation introduce market inefficiencies, whereby equity prices will significantly deviate from their intrinsic value. Such a system can be subject to extreme speculation, and can also be heavily controlled by those holding privileged information.
4) Less Liquidity
Emerging markets are generally less liquid than those found in the developed world. This market imperfection results in higher broker fees and an increased level of price uncertainty. Investors who try to sell stocks in an illiquid market face substantial risks that their orders will not be filled at the current price, and the transactions will only go through at an unfavorable level. Additionally, brokers will charge higher commissions, as they have to make more diligent efforts to find counterparties for trades. Illiquid markets prevent investors realizing the benefits of fast transactions.
5) Difficulty Raising Capital
A poorly developed banking system will prevent firms from having the proper access to financing that is required to grow their businesses. Attained capital will usually be issued at a high required rate of return, increasing the companys weighted average cost of capital (WACC). The major concern with having a high WACC is that fewer projects will produce a high enough return to yield a positive net present value. Therefore, financial systems found in developed nations do not allow companies to undertake a higher variety of profit-generating projects. (This asset class has left much of its unstable past behind. Find out how to invest in it, in Investing In Emerging Market Debt.)
6) Poor Corporate Governance System
A solid corporate governance structure within any organization is correlated with positive stock returns. Emerging markets sometimes have weaker corporate governance systems, whereby management, or even the government, has a greater voice in the firm than shareholders. Furthermore, when countries have restrictions on corporate takeovers, management does not have the same level of incentive to perform in order to maintain job security. While corporate governance in the emerging markets has a long road to go before being considered fully effective by North American standards, many countries are showing improvements in this area in order to gain access to cheaper international financing.
7) Increased Chance of Bankruptcy
A poor system of checks and balances and weaker accounting audit procedures increase the chance of corporate bankruptcy. Despite that bankruptcy is common in every economy, such risks are most common outside of the developed world. Within emerging markets, firms can more freely cook the book to give an extended picture of profitability. Once the corporation is exposed, it experiences a sudden drop in value. This is not to say that such occurrences do not happen in North America and Europe.
Because emerging markets are viewed as being more risky, they will have to issue bonds that pay higher interest rates. The increased debt burden further increases borrowing costs and strengthens the potential for bankruptcy.
8) Political Risk
Political risk refers to uncertainty regarding adverse political decisions. Developed nations tend to follow a free market discipline of low government intervention, whereas emerging market businesses are often privatized upon demand. Some additional factors that contribute to political risk are: possibility of war, tax increase, loss of subsidy, change of market policy, inability to control inflation and laws regarding resource extraction. Major political instability can also result in civil war and a shutdown of industry, as workers either refuse or are no longer able to do their jobs. (Find out how these worldly offerings can spice up your portfolio. Check out Go International With Foreign Index Funds.)
Conclusion
Investing in emerging markets can produce substantial returns to ones portfolio. However, investors must be aware that all high returns must be judged within the risk and reward framework. The aforementioned risks are some of the most prevalent that must be assessed prior to investing. Unfortunately, however, the premiums associated with these risks can often only be estimated, rather than determined on a concrete basis.
Profiting In A Post-Recession Economy
People will always question what the future economy will look like after it suffers a recession. Though there are different implications with each recession - owing to its causes and the governmental and financial changes that are brought about - the economy will definitely shift and there will emerge new economic practices and trends for industries, consumers and investors.
Following the depths of the 2007-2009 recession theres a new world characterized by:
• Non-existent consumer discretionary spending
• Tighter credit and borrowing standards
• Reduced home ownership
• Increased consumer savings
The above effects will serve to:
• Hold down corporate profit growth
• Restrict employment growth
• Likely reduce future expected market returns
Despite the above, investors have options and opportunities as long as they keep their expectations in line with the expected future outcome. Some wonderful investment opportunities exist for investors in all stages of life.
Industries to Look For
When it comes to investing in the economy defined by the characteristics above, one question should dominate your investment consideration: Does this company make an essential or non-essential product?
When times are tough, people respond with their wallets. Unless folks are given great incentives, they wont buy unless they have to. In that kind of environment, I would favor food companies to retailers, healthcare providers to homebuilders, and defense contractors to automakers. Things like food, medicine and national security are musts in this world. An extra purse or a new car or bigger homes are not. And heres the best part: most of the companies that provide these necessary goods will continue to be around for a long time. (These type of companies are normally grouped in a sector called consumer staples – to learn more see A Guide To Consumer Staples.)
When economies are sour, the stock market tends to punish all companies regardless of what line of business they are in. In other words, a business like a Kraft or Johnson and Johnson that sell essential food and health products all over the world may likely see its shares suffer along with other discretionary businesses like retailers. And you can be comforted by the fact that even in tough times, people still need to buy food and Tylenol. Looking for these types of companies will likely earn you market-beating returns during the several years following a recession, despite an overall sluggish economy.
Despite the temptation, avoid retailers and other companies that make non-discretionary consumer goods. Such companies will likely experience reduced profit margins as they are forced to mark down their products to entice consumers.
Importance of Commodities
Commodities are the most fundamental of human essentials. Things like wheat, corn, oil, zinc, copper and coal. While you might not physically buy some of these commodities, you cant go through a normal day without them. Every time you turn on a light switch or power up your stove, the electricity used is provided by coal or natural gas. Grains are the basic building blocks for all the foods we eat. Oil, besides being refined into gasoline, goes in things like plastic, carpets, soaps and detergents.
Besides being essentials, commodities also have inflationary pricing power. If the government prints massive amounts of money to combat the recession, inflation will likely happen. It might not happen immediately afterwards, but it will rear its ugly head. Commodities, for those reasons are a good place to be.
Fertilizer companies are also great considerations. Fertilizer is the necessary ingredient to boost crop yield - that is, producing more food from the same amount of land. As the global population grows, so will the need to maximize food production. When looking at commodity plays, focus on the larger businesses with the quality assets such as the large integrated oil companies. We will always need oil and the biggest companies have the deepest pocket book to continue providing us with the black gold during various pricing environments. Otherwise look for those companies that are the low cost producers.
International Investment Exposure
To illustrate why investors should also consider diversifying internationally we can take a look at the 2007-2009 recession. Although this was a global economic recession, it didnt affect every country equally. According to J.D. Power Asia-Pacific, as of 2009, it was estimated that there were 820 cars for every 1,000 people in the US. In China, the figure was 34 cars per 1,000. Numbers like this illustrate the potential in countries like China, Brazil and India.
Major international commodity companies are now almost certain to have exposure to the growth in China. Such businesses enable investors to get the exposure without having to invest directly in China. The growth engines for companies like Johnson and Johnson is the fact that billions of people outside the U.S. will need its products.
Conclusion
As long as investors are aware of the likely economic shifts that lie before them in a post-recession environment, the opportunity to make excellent investments is there.
How To Choose Stocks For Day Trading
Day trading is a specific trading technique where a trader buys and/or sells a financial instrument multiple times over the course of a day, to exploit minute volatility in the assets pricing. While private investors may practice this investment strategy, it is more commonly an institutional phenomenon, as a financial institution can highly leverage its transactions to boost its profitability. As many brokerages allow for trading online, day trading can be conducted from virtually anywhere, with only a few necessary tools and resources. However, day trading is inherently a highly risky investment strategy.
High Liquidity and Volatility
Liquidity, in financial markets, refers to the relative ease with which a security is obtained, as well as the degree by which the price of the security is affected by its trading. Stocks that are more liquid are more easily day traded; moreover, liquid stocks tend to be more highly discounted than other stocks and are, therefore, cheaper. In addition, equity offered by corporations with higher market capitalizations are often more liquid than corporations with lower market caps, as it is easier to find buyers and sellers for the stock in question.
Stocks that exhibit more volatility lend themselves to day trading strategies , as well. For example, a stock may be volatile if its issuing corporation experiences more variance in its cash flows. While markets will anticipate these changes for the most part, when extenuating circumstances transpire, day traders can capitalize on asset mispricing, such as the currently ongoing euro crisis. Uncertainly in the marketplace creates an ideal day trading situation.
Trading Volume and Trade Volume Index (TVI)
The volume of the stock traded is a measure of how many times it is bought and sold in a given time period. This time period is most commonly within a day of trading. More volume indicates interest in a stock, whether that interest is of a positive or negative nature. Oftentimes, an increase in the volume traded of a stock is indicative of price movement that is about to transpire. Day traders frequently use the Trade Volume Index (TVI) to determine whether or not to buy into a stock, which measures the amount of money flowing in and out of an asset.
Financial Services
Financial services corporations provide excellent day-trading stocks. Bank of America, for example, is one of the most highly traded stocks per shares traded per trading session. BoA is a prime candidate for day trading, despite the banking system being viewed with increasing skepticism, as the industry has demonstrated systemic speculative activity, culminating in JP Morgans $2 billion derivative gaffe.
In addition, Bank of Americas trading volume is high, making it a relatively liquid stock. For the same reasons, Wells Fargo, JP Morgan
Why You Should Be Wary Of Target-Date Funds
Its the in thing now; everybodys doing it, so why wouldnt you? Heres how the story repeatedly plays out, especially for those who recently opened a new 401(k) or 403(b) account. The benefits manager of your company sent you a big stack of documents and told you to complete the application. You thumbed through everything, skimming the microscopic print in these pamphlets called prospectuses, and found yourself completely overwhelmed.
Luckily, as you were completing the application, you noticed that you could either pick your own investment options or choose the ready-made option that placed all of your retirement funds into a target-date fund. You didnt know what it was, but you didnt know how to pick your investment options anyway, so into this target-date fund is where your money has gone.
What Is a Target-Date Fund?
The concept is very simple. A target-date fund adjusts the assets in the fund to line up with your retirement timeline. If youre planning to retire in 15 years, you might pick a target-date fund of 2025 or 2030. The fund manager will adjust the holdings and when you near retirement age, that fund will hold a lot of bonds, instead of the more risky stocks.
You dont have to worry about adjusting your investment portfolio because the fund does it for you. If you dont have the time or desire to learn how to manage your retirement portfolio, these target-date funds might be a great idea.
As your grandparents might have said, if its too good to be true, it probably isnt and that might be the case with target-date funds.
The Whole You
First, you are more than a date. Knowing that you plan to retire in 2025 or 2030 isnt enough information to assemble your retirement portfolio; imagine a doctor asking nothing more than your age. Your investment portfolio should be crafted around your tolerance for risk, the other assets you own, your family situation, social security and more. A target-date fund doesnt take any of that into account, because its designed for a large amount instead of you, personally.
They Might Cost a Lot
According to Consumer Reports, the median expense ratio of target-date funds is 0.68%, compared to 0.71% for stock funds. That isnt bad if your plan offers a target-date fund around the median, but the median expense ratio of index funds, a fund that tracks the performance of a certain investment index, is only 0.5% and you can find index funds for as low as 0.1%.
In general, actively managed funds, funds that have a team of people picking stocks and bonds in an attempt to beat the overall market, will cost more, but over the long term they dont perform any better than an index fund that is cheaper.
Theyre Hard to Understand
Target-date funds are like a brand new car . They look good on the outside but theyre hard to figure out when you open the hood. A recent SEC study found that many people believed that a target-date fund guarantees an income stream at retirement much like an annuity or a pension.
Others believed that once the fund reached the target-date, no more allocation changes in the fund were made. Both of these facts are untrue but this, along with the fact that a 2025 fund may vary greatly between companies, makes these funds dangerous for investors to take at face value.
The Bottom Line
Regardless of what you read today or in the future, there is no one investment product that will address all of your investing needs. A combination of products that may include a target-date fund is the best way to insure your retirement needs are met. Diversification will likely always be the best way to protect and grow your portfolio.
The Value Investors Handbook
Value investing, and any type of investing for that matter, varies in execution with each person. There are, however, some general principles that are shared by all value investors. These principles have been spelled out by famed investors like Peter Lynch, Kenneth Fisher, Warren Buffet,John Templeton and many others. In this article, we will look at these principles in the form of a value investors handbook.
Buy Businesses
If there is one thing that all value investors can agree on, its that investors should buy businesses, not stocks. This means ignoring trends in stock prices and other market noise. Instead, investors should look at the fundamentals of the company that the stock represents. Investors can make money following trending stocks, but it involves a lot more activity than value investing. Searching for good businesses selling at a good price based on probable future performance requires a larger time commitment for research, but the payoffs include less time spent buying and selling and fewer commission payments. (False signals can drown out underlying trends. Find out how to tone them down and tune them out in Trading Without Noise.)
Love the Business You Buy
You wouldnt pick a spouse based solely on his or her shoes, and you shouldnt pick a stock based on cursory research. You have to love the business you are buying, and that means being passionate about knowing everything about that company. You need to strip the attractive covering from a companys financials and get down to the naked truth. Many companies look far better when you judge them on basic price to earnings (P/E), price to book (P/B) and earnings per share (EPS) ratios than they do when you look into the quality of the numbers that make up those figures.
If you keep your standards high and make sure the companys financials look as good naked as they do dressed up, youre much more likely to keep it in your portfolio for a long time. If things change, youll notice it early. If you like the business you buy, paying attention to its ongoing trials and successes becomes more of a hobby than a chore.
Simple Is Best
If you dont understand what a company does or how, then you probably shouldnt be buying shares. Critics of value investing like to focus on this main limitation. You are stuck looking for businesses that you can easily understand because you have to be able to make an educated guess about the future earnings of the business. The more complex a business is, the more uncertain your projections will necessarily be. This moves the emphasis from educated to guess.
You can buy businesses you like but dont completely understand, but you have to factor in uncertainty as added risk. Any time a value investor has to factor in more risk, he has to look for a larger margin of safety - that is, more of adiscount from the calculated true value of the company. There can be no margin of safety if the company is already trading at many multiples of its earnings, which is a strong sign that, however exciting and new the idea is, the business is not a value play. Simple businesses also have an advantage, as its harder for incompetent management to hurt the company. (For a complete guide to reading the financial reports, check out our Financial Statements Tutorial.)
Look for Owners, Not Managers
Management can make a huge difference in a company. Good management adds value beyond a companys hard assets. Bad management can destroy even the most solid financials. There have been investors who have based their entire investing strategies on finding managers that are honest and able. To quote Buffett, look for three qualities: integrity, intelligence, and energy. And if they dont have the first, the other two will kill you. You can get a sense of managements honesty through reading several years worth of financials. How well did they deliver on past promises? If they failed, did they take responsibility, or gloss it over? (Find out more about Buffetts investing in Warren Buffett: How He Does It.)
Value investors want managers who act like owners. The best managers ignore the market value of the company and focus on growing the business, thus creating long-term shareholder value. Managers who act like employees often focus on short-term earnings in order to secure a bonus or other performance perk, sometimes to the long-term detriment of the company. Again, there are many ways to judge this, but the size and reporting of compensation is often a dead give away. If youre thinking like an owner, you pay yourself a reasonable wage and depend on gains in your stock holdings for a bonus. At the very least, you want a company that expenses its stock options. (Still wondering how to investigate the top brass? Check out Evaluating A Companys Management.)
When You Find a Good Thing, Buy a Lot
One of the areas where value investing runs contrary to commonly accepted investing principles is on the issue of diversification. There are long stretches where a value investor will be idle. This is because of the exacting standards of value investing as well as overall market forces. Toward the end of a bull market, everything gets expensive, even the dogs, so a value investor may have to sit on the sidelines waiting for the inevitable correction. Time, an important factor in compounding, is lost while waiting, so when you do find undervalued stocks, you should buy as much as you can. Be warned, this will lead to a portfolio that is high-risk according to traditional measures like beta. Investors are encouraged to avoid concentrating on only a few stocks, but value investors generally feel that they can only keep proper track of a few stocks at a time.
One obvious exception is Peter Lynch, who kept almost all of his funds in stocks at all times. Lynch broke stocks into categories and then cycled his funds through companies in each category. He also spent upwards of 12 hours every day checking and rechecking the many stocks held by his fund. As an individual value investor with a different day job, however, its better to go with a few stocks for which youve done the homework and feel good about holding long term. (Learn the basic tenets that helped this famous investor earn his fortune in Pick Stocks Like Peter Lynch.)
Measure Against Your Best Investment
Anytime you have more investment capital, your aim for investing should not be diversity, but finding an investment that is better than the ones you already own. If the opportunities dont beat what you already have in your portfolio, you may as well buy more of the companies you know and love, or simply wait for better times. During idle times, a value investor can identify the stocks he or she wants and the price at which theyll be worth buying. By keeping a wish list like this, youll be able to make decisions quickly in a correction.
Ignore the Market 99% of the Time
The market only matters when you enter or exit a position; the rest of the time, it should be ignored. If you approach buying stocks like buying a business, youll want to hold onto them as long as the fundamentals are strong. During the time you hold an investment, there will be spots where you could sell for a large profit and others were youre holding an unrealized loss. This is the nature of market volatility.
The reasons for selling a stock are numerous, but a value investor should be as slow to sell as he or she is to buy. When you sell an investment, you expose your portfolio to capital gains and usually have to sell a loser to balance it out. Both of these sales come with transaction coststhat make the loss deeper and the gain smaller. By holding investments with unrealized gains for a long time, you forestall capital gains on your portfolio. The longer you avoid capital gains and transaction costs, the more you benefit from compounding. (Find out how your profits are taxed and what to consider when making investment decisions in Tax Effects On Capital Gains.)
The Bottom Line
Value investing is a strange mix of common sense and contrarian thinking. While most investors can agree that a detailed examination of a company is important, the idea of sitting out on a bull market goes against the grain. Its undeniable that funds held constantly in the market have outperformed cash held outside the market, waiting for a down market. This is a fact, but a deceiving one. The data is derived from following the performance of indexes like the S
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.
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.
How To Manage Your Company Stock
If you work for a larger corporation theres a good chance that you have access to company stock as part of your compensation package. Your company may issue stock options or you may have access to company stock in your 401(k) retirement plan or an employee stock purchase plan. Heres what you need to know about managing company stock.
Its Not Different
When you think about your company stock, do you see it as a different kind of investment than you would make in the stock market? Does it feel more stable and secure to you since you know so much about the company? Holding company stock as part of your overall investment portfolio is no different than buying the stock of another company through your brokerage account.
The truth is that you likely have very little knowledge of news and events that would directly affect the price of the stock. Its illegal for company management to give you advance knowledge of coming events and if youre one of the decision makers that has access to the knowledge, youre aware of the tight restrictions you have when trading your stock.
Dont adopt a false sense of security because you work there. History is filled with past employees of now bankrupt companies that were left holding worthless company stock, (Enron, Lehman Brothers, etc.)
Dont Own More Than 10%.
If your main investment dollars are in a 401(k), no more than 10% of your 401(k) should be in company stock and some experts advise much less. If you have investments outside of your 401(k), your company stock should make up no more than 10% of your entire portfolio. How would you feel if you lost 10% of your portfolio? If that scares you, trim your company stock down to 5% or even less.
How About Company Stock Options?
Many employees make the mistake of letting their stock options gain too much value, because they dont understand how they work. They also dont understand that the value of stock options degrade over time. If youre awarded stock options, typically you receive a certain amount of options that have to go through a vesting period - this means that you cant exercise these options right away. Once youre able to exercise the options, you want the options to be above the strike price before you exercise.
Employee stock options not only have a minimum amount of time that goes by before you exercise the option, theres also a maximum. Count these options as part of your overall portfolio and although you shouldnt let this part of your portfolio become too large, when to exercise the options is complicated and best done with the help of a trusted financial adviser. Make sure they discuss the tax implications with you.
Should You Sell?
According to Reuters, purchasing company stock is on the decline and for good reason. For investors without the time or experience to manage individual stocks, mutual funds, some exchange traded funds and index funds are better, more diversified alternatives to owning single company stocks, even if the company happens to be your employer. If you dont have a high level of stock market knowledge, owning company stock outside of stock options is a bad idea.
The Bottom Line
The company stock you own in one of the many forms should not violate the rules of good diversification. No more than 10% of your portfolio should be in any one stock even if the company supplies your paycheck. Also remember that like any investment, company stock comes with the same risk as any other single stock. Dont hold a false sense of security since the company happens to employ you.
Biggest Industry Ups And Downs Of 2011
February 06, 2012 | Filed Under » Bear Market, Bull Market, Economy, Investing Basics
2011 was an eventful year for the American economy, and it seems to be slowly getting back on track. The last few weeks of 2011 started seeing some positive activity in consumer spending. Banking is slowly recovering, as is the demand for cars. Employment opportunities have improved with unemployment down to 8.5%. However, it was a recession-hit year for the economy, with greater focus on creating higher consumption through greater government spending.
SEE: Consumer Spending As A Market Indicator
According to the Chief Financial Officer of Washington DC, Natwar Gandhi, There is no consumer demand as we speak. The businesses are not investing, as they do not see any demand out there. So the only player who can really generate demand is government. The government needs to spend money. There is a need to spend money on our infrastructure, which is abysmal. Unless government spends money to generate demand, I see very likely a lost decade, the kind that the Japanese have experienced over the last 10 years.
Lets take a look at the industries that performed the best and the worst in the year 2011. We will keep the Standard and Poors (S
How To Efficiently Read An Annual Report
A companys annual report is the single most important way for it to convey itself to potential investors. As such, it should come as no surprise that an annual report serves to present the company in best light possible without violating any Securities and Exchange Commission (SEC) regulations. Unfortunately, many investors read annual reports but fail to read them effectively. In other words, while annual reports are clearly prepared without any intent to deceive or reflect dishonesty about the business, investors should always read them with a sense of skepticism. In other words, learn how to read between the lines and decipher the actual condition of the company. Annual Report Vs. 10-K Filing
Typically, a company will file both an annual report and 10-K report to the SEC. An annual report is the shorter version that often comes with pictures, nice glossy color pages, a letter from the Chairman/CEO and an overview of the financials.
The 10-K is the black and white, no color pictures document that is submitted to the SEC. Very often, a business will simply file the 10-K as its annual report since that document is mandatory for every public company. So guess which one carries more significance to the investor - the longer and more boring 10-K filing. Think of the glossy annual report as informative marketing material. If a company does file both reports, use the annual report as a great first look at a business before tackling the 10-K filing. Very often, the annual report and 10-K are merged into one document, with the annual report at the beginning to provide an overview of the years results.
The Components of an Annual Filing
If you are interested in investing in a public company you can not avoid examining and reading the 10-K filing, which I will now refer to as the annual report.
The 10-Ks begin with a detailed description of the business, followed by risk factors, a rundown of any legal issues, and, finally, the numbers and financial notes in the back. Oftentimes, the most essential components of the annual filing are the following items:
• Item 1: Business - a description of the companys operation
• Item 1A: Risk Factors
• Item 3: Legal Proceedings
• Item 6: Selected Financial Data
• Item 7: Managements Discussion and Analysis of Financial Condition
How to Tackle
People read annual reports in different ways. Some investors even prefer to start at the back and work their way to the beginning. It makes no difference how you read them, as long you absorb the essential points of the business and its financial condition. However, there is a good way to tackle these reports that is both most efficient and most effective.
Without question, you should first read Item 1, which is the business description. You cant possibly go any further in your research without knowing what the company does! Also, by getting to know the business first, you can then determine if you need to go any further. That determination is simple. Just ask yourself if you understand what the company does, who its customers are, and the industry it operates in. If you answer no, youre done. Move on to the next business.
Next, you should jump to Items 6 and 7 and examine and analyze the financial data . How has the company performed over a period of years? Has the balance sheet gotten stronger or weaker over time? Look over the cash flow statement and see if the business has been a generator of cash or a user of cash. Its possible for businesses to report net income while at the same time remaining cash flow negative. Compare the income statement with the cash flow statement for any red flags. If you like what you see, move on and if not, move on to the next company.
Afterwards its time to determine if any hidden surprises may lurk beneath the surface. So you must now go back and read the risk factors section and the legal proceedings section, if any legal matters exist. Because this is a filing to the SEC, the risk factors will be very detailed and include risks like our industry is highly fragmented with lots of competitors or our stock price may experience periods of volatility. While these are important risks to consider, they should not significantly reduce the desirability of the business.
Instead, focus on any unusual risk factors, such as if the company generates a substantial portion of its revenues for one or two customers. In addition, the Legal Proceedings section will alert you if any significant lawsuits are in the works. Again, dont ignore any legal liabilities, but if youre looking at a billion dollar company and it has a pending lawsuit against it for damages of $10 million, thats not uncommon. Pfizer, one of the largest drug companies in the world, will also have patent lawsuits and drug liability claims that may exceed hundreds of millions of dollars. But thats part of the normal course of business for any major pharmaceutical company, and a drop in the bucket for Pfizer when you see that the company has over $50 billion in cash and short-term investments on the balance sheet.
Focus on What You Know
We all have different ways of deciphering and storing information. Feel free to read the annual report in a way that works for you. But learn to concentrate on the most important aspects of a companys 10-K filing. By doing so, you will avoid wasting unnecessary time on companies that do not meet your investment suitability. But always remember that just because you arent investing in that particular business that you have wasted your time. Investing is a discipline that rewards those who are continuously learning.
Banking On Blue Chip Stocks
Blue chip stocks, named after the highest-valued chips in poker, are prized investment holdings representing ownership in some the most successful firms in the economy. If you want to invest in companies that have proven their ability to ride out economic downturns and maintain profitability even when times get tough, you should take a look at these stocks.
Basic Characteristics of Blue Chip Stocks
A blue chip stock is a share of ownership in a large, well-established and stable company that has a long history of consistent earnings growth and dividend payments. Blue chip companies have a large market capitalization, strong balance sheets and good cash flow. Blue chip stocks have low volatility overall, but strong changes in the overall market can also have strong effects on these stocks. The performance of an individual blue chip company will tend to correlate closely with the performance of the S
Dollar-Cost Averaging Pays
Dollar-cost averaging (DCA) is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. This type of systematic investment program is familiar to many investors, as they practice it with their 401(k) and 403(b) retirement plans. When it comes to implementing investment strategies based on dollar-cost averaging, there may be no better investment vehicle than the no-load mutual fund - the structure of these mutual funds almost seems to have been designed with dollar-cost averaging in mind. Here we look at why, helping you use dollar-cost averaging when investing in mutual funds .
Review of Dollar-Cost Averaging
Dollar-cost averaging is carried out simply by investing a fixed dollar amount into your mutual fund (or other investment instrument) at pre-determined intervals. The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per dollar invested due to the higher cost per share. When the markets are down, the situation is reversed and you purchase a greater of number of shares per dollar invested. Its a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you dont have to invest the time and effort to monitor market movements and strategically time your investments.
Why Dollar-Cost Averaging Works Well With Mutual Funds
The expense ratio that mutual fund investors pay to invest in a fund is a fixed percentage of your contribution. That percentage takes the same relative bite out of a $25 investment or regular installment amount as it would out of a $250 or $2,500 lump-sum investment. Compared tostock trades , for example, where a flat commission is charged on each transaction, the value of the fixed-percentage expense ratio is startlingly clear. Consider the following:
Example A
• By making a $25 installment in a mutual fund that charges a 20 basis-point expense ratio, you pay $0.05, which amounts to a 0.2% fee.
• By making a $250 lump-sum investment in the same fund, you pay $0.50, or a 0.2% fee.
Example B
• By making a $25 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10, which amounts to a 40% fee.
• By making a $250 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10.00, which amounts to a 4% fee.
The examples above show that you have to buy more stock in order for the percentage of the commissions to go down. In comparison, the structure of the mutual fund expense ratio makes the investment more accessible: the no-commission trading of the mutual fund coupled with low minimum investment requirements allows almost everyone to afford mutual funds.
Furthermore, many mutual funds waive their required minimums for investors who set up automatic contribution plans (plans that put dollar-cost averaging into action). All this enables low-wage earners and folks with tight budgets to invest $10 or $25 or another nominal amount on a regular basis without worrying about the impact of trading costs. While small contributions may not seem impressive at first glance, they enable investors to get into the habit of saving, and can really add up over the course of a lifetime thanks to the power of compounding.
Of course, dollar-cost averaging with mutual funds isnt a strategy that is limited to use by the less than affluent. If you have a large sum of money and invest it all at once, you face the risk that declining financial markets will take a huge chunk out of your portfolio. Dollar-cost averaging offers the perfect solution to your dilemma. To facilitate a long-term strategy for investing large sums of money, many mutual funds offer investors the ability to make a lump-sum investment in a money market fund, from which predetermined amounts are automatically invested into a designated higher-risk mutual fund at pre-arranged intervals. Its a convenient, cost-efficient solution that mitigates concerns about investing a large sum of money at the wrong time.
A Long-Term Strategy
Regardless of the amount of money that you have to invest, dollar-cost averaging is a long-term strategy. While the financial markets are in a constant state of flux, they tend to move in the same general direction over fairly long periods of time. Bear markets and bull markets can last for months, if not years. Because of these trends, dollar-cost averaging is generally not a particularly valuable short-term strategy.
Consider, for example, an investor making 10 purchases of a mutual funds shares over the course of a month. While it is unlikely that the purchase price of the shares will be identical for each transaction, it is also unlikely that they will differ significantly over such a short time frame.
On the other hand, over the course of a market cycle lasting five or 10 years and including a bull market and a bear market, the price of a given security is likely to change significantly. Dollar-cost averaging will help to ensure that your average cost per share represents both the premiumsof a bull market and the discounts of a bear market, as opposed to just the premiums usually paid by investors in a bull market.
Conclusion: Keep Costs in Mind
While low, percentage-based expense ratios make mutual funds the perfect vehicle for dollar-cost averaging, it pays to exercise caution when it comes to your investments . Some mutual funds charge low-balance fees, sales loads, purchase fees and/or exchanges fees. Be sure to read the disclosure materials prior to investing and make sure you are aware of all expenses associated with your investments.
Valuing Firms Using Present Value Of Free Cash Flows
Decisions to invest can be made based on simple analysis such as finding a company you like with a product you think will be in demand in the future. The decision might not be based on scouring the financial statements, but the underlying reason for picking this type of company over another is still sound. Your underlying prediction is that the company will continue to produce and sell high-demand products and thus will have cash flowing back to the business. The second, and very important, part of the equation is that the companys management knows where to spend this cash to continue operations. A third assumption is that all of these potential future cash flows are worth more today than the stocks current price.
To place numbers into this idea, we could look at these potential cash flows from the operations, and find what they are worth based on their present value. In order to determine the value of a firm, an investor must determine the present value of operating free cash flows. Of course, we need to find the cash flows before we can discount them to the present value.
Calculating Operating Free Cash Flow
Operating free cash flow (OFCF) is the cash generated by operations, which is attributed to all providers of capital in the firms capital structure. This includes debt providers as well as equity. Calculating the OFCF is done by taking earnings before interest and taxes and adjusting for the tax rate, then adding depreciation and taking away capital expenditure, minus change in working capital and minus changes in other assets. Here is the actual formula:
OFCF = EBIT(1-T) depreciation - CAPEX - ??working capital - ??any other assets
Where:
EBIT = earnings before interest and taxes
T= tax rate
CAPEX = capital expenditure
This is also referred to as the free cash flow to the firm, and is calculated in such as way to reflect the overall cash-generating capabilities of the firm before deducting debt related interest expenses and non-cash items. Once we have calculated this number, we can calculate the other metrics needed such as the growth rate. (These five qualitative measures allow investors to draw conclusions about a corporation that are not apparent on the balance sheet. check out Using Porters 5 Forces To Analyze Stocks.)
Calculating the Growth Rate
The growth rate can be difficult to predict and can have a drastic effect on the resulting value of the firm. One way to calculate it is to take the return on the invested capital (ROIC) multiplied by the retention rate. The retention is the percent of earnings that are held within the company and are not paid out as dividends. This is the basic formula:
g = RR x ROIC
Where:
RR= average retention rate, or (1- payout ratio)
ROIC= EBIT(1-tax)/total capital
Present Value of Operating Free Cash Flows
The valuation method is based on the operating cash flows coming in after deducting the capital expenditures, which are the costs of maintaining the asset base. This cash flow is taken before the interest payments to debt holders in order to value the total firm. Only factoring in equity, for example, would provide the growing value to equity holders. Discounting any stream of cash flows requires a discount rate, and in this case it is the cost of financing projects at the firm. The weighted average cost of capital (WACC) is used for this discount rate. The operating free cash flow is then discounted at this cost of capital rate using three potential growth scenarios; no growth, constant growth and changing growth rate.
No Growth
To find the value of the firm, discount the OFCF by the WACC. This discounts the cash flows that are expected to continue for as long as a reasonable forecasting model exists.
Firm Value = ? Operating Free Cash Flowst
(1 WACC)t
Where:
Operating Free Cash Flows = the operating free cash flows in period t
WACC = weighted average cost of capital
If you are looking to find an estimate for the value of the firms equity, subtract the market value of the firms debt.
Constant Growth
In a more mature company you might find it more appropriate to include a constant growth rate in the calculation. To calculate the value, take the OFCF of next period and discount it at WACC minus the long-term constant growth rate of the OFCF.
Value of the firm = ?OFCF1
k-g
Where:
OFCF1 = operating free cash flow
k = discount rate (in this case WACC)
g = expected growth rate in OFCF
Multiple Growth Periods
Assuming the firm is about to see more than one growth stage, the calculation is a combination of each of these stages. Using the supernormal dividend growth model for the calculation, the analyst needs to predict the higher-than-normal growth and the expected duration of such activity. After this high growth, the firm might be expected to go back into a normal steady growth into perpetuity. To see the resulting calculations, assume a firm has operating free cash flows of $200 million, which is expected to grow at 12% for four years. After four years, it will return to a normal growth rate of 5%. We will assume that the weighted average cost of capital is 10%. (Learn about the components of the statement of financial position and how they relate to each other. See Reading The Balance Sheet.)
