October 26, 2008

Bubble Patterns

In these turbulent times it is good to step back and examine the financial markets with as much objectivity as we can. Historical charts have a blunt way of putting some perspective on things. Here is a simple and condensed way of looking at some of the essentials of what is driving market prices up and down. More buyers than sellers = prices go up and vice versa…

We all recall the Dot.Com craze and the hype that went along with it. I specifically remember being called an idiot for not investing in the likes of Netscape and some of the more obscure high-flying “dot-bust” names such as Webvan and eToys. You too may have come across some people who quit their day jobs to basically pick stocks for a living. In those days, anyone was a genius trader, for a while…

Continue reading at: http://blog.fxistrategies.com/

October 17, 2008

Be fearful when others are greedy, and greedy when others are fearful

If you’re not sick of the daily swings in the global stock markets yet, I dare you to look at the action in commodities and currencies. The oil price went from an all-time high of over $148 in Mid-July to about $69 yesterday. That’s a drop of 54% in just 3 months. The currency markets have been equally volatile and increasingly erratic, defying most rational traders’ expectations.

On Equities
Some positive signs appeared this week. Although the gyrations continue to be gut bursting at times, we have seen a slight improvement in the frozen credit markets. LIBOR, the benchmark for international short term lending rates, continued to slide down from the recent highs. The lower the “real” short term credit rates are available for businesses, the sooner liquidity can return to the financial system and do what it’s supposed to do: Spur economic activity.

However, the best news today was the Op-Ed by Warren Buffet in today’s New York Times:

Warren Buffet shows his exemplary courage in times of tremendous economic stress when he says: “Be fearful when others are greedy, and greedy when others are fearful.” He noted that he has been on a buying spree of American Stocks in his personal account which is typically fully invested in US Government Bonds. Whether he is a fool or a genius, only time can tell. But clearly, volatility will not disappear anytime soon and the markets will continue to be choppy for some time. If your gut is sensitive and your pockets are half empty, stay out!

Continue reading at: http://blog.fxistrategies.com/?p=31

October 10, 2008

Money & More Pain?

Dear Friends & Fellow Investors

Wow…finally the trading week is over, time to exhale if you haven’t done so yet.

Last week, I talked about money & pain. Where do we stand today after the Dow having its worst week ever in history? Have we reached our pain threshold yet?

These are clearly difficult financial times, the effects of which will impact many aspects of our lives in the coming years. It may change our perception of the value of money and our relationship towards money and investing as well; at least I hope it will because the excesses and the horrible effects of leverage have unearthed the dark side of free market capitalism. The current downward spiral is a necessary de-leveraging process and going back to the traditional way of investing may not be such a bad thing after all. Less potential (illusive) reward but also much less risk.Earlier this week, the Vanguard Group founder John Bogle reminded us of the “age-related” retirement (investment) formula, in which your bond position equals your age. This may be an oversimplification for the more sophisticated investor, but I personally like simple plans - easy to understand and easy to apply. Let’s look at some numbers…

Say you’re 50 years old: Based on John Bogle’s approach, you should invest 50% of your assets in bonds. If Bonds are too complex, invest those 50% in income producing assets which are guaranteed i.e. money market, CDs, savings accounts etc. At the beginning of 2008 you could get CDs at around 4.5%, let’s use those as the benchmark. If you had $200,000 to invest and you put half in CDs generating 4.5%, your year-to-date value of $100,000 safely invested would be $103,489.04 today and $104,500 at year-end. The other half invested in the market (S&P500) would be worth only $61,239.75 today, reflecting the over 38% decline thus far - and we don’t know where we will be at the end of 2008…

But since you’re hedging your bets, your overall (paper) loss is (only) about $35,000 or about 17.5% so far – still painful, but probably more manageable. Granted, this is an over-simplification but it illustrates the risk/reward principle nicely; and asset allocation does make sense. Obviously the insane gyrations of the current market may only occur once every generation; but if you are not comfortable with risk and particularly if you’re approaching retirement age, you should simply leave some of those “illusive returns” on the table and just be happy with a leaner but much safer investment portfolio.Now, to further limit the downside on an already painful investment portfolio, I would again make the case to invest in the lowest cost index tracking funds such as Vanguard 500 or SPY Exchange Traded Funds. The cost of investing in Mutual Funds on average takes 1-2% off your returns in profitable years and adds 1-2% to your loss in declining years. These costs are avoidable since you should not pay some sleek fund managers trying to chase “illusive returns” by attempting to outperform the market. The majority of them don’t, you can save your money.

