The Talk: Children and Debt

Mutual fund giant Vanguard shared a link from DebtWatchdog.com entitled "How to Stop Your Children from Getting Into Debt". The article offers up six different ways in which parents can teach their children how to manage their money better. While I like many of the points that the article brings up, I think they're all predicated on a single issue: honesty.

By being honest with your children regarding money issues, there will be a deep mutual respect that will last a lifetime. After all, if your child does not know that you are a struggling financially, how can you expect to "give them the world" when "the world" requires lots of money these days? Indeed, the old adage is correct in that money isn't everything; unfortunately, in this day and age we're often of the perception that it is - and perception is everything. Remain honest with your children and talk with them about your financial mistakes. After all, if they don't recognize that bad financial decision making can lead to severely adverse consequences, then what will prevent them from making the same mistakes you did?

Correlation Does Not Imply Causation

A key scientific principle is that correlation does not imply causation - basically, even though event A and B may be correlated, it's not necessarily true that one caused the other. This is very true in the investment world, in large part because financial markets are so complex and there are so many different variables at work. After all, with trillions of investment dollars sloshing around worldwide, it's highly unlikely that a singular event will be the absolute cause of something else happening. Even when venerable investment banks Bear Stearns and Lehman Brothers failed, many securities fell for reasons relating to their collapse or financial destruction elsewhere - it's simply impossible to tell.

I bring this up because I read an article on TheStreet.com this morning which stated the following:

"The charts of the U.S. dollar index and the SPDR S&P 500 ETF clearly show the inverse relationship they have. Right now it seems everything is directly connected with the dollar; it has been like that most of the year."

While the article doesn't explicitly imply that the two are correlated, the author seems to suggest that because certain indexes and financial products have a chart pattern inverse of the dollar, that the dollar's movements seem to affect them. While this may be the cause in some extreme instances, ultimately, the dollar is moving because of other variables - monetary and fiscal policy, economic indicators and geopolitical issues, among other things. To understand why a security is moving, you have to dig a little deeper; don't take a chart pattern at face value.

Final Tax Vote Up to House

The Senate has passed a 2-year extension of the Bush tax cuts which will now go in front of the House for a final vote. The good news is that it appears as if this bipartisan package will pass and every American will retain lower income, dividends and capital gains taxes which should help spur investment and economic growth. This is fantastic news, particularly for Gen Y investors who will be able to use the lower tax rates to their advantage and compound returns over a larger base. The next step for Congress heading into the 2012 elections should be making these tax cuts permanent.

Higher Risk Lending Returns

Some credit card issuing banks have begun to lend again to higher risk borrowers - but at a higher cost. The article notes "in contrast to the boom years, when banks “preapproved” seemingly everyone, lenders are choosing their prospects more carefully and setting stricter terms to guard against another wave of losses"

This is encouraging. After all, we simply don't know the circumstances surrounding many credit card defaults. It's one thing if a person got hammered by the recession - losing their job and subsequently any income stream - and failed to pay their credit card debts. It's entirely another situation if someone just stopped paying because they charged too much and got in over their head with debt. The person in the former situation may be a worthy borrower now, provided they have a job and a means to pay off their debts. The person in the latter situation requires a bit more scrutiny, so it's good to see that credit card companies have begun to wise up and analyze their credit risks more (as they should have been doing all along!)

I do draw solace from the fact that the article notes "For consumers, the resurgence of card offers, however cautious, provides an opportunity to repair damaged credit and regain the convenience of paying with plastic. But there is a catch: the new cards have higher interest rates and annual fees."

Hopefully, those higher interest rates and annual fees will act as a deterrent for those borrowers who had no plans of paying off their new credit cards and instead encourages only serious borrowers. If that's the case, more capital can flow safely through the economy and we will have avoided the mistakes that got us into the financial crisis in the first place.

Companies Cling to Cash - Should You?

The Wall Street Journal's Justin Lahart has a good article today pointing out that cash now accounts for 7.4% of corporate America's assets - the highest percentage since 1959. This is due mostly to the fact that companies are not finding profitable ventures to deploy their cash into, and instead are hunkering down with it given the slow economic recovery. Typically, companies with excess cash will either plow it back into the business by buying capital assets and growing their businesses, or pay out a higher dividend in order to offer a return to shareholders. In this environment however, the concern over the potential for a prolonged economic recovery has led more and more companies to pad their balance sheets with liquidity, and the most liquidity asset is cash.

Thus, if corporate America is hoarding cash, should you? Well, yes and no. The problem with hoarding cash in a low interest rate environment is that any return you earn on your cash in a savings account or a time deposit will likely be eroded by inflation. On the flip side, the liquidity that you will have as a result will give you peace of mind, particularly if the economic recovery takes longer than we would likely. I propose putting roughly 5-15% of your paycheck in an interest bearing money market account that offers checkwriting privileges. The most important thing about doing that is for you not to view it as an investment vehicle - it's not - and instead as untapped liquidity that's also earning something. After all, the liquidity is absolutely necessary, particularly in this environment. If things get worse, you'll have the extra cash available to help out and it won't appear as if you simply have "dead money" laying around.

Investors Cheer Tax Cut Deal News

Last night's news of a potential deal between President Obama and Republicans in Congress regarding an extension of President Bush's tax cut package helped fuel a market rally which has sent the S&P 500 and the Russell 2000 small-cap index to 2-year highs. This news is very encouraging and is something I have written about before - the need to keep tax rates low to spur economic growth, create jobs and allow more money to flow throughout the economy by keeping it in the hands of individuals.