Multi-Growth Periods of Operating Free Cash Flow (in Millions)
Period OFCF Calculation Amount Present Value
1 OFCF1 $200 x 1.121 $224.00 $203.64
2 OFCF 2 $200 x 1.122 $250.88 $207.34
3 OFCF 3 $200 x 1.123 $280.99 $211.11
4 OFCF 4 $200 x 1.124 $314.70 $214.95
5 OFCF 5 … $314.7 x 1.05 $330.44
$330.44 / (0.10 - 0.05) $6,608.78
$6,608.78 / 1.104 $4,513.89
NPV $5,350.92
Table 1: The two stages of the OFCF goes from a high growth rate (12%) for four years followed by a perpetual constant 5% growth from the fifth year on. It is discounted back to the present value and summed up to $5.35 billion dollars.
Both the two-stage dividend discount model (DDM) and FCFE model allow for two distinct phases of growth: an initial finite period where the growth is abnormal, followed by a stable growth period that is expected to last forever. In order to determine the long-term sustainable growth rate, one would usually assume that the rate of growth will equal the long-term forecasted GDP growth. In each case the cash flow is discounted to the present dollar amount and added together to get a net present value.
Comparing this to the companys current stock price can be a valid way of determining the companys intrinsic value. Recall that we need to subtract the total current value of the firms debt to get the value of the equity. Then, divide the equity value by common shares outstanding to get the value of equity per share. This value can then be compared to how much the stock is selling for in the market to see if it is over- or undervalued.
The Bottom Line
Calculations dealing with the value of a firm will always use unique methods based on the firm being examined. Growth companies might need a two-period method when there is higher growth for a couple years. In a larger, more mature company you can use a more stable growth technique. It always comes down to determining the value of the free cash flows and discounting them to today. (Calculate whether the market is paying too much for a particular stock.
How To Double Your Money Every 6 Years
Double your money, fast! Do those words sound like the tagline of a get-rich-quick scam? If you want to analyze offers like these or establish investment goals for your portfolio, theres a quick-and-dirty method that will show you how long it will really take you to double your money. Its called the rule of 72, and it can be applied to any type of investment. (For more ideas on how you can double your money, check out 5 Ways To Double Your Investment.)
TUTORIAL: Investing 101
How the Rule Works
To use the rule of 72, divide the number 72 by an investments expected annual return. The result is the number of years it will take, roughly, to double your money. For example, if the expected annual return of about 2.35% (the current rate on Ally Banks 5-year high-yield CD) and you have $1,000 to invest, it will take 72/2.35 = 30.64 years for you to accumulate $2,000.
Depressing, right? CDs are great for safety and liquidity, but lets look at a more uplifting example: stocks. Its impossible to actually know in advance what will happen to stock prices. We know that past performance does not guarantee future returns. But by examining historical data, we can make an educated guess. According to Standard and Poors, the average annualized return of the S
What Is Money?
Everyone uses money . We all want it, work for it and think about it. If you dont know what money is, you are not like most humans. However, the task of defining what money is, where it comes from and what its worth belongs to those who dedicate themselves to the discipline ofeconomics. While the creation and growth of money seems somewhat intangible, money is the way we get the things we need and want. Here we look at the multifaceted characteristics of money. (Get A Short-Term Advantage In The Money Market. This investment vehicle is often the perfect stop-gap measure for growing your money.)
What is Money?
Before the development of a medium of exchange, people would barter to obtain the goods and services they needed. This is basically how it worked: two individuals each possessing a commodity the other wanted or needed would enter into an agreement to trade their goods.
This early form of barter, however, does not provide the transferability and divisibility that makes trading efficient. For instance, if you have cows but need bananas, you must find someone who not only has bananas but also the desire for meat. What if you find someone who has the need for meat but no bananas and can only offer you bunnies? To get your meat, he or she must find someone who has bananas and wants bunnies .
The lack of transferability of bartering for goods, as you can see, is tiring, confusing and inefficient. But that is not where the problems end: even if you find someone with whom to trade meat for bananas, you may not think a bunch of them is worth a whole cow. You would then have to devise a way to divide your cow (a messy business) and determine how many bananas you are willing to take for certain parts of your cow. (It can be hard to talk about money with your children, especially when times are tough. Talking About Money When Times Are Tough has some tips to make it easy.)
To solve these problems came commodity money, which is a kind of currency based on the value of an underlying commodity. Colonialists, for example, used beaver pelts and dried corn as currency for transactions. These kinds ofcommodities were chosen for a number of reasons. They were widely desired and therefore valuable, but they were also durable, portable and easily stored.
Another example of commodity money is the U.S. currency before 1971, which was backed by gold. Foreign governments were able to take their U.S. currency and exchange it for gold with the U.S. Federal Reserve. If we think about this relationship between money and gold, we can gain some insight into how money gains its value: like the beaver pelts and dried corn, gold is valuable purely because people want it.
It is not necessarily useful - after all, you cant eat it, and it wont keep you warm at night, but the majority of people think it is beautiful, and they know others think it is beautiful. Gold is something you can safely believe is valuable. Before 1971, gold therefore served as a physical token of what is valuable based on peoples perception. You dont need an MBA to learn how to save money and invest in your future.
Impressions Create Everything
The second type of money is fiat money, which does away with the need to represent a physical commodity and takes on its worth the same way gold did: by means of peoples perception and faith. Fiat money was introduced because gold is a scarce resource and economies growing quickly couldnt always mine enough gold to back their money requirement. For a booming economy, the need for gold to give money value is extremely inefficient, especially when, as we already established, value is really created through peoples perception.
Fiat money, then becomes the token of peoples apprehension of worth - the basis for why money is created. An economy that is growing is apparently doing a good job of producing other things that are valuable to itself and to other economies. Generally, the stronger the economy, the stronger its money will be perceived (and sought after) and vice versa. But, remember, this perception, although abstract, must somehow be backed by how well the economy can produce concrete things and services that people want.
That is why simply printing new money will not create wealth for a country. Money is created by a kind of a perpetual interaction between concrete things, our intangible desire for them, and our abstract faith in what has value: money is valuable because we want it, but we want it only because it can get us a desired product or service.
How is it Measured?
Sure, money is the $10 bill you lent to your friend the other day and dont expect back anytime soon. But exactly how much money is out there and what forms does it take? Economists and investors ask this question everyday to see whether there is inflation or deflation. To make money more discernible for measurement purposes, they have separated it into three categories:
• M1 – This category of money includes all physical denominations of coins and currency, demand deposits, which are checking accounts and NOW accounts, and travelers checks. This category of money is the narrowest of the three and can be better visualized as the money used to make payments.
• M2 – With broader criteria, this category adds all the money found in M1 to all time-related deposits, savings deposits, and non-institutional money-market funds. This category represents money that can be readily transferred into cash.
• M3 – The broadest class of money, M3 combines all money found in the M2 definition and adds to it all large time deposits, institutional money-market funds , short-term repurchase agreements, along with other larger liquid assets.
By adding these three categories together, we arrive at a countrys money supply, or total amount of money within an economy.
How Money is Created
Now that weve discussed why and how money, a representation of perceived value, is created in the economy, we need to touch on how the central bank (the Federal Reserve in the U.S.) can manipulate the money supply.
Among other things, a central bank has the ability to influence the level of a countrys money supply. Lets look at a simplified example of how this is done. If it wants to increase the amount of money in circulation, the central bank can, of course, simply print it, but as we learned, the physical bills are only a small part of the money supply.
Another way for the central bank to increase the money supply is to buy government fixed-income securities in the market. When the central bank buys these government securities, it puts money in the hands of the public. How does a central bank such as the Federal Reserve pay for this? As strange as it sounds, they simply create the money out of thin air and transfer it to those people selling the securities! To shrink the money supply, the central bank does the opposite and sells government securities. The money with which the buyer pays the central bank is essentially taken out of circulation. Keep in mind that we are generalizing in this example to keep things simple.
Conclusion
Remember, as long as people have faith in the currency, a central bank can issue more of it. But if the Fed issues too much money, the value will go down, as with anything that has a higher supply than demand. So even though technically it can create money out of thin air, the central bank cannot simply print money as it wants.
Pros And Cons Of Offshore Investing
Offshore investing is often demonized in the media, which paints a picture of investors stashing their money with some illegal company located on an obscure Caribbean island where the tax rate is next to nothing. While its true that there will always be instances of shady offshore deals, the vast majority of offshore investing is perfectly legal. In fact, depending on your situation, offshore investing may offer you many advantages.
Tutorial: Personal Income Tax Guide
What Is Offshore Investing?
Offshore investing refers to a wide range of investment strategies that capitalize on advantages offered outside of an investors home country. We will briefly touch on the advantages and disadvantages of offshore investing. The particulars are far beyond the scope of this introductory article.
There is no shortage of money-market, bond and equity assets offered by reputable offshore companies that are fiscally sound, time-tested and, most importantly, legal.
Advantages
There are several reasons why people invest offshore:
Tax Reduction - Many countries (known as tax havens) offer tax incentives to foreign investors. The favorable tax rates in an offshore country are designed to promote a healthy investment environment that attracts outside wealth. For a tiny country with very few resources and a small population, attracting investors can dramatically increase economic activity. Simply put, offshore investment occurs when offshore investors form a corporation in a foreign country. The corporation acts as a shell for the investors accounts, shielding them from the higher tax burden that would be incurred in their home country. Because the corporation does not engage in local operations, little or no tax is imposed on the offshore corporation. Many foreign companies also enjoy tax-exempt status when they invest in U.S. markets. As such, making investments through foreign corporations can hold a distinct advantage over making investments as an individual. (For additional information, read What is an Emerging Market Economy?)
In recent years, however, the U.S. government has become increasingly aware of the tax revenue lost to offshore investing, and has created more defined and restrictive laws that close tax loopholes. Investment revenue earned through offshore investment is now a focus of regulators and the tax man alike. According to the U.S. Internal Revenue Service (IRS), U.S. citizens and residents are now taxed on their worldwide income. As a result, investors who use offshore entities to evade U.S. federal income tax on capital gains can be prosecuted for tax evasion. Therefore, although the lower corporate expenses of offshore companies can translate into better gains for investors, the IRS maintains that U.S. taxpayers are not to be allowed to evade taxes by shifting their individual tax liability to some foreign entity. (To learn more, see How International Tax Rates Impact Your Investments.)
Asset Protection - Offshore centers are popular locations for restructuring ownership of assets. Through trusts, foundations or through an existing corporation individual wealth ownership can be transferred from people to other legal entities. Many individuals who are concerned about lawsuits, or lenders foreclosing on outstanding debts elect to transfer a portion of their assets from their personal estates to an entity that holds it outside of their home country. By making these on-paper ownership transfers, individuals are no longer susceptible to seizure or other domestic troubles. If the trustor is a U.S. resident, their trustor status allows them to make contributions to their offshore trust free of income tax. However, the trustor of an offshore asset-protection fund will still be taxed on the trusts income (the revenue made from investments under the trust entity), even if that income has not been distributed.
Confidentiality - Many offshore jurisdictions offer the complimentary benefit of secrecy legislation. These countries have enacted laws establishing strict corporate and banking confidentiality. If this confidentiality is breached, there are serious consequences for the offending party. An example of a breach of banking confidentiality is divulging customer identities; disclosing shareholders is a breach of corporate confidentiality in some jurisdictions. However, this secrecy doesnt mean that offshore investors are criminals with something to hide. Its also important to note that offshore laws will allow identity disclosure in clear instances of drug trafficking, money laundering or other illegal activities. From the point of view of a high-profile investor, however, keeping information, such as the investors identity, secret while accumulating shares of a public company can offer that investor a significant financial (and legal) advantage. High-profile investors dont like the public at large knowing what stocks theyre investing in. Multi-millionaire investors dont want a bunch of little fish buying the same stocks that they have targeted for large volume share purchases - the little guys run up the prices.