With regard to the markets, it is hard to say whether we have reached a bottom, but it sure feels a lot like one (so we all wish). Whatever lies ahead, it is important to remember that the basic concepts of asset allocation and money management are critical in any market and any investor can use asset allocation in its most basic form to mitigate some risk. I’ll gladly send you a copy of this basic asset allocation tool and you can assess what your personal situation would look like based on the latest numbers.

Please send me an email if you have any questions:

October 04, 2008

Money & Pain

When I glanced through the headlines of the Financial Times this Wednesday, I came across an article which is so fitting of the current situation in the financial markets: http://www.johnkay.com/regulation/571

In his article: Why pain is good - in both medicine and finance, John Kay argues that “pain is beneficial because, on balance, evolution is smarter than you are at deciding how you should respond in situations that could hurt you.” This makes a lot of sense to me not just in daily life, but also in the world of finance and investing.

Pain in financial terms is often associated with risk tolerance and said risk tolerance, among other factors, is a very crucial component in terms of defining your specific investment strategy. Every broker and financial advisor is supposed to follow the suitability rule when making recommendations to clients.

The SEC defines Suitability as follows:
When your broker recommends that you buy or sell a particular security, your broker must have a reasonable basis for believing that the recommendation is suitable for you. In making this assessment, your broker must consider your risk tolerance, other security holdings, financial situation (income and net worth), financial needs, and investment objectives.In practice this means: your broker asks you a few questions, enters some tick boxes and then establishes a risk profile. Typically they have 5-6 choices to pigeonhole you from conservative to aggressive investor and their standard models then spit out a recommended asset allocation. So let’s say someone pigeonholed you as a “moderately aggressive” investor and gives you the recommended asset allocation. Do you know what this means? In terms of risk tolerance, how comfortable are you losing $1,000 or see your portfolio decline by $10,000, $100,000 or more? It all depends of course. Notice that I didn’t say your portfolio is down by 10%, 20% etc. I prefer looking at real dollar values and a good test is: check how many hours, weeks or months it would take you to cover your losses. And to say I’ve just lost 2 weeks/months of my annual income in real dollar terms hurts more than mere percentages.

Another way of looking at risk tolerance and pain has been outlined by Ken Fisher (the famous fund manager and Forbes columnist) in his book “The Only Three Questions That Count”. He argues that “these so-called risk rankings don’t mean anything – simply reflect no reality.” I couldn’t agree more with his comparison when he writes: “Most people are simply unable to assess how risk tolerant they are any more than most people who’ve never taken a hard punch to the gut can know how they’ll emotionally feel after one – until it happens to them a number of times and various ways – like a boxer.”

Based on current market conditions, some of us may be in for substantial financial pain and may continue to experience that pain for some time to come. We all have our own financial pain threshold but that threshold is also shaped by our financial behavior. Our financial behavior has been defined by an overabundance of credit. Granted, we really can’t afford the new gadget we “need” to have, but no problem - we don’t need to experience the pain of not being able to buy it, “0% interest for 12 months” is there to help. If we’re used to taking lots of heavy “financial pain killers”, for instance by using credit cards irresponsibly or using our home equity to buy the new cars, entertainment centers or other depreciating assets, then we must be prepared for some rude awakening and perhaps intolerable pain.

Our lives are filled with these financial painkillers but we must go back to basics to learn that small doses of pain should be tolerated to alleviate longer lasting, perhaps intolerable financial pain. That’s also true for investing and more so for the frequent trader. A day trader for instance experiences pain or pleasure and sometimes both even within the same day, especially in this wild markets.

But in the long run, with a good asset allocation and proper diversification you can alleviate a lot of pain. Nevertheless, pain is involved because you will have to forego some potentially higher returns now for alleviating much more financial pain later.Understanding the risks and more importantly, understanding your own financial pain threshold can be an immeasurable investment tool.

The financial markets are in disarray at the moment, and if your pain threshold is very low you may get out of certain investments at the wrong time. While I don’t suggest to start following the steps of Warren Buffett right now, in the long run, good companies with solid balance sheets and a good cash cushion will master this crisis. A few years from now, we may look back at these times as one of the best opportunities to buy solid companies at a discount.

Going back to the original point John Kay was making, financial pain cannot and should not be avoided completely. But it should be managed with the view of your own personal risk tolerance and your long term investment objectives in mind. If you’re not prepared to experience some pain at certain times, then you should not invest in assets with fluctuating prices (i.e. stocks, property, futures etc.). No pain, no gain – literally!

And lastly, associate the concept of financial painkillers to the $700bn bailout plan approved yesterday. As Warren Buffett noted this week, the rescue bill will help but is not a panacea to the underlying economy. The bill has been rushed through and it may be the necessary “painkiller” at this time. But it is arguable whether it may just prolong the inevitable and some massive “financial surgery” may be due at some point.

As always, I would appreciate comments or questions: