Friday, May 22, 2009

The International Arena

Despite what you might as a result of 2008, asset allocation does work. There will be periods of time when you can question the benefits of being diversified amongst different asset classes. But, over time it has proven to work effectively in lowering portfolio risk and increasing returns.

One asset class that should be included in every portfolio is International investing. This can cover stocks & bonds of companies in developed and emerging countries. The former refers to countries such as England, Italy, Spain & France while the latter includes nations such as China, Argentina, India, Korea, etc.

Foreign exposure can be obtained through mutual fund investments in either Global or International funds. Global pertains to investing anywhere in the world - including the USA. International refers to anything outside the USA.

As capitalism, transportation and technology have advanced, many new economic opportunities have arisen and confirmed the concept of Global Village. The world truly is a smaller place. A decade ago, we didn't think of the "BRIC" nations as viable investments choices. Today, Brazil, Russia, India & China are virtually household names in the investment community and are available through various venues. Many Economists feel China will be the economic powerhouse of the next 100 years. Some would argue, it's already happening.

Mutual funds have been a staple for many investors. However, technology has opened the door to other investment alternatives in recent years. One such product is the exchange traded fund or ETF for short. ETF's are similar to mutual funds in many regards. They represent a basket of stocks (or bonds) in a region, country or sector. The key difference is they are traded on various exchanges and thus can be bought or sold during the day. Mutual funds can only be purchased at the end of each day.

To learn more about ETF's, check out iShares and Poweshares. They are both industry pioneers and offer numerous products.



Wednesday, May 13, 2009

The Magic of Compound Interest


"The most powerful force in the universe is compound interest."
Albert Einstein


Sometimes you have to step back and look at the big picture. Granted, if you're referring to the stock market, this isn't an easy task. The 24/7 news world we live in forces people to analyze, scrutinize and criticize things on a minute-by-minute basis. Several things though are best left for longer time horizons.

Often considered to be the 9th wonder of the world, compound interest is a magical concept. As defined, compound interest is the interest computed on the sum of an original principal and accrued interest. Very simply, it's the money you make on an investment over time!

For our purpose, we'll use the "Rule of 72" to illustrate. If an individual invests $10,000 and gets an annual return of 5% per year, it will take 14.4 years to double his/her money (72/annual return = amount of years required to double investment). Should the investment be more growth oriented and annualize at 8% per year, your time frame is reduced to 9 years. If we shoot for the stars and get 12% year over several years, you will require a mere 6 years to see your $10,000 investment grow to $20,000.

This concept works at any age, but the younger you are, the better. Recent college graduates make a good case study. They have a plethora of time and ample opportunity. Coming up with any type of lump sum is unlikely, but they can rely upon dollar-cost-averaging. Mutual funds will allow new investors to get started for as little as $100 per month. This may not sound like much, but let's take a closer look.

You can be a millionaire! Recent grads can rely upon employment income to come up with $100 per month. If he/she invests $100 per month at 10% per year for 44 years - a total of $42,800 - they will witness the magic of compound interest and watch their account value grow to $1,000,000 by the age of 65! Should their investment do a little better and make 12% per year on average, they will reach the million dollar mark at the age of 60!

The concept is very simple. The difficult part pertains to discipline. Having the courage & fortitude to stick with something for many years is challenging. There will be turbulent stock markets and investment gurus telling you when to sell & buy. As we should know by now, "It's time in the market, not timing the market" that prevails in the end.


Tuesday, May 5, 2009

Riding the Stock Market Roller Coaster

As the global economy continues to weaken due to lower corporate profits, higher unemployment and tight credit markets, the volatility in the stock market(s) should remain with us through 2009.

Last year was the most volatile market in the last two decades. There were 71 trading days in which the S&P500 moved up or down by more than 2%. Remarkably, 28 of those days experienced extreme volatility of 4% or more. By comparison, 2002 had six such days and 1987 experienced seven days. In the 4th quarter of 2008, three days had gains or losses of 9%. This has only happened twice since 1978!

So, volatility (or risk) is here to stay. At least for the foreseeable future as capital markets deleverage and re-evaluate the proper prices for stocks and bonds.

This can be unnerving... even paralyzing at times. But, volatility is a two way street. It can take stocks lower, but can also take stocks significantly higher. Positive annualized gains can often be contributed to a select few days in which markets soared. This is why most gurus and publications will preach 'stay the course'.

Asset Allocation: It is often said there are no free lunches. This is true in the financial world as well. But, there is one huge exception - Asset Allocation. While it doesn't work in every market environment (2008 to be exact), it has proven to work over time. A mixture of non-correlated assets... stocks/bonds/real estate/commodities... will diversify a portfolio and reduce account fluctuations.

Buy Low: Warren Buffet has often said, "Buy when people are fearful and sell when they're greedy." Great advice. However, the average investor will tend to do the opposite. Fear takes over and they make 'emotional' - as opposed to 'practical' - decisions.

A good example of why you should buy instead of sell during troubled times is evidenced in this March/April time frame. The Dow Jones Industrial Average (DJIA) seems to have bottomed in March at 6,500. While it's nearly impossible to predict the bottom in any market, there has been a significant recovery in the last two months. The DJIA is now 8,400 or 29% higher. Individuals who panicked and sold in March are certainly disappointed they didn't have staying power in hindsight. People who had the courage to follow Warren Buffet's advice have been well rewarded.

Rebalance: Portfolios should be rebalanced every now and then. Most experts would agree, once a year is appropriate. Many life cycle funds and asset allocation models have this feature built into the product. They automatically shift assets back to their original targets. If you started with a 60%/40% mixture of stocks and bonds, the account will automatically rebalance should the allocation change to say 70%/30% due to an increasing stock market.

Contrary to popular belief during turbulent times, 'rebalance' doesn't mean going from fully invested to a money market account. This all or nothing approach may seem logical at times, but often results in under performance over time. As fear sets in, this may seem like a logical decision. But, as I outlined above, investors who had the courage to add to their accounts when the DJIA was at 6,500 have outperformed any other asset class in that time frame - including money market accounts.