Because nations are not required to accept the laws of a foreign government, offshore jurisdictions are, in most cases, immune to the laws that may apply where the investor resides. U.S. courts can assert jurisdiction over any assets that are located within U.S. borders. Therefore, it is prudent to be sure that the assets an investor is attempting to protect not be held physically in the United States.
Diversification of Investment - In some countries, regulations restrict the international investment opportunities of citizens. Many investors feel that such restriction hinders the establishment of a truly diversified investment portfolio. Offshore accounts are much more flexible, giving investors unlimited access to international markets and to all major exchanges. On top of that, there are many opportunities in developing nations, especially in those that are beginning to privatize sectors that were formerly under government control. Chinas willingness to privatize some industries has investors drooling over the worlds largest consumer market. (To read more, see Investing Beyond Your Borders.)
Disadvantages
Tax Laws are Tightening - Tax agencies like the IRS arent ignorant of offshore strategies. Theyve clamped down on some traditional ways of tax avoidance. There are still loopholes, but most are shrinking more and more every year. In 2004, the IRS amended the Internal Revenue Code (IRC) and began to collect taxes from both American corporations that operate out of another country and American citizens and residents who earn money through offshore investments. (For more information on tax laws that affect offshore investors, see the IRS International Taxpayer - Expatriation Tax.)
Cost - Offshore Accounts are not cheap to set up. Depending on the individuals investment goals and the jurisdiction he or she chooses, an offshore corporation may need to be started. Setting up an offshore corporation may mean steep legal fees, corporate or account registration fees and in some cases investors are even required to own property (a residence) in the country in which they have an offshore account or operate a holding company. Furthermore many offshore accounts require minimum investments of between $100,000 and $1 million. Businesses that make money facilitating offshore investment know that their offerings are in high demand by the very wealthy and they charge accordingly.
How Safe Is Offshore Investing?
Popular offshore countries such as the Bahamas, Bermuda, Cayman Islands and Isle of Man are known to offer fairly secure investment opportunities. More than half of the worlds assets and investments are held in offshore jurisdictions and many well-recognized companies have investment opportunities in offshore locales. Still, like every investment you make, use common sense and choose a reputable investment firm. It is also a good idea to consult with an experienced and reputable investment advisor, accountant, and lawyer who specializes in international investment. If you are looking to protect your assets, or are concerned with estate planning or business succession, it would be prudent to find an attorney (or a team of attorneys) specializing in asset protection, wills or business succession. Of course, these professionals come at a cost. In most cases the benefits of offshore investing are outweighed by the tremendous costs of professional fees, commissions, travel expenses and downside risk. (For more information, see Investment Scams: Prime Banks.)
Conclusion
We are not lawyers, tax accountants or offshore investment experts in any country. Every individuals situation is different. Offshore investment is beyond the means of most investors, and above the risk tolerance of others.
Despite the many pitfalls of offshore investing, it can still pay off to shift some investment assets from one jurisdiction to another. As with even the most insignificant investment, do your research before parting with your money - unless youre prepared to lose it.
Is Your Investment Strategy Going Extinct?
Nothing lasts forever, including the effectiveness of some investment strategies. True, some basic ideas like buy the stocks of high-quality companies when theyre trading cheaply seem to operate with no expiration date, but other strategies seem to work only for a while, before reverting back to market-average or worse returns. Let us examine some of the strategies that may be on the way out. (Avoid taking premature profits or running losses by setting appropriate exit points, see A Look At Exit Strategies.)
TUTORIAL: Stock-Picking Strategies
The Safe Haven
Whenever the markets turn rough and some sector happens to go up (or go down less), investors and commentators are more than happy to anoint a new safe haven for investors. Gold has been a safe haven at many points in history. Bonds have been safe havens, as have dividend-paying stocks, utility stocks, consumer goods stocks and so on. (For related reading, see The Advantages Of Bonds.)
For example, healthcare was supposed to be a safe haven. Yet, during the recession in the late 2000s healthcare underperformed as pharmaceutical companies suffered from patent cliffs and medical device companies bore the brunt of lower patient visits and tight hospital capital budgets.
That, then, is the problem – every crisis is different, as is the optimal path through that crisis. Whats more, people often underestimate the importance of timing when it comes to picking a safe haven. If an investor has a firm conviction that Asset X is going to be a safe place to weather the next storm, he or she would do well to get in early so that the other investors piling in later push up the price. Likewise, getting out on time is important as well – once the danger passes and everybody wants out of the safe haven, prices can drop so quickly that those slow to leave end up holding the bag.
Arbitrage
Arbitrage investing is all about making dollars a few pennies at a time – trading on the small discrepancies in prices between exchanges or an announced deal and current valuations. Unfortunately, the increased liquidity and access to markets has largely eliminated these easy profits. Arbitrage is still possible, but it tends to only be profitable for traders with the infrastructure to make large trades at lightning speed. This is not something that can be handled by a friendly retail internet broker. (For related reading, see Trading The Odds With Arbitrage.)
Dogs of the Dow
The Dogs of the Dow offered a simple value-oriented approach to investing. Investors would choose from those stocks making up the Dow Jones Industrial Average, selecting for a portfolio on the basis of the highest dividend yields and lowest stock prices, with annual rebalancing. In theory, this offered up a portfolio of relatively undervalued large-cap companies that should outperform the market (based in large part on the assumption that those dividend yields should revert to the mean).
The evidence is mixed as to whether the Dogs of the Dow strategy ever worked as advertised; some academics have made the case that the advertised results were a product of data mining and not reproducible in practice. In any case, there have been several public attempts to implement the strategy and they have failed. Whether that failure is a product of the markets simply filling in a previously unknown gap or whether the strategy never worked at all is moot – the point is that it no longer seems to work. (For related reading, see Barking Up The Dogs Of The Dow Tree.)
Guru of the Month
From time to time an investment advisor pops up with a sure-fire strategy for making money in the market. Many of these approaches are outright scams, but some are sincere attempts to offer a combination of formulas and stock characteristics that seem to lead to market outperformance.
The problem with many guru approaches, the legitimate ones at least, is that they exploit an inefficiency in the market. Once enough people know about an inefficiency, it tends to disappear fairly quickly. In fact, if there is some combination of return on equity, margins and EV/EBITDA that spells investment success, investors will program computers to jump on those opportunities. Moreover, other investors who try to think one step ahead will anticipate stocks that will soon sport those characteristics to take advantage of the automated market jump these stocks can expect from the computer programs – and on it goes. With all of that buying activity, the stocks are soon revalued and the market-beating potential vanishes.
Deep Value Investing
It is probably inaccurate to describe deep value investing as going extinct; most likely the last specimens died in captivity long ago. After reading some of the seminal works of investment strategy, Benjamin Grahams Security Analysis and Intelligent Investor, it used to be possible to find stocks trading below the value of the net current assets on the balance sheet. Likewise, companies often held assets worth far in excess of their stated value and the market capitalization of the company. There were profitable trades to be made by finding these stocks and waiting for the market to realize the value. (For more on value investing, see The Value Investors Handbook.)
Now, though, the market moves much faster and information is both more easily available and available more quickly than before. As a result, companies with $1 per share of cash and a $0.50 stock price just do not stick around for long. Whats more, companies have gotten savvier about singing their own praises and maximizing the market value of both their assets and stocks.
Invest Your Age
There is a school of thought that holds that investors would do well to allocate their portfolio according to their age by matching their portfolio weighting to bonds to their age in years. In other words, a 30 year old investor should hold 30% of his or her assets in fixed income, while a 60 year old investor should have double that allocation.
Back in the days of pensions and defined-benefit retirement plans, maybe this wasnt such bad advice.
Nowadays, though, it seems like a dangerously over-conservative way to invest. Whats more, people are living longer than ever before but still retiring at basically the same age (around 65). That means that they need more money in their portfolio at the time of retirement, and must continue to earn good returns on that money throughout retirement or risk running out of money.
Though it is true that stocks are generally more volatile than fixed income investments, that volatility cuts both ways; it is relatively rare for long-term equity investors to underperform fixed income. Worse still, with the corrosive and often underreported impact of inflation on fixed income assets, over-allocation to fixed income can lead to a worker having too little money saved away for retirement. (For related reading, see Young Investors: What Are You Waiting For?)
Buy-and-Hold
Perhaps the most controversial idea is that buy-and-hold investing is dead. The idea here seems to be that markets are so quick and efficient in addressing undervaluation, there is simply no chance that a stock can be undervalued for years at a time and worth holding for the long haul.
This notion seems to have really gained currency in the wake of the tech bubble, and it is certainly possible to see a few points in its favor. After all, anybody who bought a tech stock like Cisco (Nasdaq:CSCO) or Microsoft (Nasdaq:MSFT) during the bubble is still sitting on a loss. Likewise, anyone who bought and held a high-quality bank stock like US Bancorp (NYSE:USB) or M
Losing Money? Dont Blame Your Broker
Wall Street has been home to more than its fair share of scandals dealing with everything from accounting, research and access, and initial public offerings. Maybe youve just lost a fortune in the market. The money is gone, and it must be somebodys fault. There must be some way to get the money back. The next step seems obvious: sue your broker.
While it is true that you may be able to recover some or all of your losses based on broker misdeeds or misinformation, keep in mind your broker and other outside forces frequently arent solely to blame. All too often, the real culprit is staring back at you every time you look in the mirror. In this article, well look at some of the things an investor should do ensure a healthy, lawyer-free relationship with his or her broker.
A Sucker Is Born Every Minute
One of capitalisms most astounding aspects is how legions of people willingly hand over their money to complete strangers without making so much as a single telephone call to verify the strangers claims of credibility.
After giving their wallets to the stranger, these people simply sit back and wait for the money to start pouring in. And if they dont get rich and lose a portion of their initial investment, they call a lawyer and sue. On occasion, they even win the lawsuit! Win or lose though, they still feel wronged. They are victims. They have been taken advantage of by unscrupulous capitalists ... or have they?
Your Obligations As An Investor
Becoming an investor gives you certain rights. When you buy stock in a public company, for example you are entitled to a number of opportunities and rewards.
However, as an intelligent investor (or, at least as somebody who would prefer not to be victimized), you also have an obligation to do all you can to learn about the person or organization you trust with your money and the investments your money will be used to purchase. Before blindly handing over your cash, the first step is making sure youve made a strong effort to hire the right kind of help.
Start by conducting some due diligence of your own. It is the safest way to protect your investments. After all, nobody cares about your money as much as you do! It doesnt take a genius to check references and ask questions about a broker. And, of course, the only dumb question is the one that wasnt asked.
Hiring someone to give advice doesnt absolve an investor of the responsibility for accepting that advice. Once the decision has been made to hire outside help, the investors obligation to pay attention and remain fully engaged in the process doesnt disappear.
As an investor:
• Every piece of paper that you are given must be read.
• Every disclosure document must be reviewed until you understand it.
• Every item that you find confusing must be questioned.
• Every investment that you make must be researched until you are positive that you completely understand it.
• Never sign anything that you dont understand, and always get a copy of everything that you do sign.
(For additional information about the sometimes naive expectations of investors, check out Do You Understand Investment Risk?)
What If You Did Your Homework, But Still Found Trouble?
If you have chosen well, the person providing financial advice to you has a fiduciary obligation to give you good advice. Despite that obligation, nobody is right every time. Before you blame your advisor for your losses, be sure you know your rights and responsibilities. If you have truly been a responsible investor, but still feel youve been the victim of a scam, you can take your issue to arbitration, or, in the most extreme case, consult a lawyer and head off to court.
Of course, the reality of litigation is often less rewarding than most people would hope. The process takes time and, if you actually get any money back, you may not get enough to cover the full amount of your loss. To put the odds in your favor, tread slowly and carefully any time money is involved. Set realistic expectations and, if it looks too good to be true, it probably is.
3 Questions To Find Your Trading Plan
You have put in the work creating a trading plan or possibly spent money on supposedly great strategies, but you still cannot seem to turn a trading profit. Or maybe you are starting out in trading and investing and want to be cautious before you start putting real money on the line. No matter what level you are at, before you trade - or if are already trading and struggling - you should have a trading plan. That plan needs to be tailored to you and your needs; a plan that is not will likely result in a drain on your trading account.
The following three questions can save you a lot of grief. Run through these questions during your planning stages to make sure your plan will serve you well. If it cannot pass this three question test, it should not be used.
SEE: Day Trading Strategies For Beginners
Why Ask These Questions?
Executing a plan is not just about the design itself, it is about the person executing that plan. Someone can search their whole life for a great trading system, not realizing it is themselves that need work, not the system. Therefore, these questions take the plan and the trader into account, making sure the two fit together. No matter how good a trading plan, it is useless if the trader cannot personally stick to it or implement it properly.
These three questions will help to clarify the traders objectives for the trading plan, take inventory of the consequences which may arise by executing the plan, and determine if they will be able to even stick with their plan, given their personality.
1. Does the Plan Allow Me to Achieve the Outcome I Want?
Sounds simple enough, but not so fast.
An outcome needs to be specific and measurable. Stipulating I want to be rich is not concise enough. What is the ultimate goal that you want your trading plan to bring you? Is the outcome feasible and reasonable? Can the plan you currently have actually produce that, or given the realities of the plan is it likely to fall short of the outcome you desire?
The plan and outcome must also balance short-term and long-term goals. While the long-term goal may be to be financially independent, continually trying to make as much money as possible in the short-term with high risk trades could jeopardize the long-term goal. Short-term goals must work in harmony with the long-term goals, not against them. Brainstorm what you want your trading plan to produce and make sure that the plan works to satisfy both the short and long-term desired outcomes.
2. What Are the Consequences and Risks of My Plan, and Can I Deal with Them?
In this step we strip away the fantasy and focus on reality. The fact is most traders lose money - even very smart ones - so how is your plan different? All plans have risk; what is the downside of the strategies you have employed? Go through the plan and write down all of the risks and pitfalls you see.
Now, also consider consequences outside of trading. Will realizing your plan mean you spend less time with family or friends? Will it mean cutting back on certain expenses? Will it create more stress (less stress) or cut into other work time?
Once all the potential risk and pitfalls of your strategy have been fully and honestly addressed, can you realistically handle all the potential consequences of trading this plan? If so, proceed. If not, rework the plan making sure the consequences of your plan are within your personal tolerance.
3. Does the Plan Account for Me Being Me?
This is the most important question, as ultimately you must be able to implement the plan. A plan means nothing if you cannot execute it.
If you cannot sit in front of a screen for more than 30 minutes, no matter how good your plan is you will likely not be a good day trader. Or, if you cannot sleep at night with an open position, your swing trading plan will likely do you no good. You will continually struggle to adhere to it.
We each have different traits and tendencies. If you have a gambling streak, account for this in your plan - maybe have a demo account off to the side (or have a play money poker game open) so you can satisfy your gambling craving without losing real money. Plan and account for everything.
Be brutally honest, and make sure your trading plan accounts for the market and yourself. Accept yourself for your tendencies, and make sure that the plan can actually be employed by you based on who you are. Do not sugar coat anything, as doing so could result in problems down the road.
If the plan is easy to implement for you and fits with who you are, use the plan. If you do not think you will be able to stick to it, come up with a plan you can follow.
The Bottom Line
A trading plan is only as good as the trader who implements it. The plan and trader must mesh, or the trader will be unable to implement the plan and it will be useless. To make sure the trading plan fits, the trader must pass the plan through three questions: Does the plan achieve the outcome I want? Can I handle the consequences of the plan? Does the plan account for me being me? If the plan can pass through all of these questions, the trader has a much better chance of being able to actually follow through with their investment strategy and is more likely to experience success in the markets
Diversifying Your Portfolio With Real Estate And Infrastructure
Real estate is undoubtedly a significant element of asset allocation, and should form a component of any institutional or personal investment portfolio. Also increasing in importance is infrastructure, which has similar advantages to real estate. Based on research at the University of Regensburg in Germany, this article will consider some of the main asset allocation issues in this context.
Both real estate and infrastructure constitute attractive investments for risk-averse investors, especially during bear markets. There are similarities and differences between the two, and you can construct a truly optimal portfolio by fully exploiting them. (For more on optimizing portfolios, see Achieving Optimal Asset Allocation.)
Diversification Through Real Estate and Infrastructure
The diversification benefits of direct and indirect real estate investments are well known, and diversifications role in institutional portfolios has been investigated extensively. The different correlations to those of stocks and bonds are extremely helpful for avoiding portfolio volatility.
In the U.S., there is a huge need to invest in and improve the infrastructure in many respects, so there is plenty of potential in the market. Pretty much all investors should take advantage of this potential to diversify more effectively than ever and in an extremely promising sector.
In the past, infrastructure has received relatively less attention, along with other alternative assets such as commodities and private equity. There has been a move away from the old-school conventional portfolios comprising equities, bonds, cash and real estate.
The allocation to real estate in particular could be affected if alternative investments significantly diversify returns from conventional investments. In fact, infrastructure has become a focus of attention and found its way into institutional portfolios, and to a lesser extent, private ones. (For more on asset allocation, see Five Things To Know About Asset Allocation.)
What makes infrastructure so appealing is that it seems quite similar to direct real estate in terms of big lot sizes and illiquidity, but also offers general stability and stable cash flows. The research on infrastructure lags behind that of real estate, and Tobias Dechant and Konrad Finkenzeller from Regensberg have attempted to bridge this gap.
Portfolio Optimization with Real Estate and Infrastructure
This research project, and earlier work in the field, demonstrates that direct infrastructure is an important element of portfolio diversification, and that firms tend to overallocate to real estate if they do not also invest in infrastructure. This is an important finding given that infrastructure is really helpful for risk-averse investors - especially in equity market downturns.
There is considerable variation in the recommended, relative amounts that should be invested in these two asset classes, The range extends from zero to as high as 70% (mainly in real estate), depending on the time frame, state of the markets and the methods used to derive the optimum.
The maximum total amount usually recommended for real estate and infrastructure allocations is about 25%, which is considerably higher than actual institutional allocations. It is important to note that efficient allocations in practice depend on numerous factors and parameters, and no specific mix proves to consistently superior. (For related reading, see Asset Allocation: The First Step Towards Profit.)
The blend of real estate and infrastructure is also controversial, but one study by Terhaar et al. (2003), for instance, suggests an even split. Some experts believe that about 5% is sufficient for each. In crisis periods, this can be three or even four times higher.
Another important finding is that real estate and infrastructure may be more useful in terms of diversification than through actual returns. Given the controversy on effective asset allocation and the turbulence in real estate markets, this is a major issue. The latter highlights the benefits of using not only real estate, but also infrastructure.
Also significant is the revelation that the targeted rate of return impacts on the appropriate level of real estate. Investors with higher portfolio return targets (who wish to earn more, but with more risk), may wish to devote less to real estate and infrastructure. This depends a lot on the state of these markets in relation to the equity markets in terms of whether the latter is in an upward or downward phase. (Asset allocation takes care of nearly 94% of your portfolios investment profile. For more, see Asset Allocation: One Decision To Rule Them All.)
The exact allocations to real estate and infrastructure depend on various parameters. Apart from the expected rate of portfolio return mentioned above, there is also the issue of how risk is defined. Other relevant factors include attitudes towards infrastructure in general, and how this relates to other alternative investments. In practice, these allocation decisions are complex, and higher or lower optima are therefore possible for different investors at different times.
Conclusions
If there is one thing that remains the top priority for all investors its having a well diversified portfolio. There is simply no substitute for this, but there is a lot of untapped potential in the market. Real estate investment, but also infrastructure, can play a vital role in optimizing portfolios. This mainly pertains to institutions, but also for private investors. Private investors can generally benefit from more diversification.
What Are SPDR ETFs?
Standard
Understanding Stocks, Mutual Funds And ETFs
There are a lot of investment products available and a lot are difficult to understand, for the consumer with little investment knowledge. Three common products, mutual funds, exchange traded funds and equities are similar, but function very differently in a portfolio.
Mutual Funds
Other than stocks, taking a close second in any investment popularity contest is the mutual fund. Anybody with a company or government sponsored retirement portfolio has most of their money invested in these funds. Mutual funds may be popular, but theyre not well understood.
Think of a mutual fund as a collection; the collection could be stocks, bonds or nearly any product. Any fund that is actively managed has a team of managers and advisors, who attempt to beat the overall performance of the market. For the person who has little or no investment experience, mutual funds offer a professionally managed product that should make money for you, without having to monitor a complicated portfolio.
The problem with mutual funds is that after fees, a majority of stock funds underperform the stock market and this isnt new. Back to the 1960s, stock mutual fund performance has lagged the market by an average of 2%. Although many stock funds underperform the market, passively managed index funds have lower costs and closely track the performance of the market. (For additional reading, check out: Is Your Mutual Fund Safe?)
Exchange Traded Funds (ETFs)
Similar to mutual funds, exchange traded funds are often a basket of stocks, bonds or other investment products, but unlike mutual funds, ETFs are traded on the stock exchanges. More importantly, ETFs dont try to beat the market like stock mutual funds, but instead reflect the performance of an index, sector or other product. The SPDR S
Make Money Trading Earnings Announcements
If you watch the financial news media, youve seen how earnings releases work. Its like the big game on Sunday; it comes with hours, and sometimes days, of endless experts providing their predictions of what the numbers will look like, and other experts providing their strategies of how to invest or trade based on the news. Some would say that it is media overhype at its finest and if you watch the endless flurry of graphics and earnings central music, its hard to argue.
But for the individual investor , is there money to be made in earnings announcements? As with most topics on Wall Street, there are a flurry of opinions, and it will ultimately come down to individual choice, but here are two of those opinions to help you decide for yourself.
SEE: Profit From Earnings Surprises With Straddles And Strangles
Why You Should Try
According to CNBC, the percentage of S
How To Pick A Good Mutual Fund
Are you thinking about investing in a mutual fund, but arent sure how to go about it or which one is the most appropriate based on your needs? Youre not alone. However, what you may not know is that the selection process is much easier than you think.
Identifying Goals and Risk Tolerance
Before acquiring shares in any fund, an investor must first identify his or her goals and desires for the money being invested. Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 8,000 mutual funds in the public domain .
In addition, investors must also consider the issue of risk tolerance. Is the investor able to afford and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment warranted? Identifying risk tolerance is as important as identifying a goal. After all, what good is an investment if the investor has trouble sleeping at night?
Finally, the issue of time horizon must be addressed. Investors must think about how long they can afford to tie up their money, or if they anticipate any liquidity concerns in the near future. This is because mutual funds have sales charges and that can take a big bite out of an investors return over short periods of time. Ideally, mutual fund holders should have an investment horizon with at least five years or more.
Style and Fund Type
If the investor intends to use the money in the fund for a longer-term need and is willing to assume a fair amount of risk and volatility, then the style or objective he or she may be suited for is a long-term capital appreciation fund. These types of funds typically hold a high percentage of their assets in common stocks and are, therefore, considered to be volatile in nature. They also carry the potential for a large reward over time.
Conversely, if the investor is in need of current income, he or she should acquire shares in an income fund. Government and corporate debt are the two of the more common holdings in an income fund.
Of course, there are times when an investor has a longer-term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds, may be the best alternative.
Charges and Fees
Mutual funds make their money by charging fees to the investor. It is important to gain an understanding of the different types of fees that you may face when purchasing an investment.
Some funds charge a sales fee known as a load fee, which will either be charged upon the initial investment or upon the sale of the investment. A front-end load fee is paid out of the initial investment made by the investor, while a back-end load fee is charged when an investor sells his or her investment, usually prior to a set time period, such as seven years from purchase.
Both front- and back-end loaded funds typically charge 3 to 6% of the total amount invested or distributed, but this number can be as much as 8.5% by law. Its purpose is to discourage turnover and to cover any administrative charges associated with the investment. Depending on the mutual fund , the fees may go to a broker for selling the mutual fund or to the fund itself, which may result in lower administration fees later on.
To avoid these sales fees, look for no-load funds, which dont charge a front- or back-end load fee. However, be aware of the other fees in a no-load fund, such as the management expense ratio and other administration fees, as they may be very high.
Other funds charge 12b-1 fees, which are baked into the share price and are used by the fund for promotions, sales and other activities related to the distribution of fund shares. These fees come right off of the reported share price at a predetermined point in time. As a result, investors may not be aware of the fee at all. The 12b-1 fees can, by law, be as much as 0.75% of a funds average assets per year.
One final tip when perusing mutual fund sales literature: The investor should look for the management expense ratio. In fact, that one number can help clear up any and all confusion as it relates to sales charges. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower the investors return will be at the end of the year.
Evaluating Managers and Past Results
As with all investments, investors should research a funds past results. To that end, the following is a list of questions that perspective investors should ask themselves when reviewing the historical record:
• Did the fund manager deliver results that were consistent with general market returns?
• Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
• Was there an unusually high turnover (which can result in larger tax liabilities for the investor)?
This information is important because it will give the investor insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return.
With that in mind, past performance is no guarantee of future results. For this reason, prior to buying into a fund, it makes sense to review the investment companys literature to look for information about anticipated trends in the market in the years ahead. In most cases, a candid fund manager will give the investor some sense of the prospects for the fund and/or its holdings in the year(s) ahead as well as discuss general industry trends that may be helpful.
Size of the Fund
Typically, the size of a fund does not hinder its ability to meet its investment objectives. However, there are times when a fund can get too big. A perfect example is Fidelitys Magellan Fund. Back in 1999 the fund topped $100 billion in assets and it was forced to change its investment process to accommodate the large daily (money) inflows. Instead of being nimble and buying small- and mid-cap stocks, it shifted its focus primarily towards larger capitalization growth stocks. As a result, its performance suffered.
So how big is too big? There are no benchmarks that are set in stone, but that $100 billion mark certainly makes it difficult for a fund manager to acquire a position in a stock and dispose of it without dramatically running up the stock on the way up and depressing it on the way down. It also makes the process of buying and selling stocks with any kind of anonymity almost impossible.
The Bottom Line
Selecting a mutual fund may seem like a daunting task, but knowing your objectives and risk tolerance is half of the battle. If you follow this bit of due diligence before selecting a fund, you will increase your chances of success.
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.)
TUTORIAL: Investing 101 For Beginner Investors
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.
Earnings Sustainability: The Key To Your Investing Future
Evaluating company valuations for investment purposes is a difficult task. Frequently, investors will use valuation ratios, such as the price-earnings (P/E) ratio, and compare them with similar companies to determine if its relatively cheap or expensive. In conjunction with ratios like the P/E, investors should look at the sustainability of the companys earnings. A company that reports abnormally high earnings in one period may see the price of their stock shoot up along with their P/E ratio. But will those earnings persist to justify the higher valuations? By analyzing the sustainability of earnings, investors can get a sense of how earnings will behave in the future.
Restructuring Charges / Write-offs
Often, restructuring charges or write-offs by a company are treated as a one-time expense and ignored by investors. However, when doing due diligence during your investment process, you should always pay attention to these items - they could be anything but one-time. For example, a company that has to perform a significant write down on their inventory will continue to be affected by the write down, through a lower cost of goods sold in future years. Similarly, if the company decides that their equipment or plants requires a write down, future depreciation will also be lower. Both these items directly impact future net income, yet are often thrown by the wayside. (For more on write-offs, also take a look at Common Clues Of Financial Statement Manipulation.)
Advertising Expenses
Some companies depend on certain core activities to sustain their earnings. For many companies in which brand recognition is especially important, marketing and advertising expenses are keys on which to focus. Often, a company will create a temporary boost in earnings by lowering their advertising expenses in the current period, but this action may be at the expense of future net income.
To analyze advertising expenses, simply calculate the amount spent on advertising during the period as a percentage of revenues. Compare the percentage spent on advertising over the course of a few years (three to five years is usually good). Large increases or decreases in this expenditure should be investigated further. For example, lets take a look at Coca Colas advertising expenses (in millions) for 2006-2008.
-- 2008 2007 2006
Net Revenues 31944 28857 24088
COGS 11374 10406 8164
Gross profit 20570 18451 15924
SG
Gold Or Oil: Which Is The Hotter Investment?
Financial innovators have issued a wide variety of financial instruments over the last decade, giving investors exposure to many asset classes that were unavailable in past years. These instruments include ones leveraged to the price of oil and gold, two of the more popular areas for investors. However, this freedom to invest is not without risk, and those interested in exposure here should research carefully before jumping in. (Gold is a very useful investment during periods of instability and high inflation. Check out Why Gold Matters.)
Gold and Oil Performance
Gold has provided an extraordinary return to buy and hold investors over the last 10 years, with the metal rising in price from under $300 per ounce to the current level of approximately $1,425 per ounce. The return on oil over the last 10 years has also been extraordinary with the price moving from less than $20 per barrel in 2001 to the current level of just under $100 per barrel.
Gold Investing Rationale
Investors have historically purchased gold as a hedge against inflation or as a reaction to a financial or political crisis. Many also invest in gold for protection when a currency is being debased or devalued by a government.
Others believe that there are strong fundamental reasons for the increase in the price of gold, as supply increases have lagged the rising demand from the market. The jewelry industry is the largest user of gold, and has seen an increase in demand for gold jewelry from the emerging economies.
Another reason for gold investing is price momentum or trend investing. As more investors pile into gold, the price keeps going up and this performance gets at10tion in the financial media. This, in turn, motivates others to buy so that they dont miss out. This type of behavior has created bubbles in other financial instruments and markets in the past. (Find out more in The Myth About Market Bubbles.)
Oil Investing Rationale
The fundamental investment case for oil is based on increased demand for energy as China, India and other emerging economies accelerate growth above historical baseline levels. This increased demand is difficult for oil producers to meet in the short and medium term as increased production requires large capital investments in multi-year projects. Some have even predicted that the worlds oil supply has peaked and rising prices for oil are inevitable. (Not sure where oil prices are headed? This theory provides some insight. See Oil As An Asset: Hotellings Theory On Price.)
Modern Innovations
Another reason that might explain the increased price of gold and oil is the ease with which investors can get exposure, as the financial industry has created many securities designed to track the performance of gold and oil.
Many of these instruments trade on the major exchanges and are extremely liquid. Investors can buy an instrument on the long or short side of gold or oil, and can leverage that exposure as well.
The SPDR Gold Trust Exchange Traded Fund (ETF) is the largest and most liquid gold ETF available (NYSE:GLD), with average daily volume of more than 14 million shares over the last three months. The trust held 1,217.3 metric tons of gold as of March 10, 2011. Another liquid ETF is the iShares Gold Trust (NYSE:IAU), which traded an average of 5.5 million shares a day over the last three months.
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On the oil side, the United States Oil Fund, LP (NYSE:USO) attempts to track the spot price of West Texas Intermediate (WTI) crude and is also liquid, with average daily volume of 14 million shares a day.
Buyer Beware
Bullish investors are passionate about the reasons to own oil and gold, and discount any talk that the strong investment performance in either of these are the result of speculation. Investors that are long these might want to think back to other investments over the last decade, where prognosticators sounded just as convinced that nothing could go wrong. Who can forget back in 1999 and 2000 when the consensus said that paying forty times the markets earnings was the right thing to do?
Another item to consider is that the downside of a bubble bursting is usually much more rapid than the ascent. The Nasdaq Composite index peaked in March 2000 and lost 87% of its value over the next thirty months until it reached the trough in September 2002. However, most of the decline occurred by early 2001, or less than a year. The price of oil fell even quicker in 2008, with the price peaking above $140 per barrel, before crashing down 75% in just five months. (These funds make investing in gold, oil or grain an easier prospect.
The Bottom Line
One of the advantages that we have over previous generations is the ease with which modern investors can invest in a wide range of securities providing exposure to asset classes and areas that used to be out of reach. Investing in gold and oil is now easy and cheap for investors, but not without risk.
5 Ways To Invest $5,000
In this economy, $5,000 may feel like a lot more money than it did just a few years ago. There are numerous ways that you may find yourself with an extra $5,000: a bonus at work, inheritance, an extra contract job that you werent expecting or a tax refund. Maybe you have it now or youre expecting it soon, but regardless of the time frame, what are you expecting to do with the money? Here are a few ideas that may help.
Pay off Credit Cards
If your household has credit card debt, you have, on average, $15,956 worth. Almost one third of that debt could be wiped out with that $5,000. If your credit card interest rate is average, you are paying 13% ,or $650 each year, to hold that balance. That $5,000 could reduce the interest youre building up by $54 a month. How long was it going to take you to save $5,000 for the sole purpose of paying your credit card debt? If it was two years, you just saved $1,300 making the return on your $5,000 - 26% over two years or 13% per year. Any investor would be very happy with that figure. Although its not necessarily fun, the best return youll get on your money is to service your debt.
High Quality Stocks
Investing in high quality, dividend paying stocks for a long period of time has shown to be a very safe investment. Because its nearly impossible to pick the few correct stocks that will perform better than the overall market, look at an index mutual fund or exchange traded fund (ETF) that tracks the total stock market.
Historic returns for the stock market over the past 50 years have averaged around 10%, making this a good investment, but not nearly as good as paying down debt.
Education
The cost of a college education has risen 130% in the last 20 years, according to USA Today. If you have a two-year old child now, the cost to send your child to college in 16 years will be $95,000, if he or she chooses a college in the state where you are a resident. If your child chooses a private university, the cost rises to as high $340,000, if college inflation rates stay as they are for another 16 years.
The best way to save for college is to use a 529 plan. These tax advantaged college savings accounts are similar to 401(k) plans where you contribute a certain amount into the plan, the money is invested into funds of your choice and you withdraw those funds when the child reaches college age.
Some 529 plans allow you to purchase years of college at todays rates for use when the child reaches college age, but most plans now invest the money without guaranteeing future results. That same $5,000 is a great start to put in a plan like this, and although the returns will average less than the overall stock market , the plan is one of the best ways to save for future college expenses.
Bond ETFs
An ETF is a basket of investment products packaged into one fund. They often come with low fees, yet offer the safety of a diverse portfolio. Some of these ETFs hold bonds, which are historically safer than stocks. Some bond ETFs have dividends of 7% or more and, barring any large investment market event, those dividends are quite safe, because of the hundreds or even thousands of bonds held in these funds. If you choose to invest in Bond ETFs, you may need to ask for help from a trust financial adviser.
Start a Small Business
If your debts are paid, you dont have children or youre well on your way to having your kids college education paid for, consider starting a small business. To get your business off of the ground, $5,000 may not go very far, but some service-type businesses have very little startup costs. Before committing the money to a small business , make sure to carefully weigh the time and financial commitment that will come with this type of endeavor.
Forecasting the annual return is nearly impossible due to the many variables that come with starting a business, but even more important, this might jump-start your dream of becoming an entrepreneur.
The Bottom Line
Even if it isnt $5,000, before deciding how to utilize a larger sum of money that found its way into your bank account, think more long term. Sure, you could purchase the big TV that youve wanted for a long time but is that the best decision to make for years to come?
Is Your Investment Strategy Going Extinct?
Nothing lasts forever, including the effectiveness of some investment strategies. True, some basic ideas like buy the stocks of high-quality companies when theyre trading cheaply seem to operate with no expiration date, but other strategies seem to work only for a while, before reverting back to market-average or worse returns. Let us examine some of the strategies that may be on the way out. (Avoid taking premature profits or running losses by setting appropriate exit points, see A Look At Exit Strategies.)
TUTORIAL: Stock-Picking Strategies
The Safe Haven
Whenever the markets turn rough and some sector happens to go up (or go down less), investors and commentators are more than happy to anoint a new safe haven for investors. Gold has been a safe haven at many points in history. Bonds have been safe havens, as have dividend-paying stocks, utility stocks, consumer goods stocks and so on. (For related reading, see The Advantages Of Bonds.)
For example, healthcare was supposed to be a safe haven. Yet, during the recession in the late 2000s healthcare underperformed as pharmaceutical companies suffered from patent cliffs and medical device companies bore the brunt of lower patient visits and tight hospital capital budgets.
That, then, is the problem – every crisis is different, as is the optimal path through that crisis. Whats more, people often underestimate the importance of timing when it comes to picking a safe haven. If an investor has a firm conviction that Asset X is going to be a safe place to weather the next storm, he or she would do well to get in early so that the other investors piling in later push up the price. Likewise, getting out on time is important as well – once the danger passes and everybody wants out of the safe haven, prices can drop so quickly that those slow to leave end up holding the bag.
Arbitrage
Arbitrage investing is all about making dollars a few pennies at a time – trading on the small discrepancies in prices between exchanges or an announced deal and current valuations. Unfortunately, the increased liquidity and access to markets has largely eliminated these easy profits. Arbitrage is still possible, but it tends to only be profitable for traders with the infrastructure to make large trades at lightning speed. This is not something that can be handled by a friendly retail internet broker. (For related reading, see Trading The Odds With Arbitrage.)
Dogs of the Dow
The Dogs of the Dow offered a simple value-oriented approach to investing. Investors would choose from those stocks making up the Dow Jones Industrial Average, selecting for a portfolio on the basis of the highest dividend yields and lowest stock prices, with annual rebalancing. In theory, this offered up a portfolio of relatively undervalued large-cap companies that should outperform the market (based in large part on the assumption that those dividend yields should revert to the mean).
The evidence is mixed as to whether the Dogs of the Dow strategy ever worked as advertised; some academics have made the case that the advertised results were a product of data mining and not reproducible in practice. In any case, there have been several public attempts to implement the strategy and they have failed. Whether that failure is a product of the markets simply filling in a previously unknown gap or whether the strategy never worked at all is moot – the point is that it no longer seems to work. (For related reading, see Barking Up The Dogs Of The Dow Tree.)
Guru of the Month
From time to time an investment advisor pops up with a sure-fire strategy for making money in the market. Many of these approaches are outright scams, but some are sincere attempts to offer a combination of formulas and stock characteristics that seem to lead to market outperformance.
The problem with many guru approaches, the legitimate ones at least, is that they exploit an inefficiency in the market. Once enough people know about an inefficiency, it tends to disappear fairly quickly. In fact, if there is some combination of return on equity, margins and EV/EBITDA that spells investment success, investors will program computers to jump on those opportunities. Moreover, other investors who try to think one step ahead will anticipate stocks that will soon sport those characteristics to take advantage of the automated market jump these stocks can expect from the computer programs – and on it goes. With all of that buying activity, the stocks are soon revalued and the market-beating potential vanishes.
Deep Value Investing
It is probably inaccurate to describe deep value investing as going extinct; most likely the last specimens died in captivity long ago. After reading some of the seminal works of investment strategy, Benjamin Grahams Security Analysis and Intelligent Investor, it used to be possible to find stocks trading below the value of the net current assets on the balance sheet. Likewise, companies often held assets worth far in excess of their stated value and the market capitalization of the company. There were profitable trades to be made by finding these stocks and waiting for the market to realize the value. (For more on value investing, see The Value Investors Handbook.)
Now, though, the market moves much faster and information is both more easily available and available more quickly than before. As a result, companies with $1 per share of cash and a $0.50 stock price just do not stick around for long. Whats more, companies have gotten savvier about singing their own praises and maximizing the market value of both their assets and stocks.
Invest Your Age
There is a school of thought that holds that investors would do well to allocate their portfolio according to their age by matching their portfolio weighting to bonds to their age in years. In other words, a 30 year old investor should hold 30% of his or her assets in fixed income, while a 60 year old investor should have double that allocation.
Back in the days of pensions and defined-benefit retirement plans, maybe this wasnt such bad advice.
Nowadays, though, it seems like a dangerously over-conservative way to invest. Whats more, people are living longer than ever before but still retiring at basically the same age (around 65). That means that they need more money in their portfolio at the time of retirement, and must continue to earn good returns on that money throughout retirement or risk running out of money.
Though it is true that stocks are generally more volatile than fixed income investments, that volatility cuts both ways; it is relatively rare for long-term equity investors to underperform fixed income. Worse still, with the corrosive and often underreported impact of inflation on fixed income assets, over-allocation to fixed income can lead to a worker having too little money saved away for retirement. (For related reading, see Young Investors: What Are You Waiting For?)
Buy-and-Hold
Perhaps the most controversial idea is that buy-and-hold investing is dead. The idea here seems to be that markets are so quick and efficient in addressing undervaluation, there is simply no chance that a stock can be undervalued for years at a time and worth holding for the long haul.
This notion seems to have really gained currency in the wake of the tech bubble, and it is certainly possible to see a few points in its favor. After all, anybody who bought a tech stock like Cisco (Nasdaq:CSCO) or Microsoft (Nasdaq:MSFT) during the bubble is still sitting on a loss. Likewise, anyone who bought and held a high-quality bank stock like US Bancorp (NYSE:USB) or M
Savings Accounts Not Always The Best Place For Cash Assets
Individuals and entities can find themselves holding cash for any number of reasons: general savings, specific savings for planned expenditures, asset sales, and more. Most people would agree that they would like to maximize their cash assets, but many people assume that a savings account at a bank is the only way to go. As you will see, there are other ways to maximize your cash assets over the short term. If you are an independent-minded investor, read on to uncover two very attractive options for achieving this end: the premium brokerage account and the direct mutual fund account.
Assumptions
There are two assumptions that should be made plain with regards to this discussion. First, the short-term nature of cash demands a very low risk exposure or, stated in a different manner, a high degree of price certainty. Specifically, this article will not advocate the comparison of checking account funds to longer-term instruments such as equity mutual funds because the value of equity mutual fund shares can often vary on a daily basis. This is not an apt comparison because a return-maximizing investor seeking to conduct an everyday transaction (i.e. buying groceries) must be certain that his or her short-term cash has not been reduced by yesterdays stock market sell-off.
Second, cash-like funds should be accessible in a reasonable time frame without a penalty. Thus, certificates of deposit (CDs) and the like are not a viable option in this regard. Although CDs are generally considered to be short-terminvestments , they cannot be turned into transactional money without the issuer assessing a penalty that destroys the investors return.
What is disintermediation?
Before exploring the actual instruments, it is important to understand the differences between financial intermediation and disintermediation.
Anyone with a checking/demand deposit or savings account uses the services of a financial intermediary (a bank). The bank, acting as a middleman, combines the small deposits of many and goes to the primary and/or secondary security markets to purchase larger denominated short-term interest bearing instruments (i.e. Treasury bills). The bank then promises to pay the depositor a stated interest rate for the funds, subject to periodic adjustment, and collects the difference.
Disintermediation, on the other hand, occurs when the depositor goes directly to the primary or secondary market to purchase short-term interest bearing instruments. The fact that a depositor uses a mutual fund arrangement to accomplish this does not change the fact that this is a direct method of investing. Under the mutual fund arrangement, shareholders collect the market interest rate minus a management fee paid to the mutual fund manager .
There are two important distinctions between using the bank and the direct method. The first difference is the existence of government-sponsored account insurance; banks are part of the Federal Deposit Insurance Corporation (FDIC) system of deposit insurance, while the direct method is subject to the many market risks and is not insured. However, if one establishes a direct account through a brokerage firm, that account may be covered by the Securities Investor Protection Corporation (SIPC), which provides limited protection against investment losses as a result of certain broker-related actions Second, money market funds are regulated under the Investment Company Act of 1940 and are sold by prospectus only.
The Premium Brokerage Account
Most brokers offer several levels of brokerage accounts. Virtually every brokerage account comes embedded with a money market mutual fund account . These funds are invested in short-term fixed income securities via mutual funds shares. The underlying instruments used by bank and direct participants are often identical; the difference is that the direct method funnels all of the interest of those underlying securities to the mutual fund shareholder minus a management fee (approximately 50 basis points). This can be a yield of several hundred basis points compared to what banks may offer on similar accounts. Factors affecting the realized difference in interest rates include the banks desire to attract funds and the prevailing market environment.
Both regular and premium accounts have the ability to hold marketable securities and money market mutual fund shares, but premium brokerage accounts stand apart from regular brokerage accounts primarily in terms of access to funds and additional features. Premium accounts may offer check-writing capabilities and debit card access to funds, allowing continuous access to funds as needed. This maximizes interest earned when funds are not needed. Furthermore, it is possible that the premium account arrangement could simplify the investors monthly statement routine through elimination and consolidation of accounts.
The Direct Mutual Fund Account
The second option for maximizing interest is the use of a fund-direct money-market mutual fund account. Most mutual fund companies offer and manage a money market mutual fund. Again, this is a direct investment in money market instruments by way of mutual fund shares. Oftentimes, both the interest rate received and the management fee charged on these funds will be approximately equal to those earned on the premium account established at a brokerage house.
The key distinction between these two options is the availability of the funds and the mechanics of moving funds. Fund-direct mutual fund account funds are not available on demand, but funds are available to be sold and transferred on non-holiday business days throughout the year. Generally, mutual fund shares require a one business day settlement period. Once settled, the funds can be dispersed via a physical check or automated clearing house (ACH) deposit directly into a checking or savings account. This is still a very attractive option considering the interest rate earned and the expectation of having liquid funds available within a few days.
Additional Considerations
There are nuances between the offerings of competing companies for both of the above products. With that in mind, an investor should be prepared to critically view the benefits and drawbacks to any one firms offering with regards to the premium brokerage account. Investors should also pay attention to the return generated on money market funds (tax-free interest funds may also be available); specifically, the net expected performance must exceed that of your next best option. The investor should analyze his or her expected balance level in relation to savings