Today's market rally is a key sign of the importance of low tax rates to the market as it creates an incentive for investment, particularly low capital gains and dividends tax rates. After all, the investment incentive begins to lessen when you have to pay out more of your investment earnings in taxes. By keeping tax rates low on income that corporations pay out (dividends) and the capital gains you make on selling an asset, investors will have more reasons to provide much needed capital to businesses going forward.

Cities Where Americans Are Getting Richer

During the financial crisis, have you wondered which American cities are actually getting richer while others struggle? It's hard to believe, but even in the worst of recessions, there are pockets of strength throughout the country. While the cities are strong for different reasons - steady employers, location, government funding - each one is an interesting case in its own right.

You can check out Forbes' list here, though be aware, some of the cities may surprise you!

Smart Holiday Money Moves

The Wall Street Journal had an article over the weekend discussing seven smart money moves to make during the holidays. While they are all worthy nuggets of advice, one of the most interesting to me was number four - "Set up funds for the children (or grandchildren). While this may have limited applicability to Gen Y, it's important nonetheless, especially if you have been a recipient of gifts from a family member. Substantial financial gifts are common during Christmas time, especially as part of an estate planning strategy. This year, tax law dictates that you are able to give up to $13,000 as a gift, tax-free!

While I recommend giving this money if you are able to, I would also like to mention what to do with it if you receive such a gift for the holidays this year. First, max out your Roth IRA contribution for the year and consider investing the majority (75% or more) in index funds should you own them in your Roth. Next, use the remaining 25% for extra liquidity by holding the cash in a savings account or money market with checkwriting capabilities. Lastly, consider giving back to your community, a favorite charity or purchasing something you enjoy. By both saving and investing this money wisely, you will see that your family's financial fortunes in the future are just as good (or better!) as they were when your relative gave you the gift.

The Importance of Year End Tax Planning

The year 2010 will go down as one of the most important years for tax planning in U.S. history. As the Bush tax cuts from 2003 get ready to expire if Congress does not act to extend them, investors will be faced with an even larger tax bill going forward if they choose to delay realizing some of their gains into next year based on some of the higher rates we'll see. Most importantly for Gen Y, capital gains and dividends taxes are set to rise, in addition to marginal income tax rates.

Capital gains taxes are especially important as a focus area because this is the perfect time to rebalance your portfolio and plug some of the gains into losing positions to get back up to your desired allocation. Since successful positions will naturally rise to a greater proportion of your overall asset allocation, taking profits in those positions will enable you to tweak your allocation to remain at your desired levels.

With capital gains tax rates at 0-15% this year based on the tax bracket you are in, you will also be able to better offset this year's smaller tax bill with potential losses that will go towards reducing the overall amount you have to pay. Keep all of this in mind as you go about preparing to get your financial situation in order as the end of the year approaches.

Extending the Bush Tax Cuts

Coming off a mid-term election which saw his Democratic majority in the House of Representatives disappear, President Barack Obama has indicated he is willing to compromise with Republicans in extending President Bush's tax cut package from 2003 for all Americans. Initially, Obama was hesitant in supporting an extension of the tax cuts for the wealthiest Americans, but it appears that the will of the people made clear during the mid-term elections will win out: Americans want less spending and lower taxes across the board.

This news is important on two fronts. First, if the tax cut extension is indeed passed, it will help spur economic growth like Bush's tax cut packages did in 2001 and 2003. In 2001, the tax cuts helped fuel growth coming off a recession and in 2003, the cuts helped perk up the labor market. By extending the tax cuts across the board, there will be more wealth and capital flowing through all areas of the economy. It's easy to vilify the "rich", but many of the people who make up this class are small business owners who employ millions of workers. Since they are paying a majority of the taxes in the U.S., by penalizing them in a recession in the form of higher taxes, we're also hurting the labor market in the process.

Secondly, from an investment standpoint, lower taxes will spur investment, particularly if the capital gains and dividends tax rates stay at their Bush-era low rates. These rates will create extra incentive to investors to provide much-needed capital to businesses which in turn will also help economic growth. Low taxes are crucial to support both economic activity and to enable individuals to save more of the wealth they've earned.

A Turnaround In the Labor Market?

Weekly jobless claims fell to a 4 month low indicating that the labor market may be picking up a bit. One of the most interesting parts of the AP report was the following quote and comment:

"The pace of hiring has picked up in the past few months," said Mark Vitner, an economist at Wells Fargo. If the drop in claims is sustained, he said, net job gains could rise from this year's average of 90,000 a month to 140,000 next year. Still, that's barely enough to keep up with population growth. The economy needs to create at least 300,000 net jobs a month to make a dent in the unemployment rate, now at 9.6 percent."

While the job market may be seeing a temporary boost for the time being, a full recovery is likely some time away. After all, 300,000 net jobs a month are not likely to be appear out of thin air.

What's Twitter Worth?

The value of many private social media companies like Twitter, facebook, Zynga and the like is oft-debated. Smart Money recently had an article analyzing the potential values of these companies should they be brought to public market.

This is all very interesting because it shows the type of power and leverage that Gen Y is having on business. After all, the lofty valuations that these companies are receiving are due in large part to their extremely large user base - primarily members of Gen Y. While much of their value relies heavily on the network effect of adding new users and generating increasing amounts of revenue via ads and other means, the amount of people using their product indicates that the potential value that the market places on each company may be more believable than the values placed on Internet companies during the tech boom - only time will tell!

Tuning Out the Noise

While looking through the news this morning, I noticed an article by E.S. Browning in The Wall Street Journal entitled, "Stocks Face Dark Side of Gridlock in Capital". Basically, Browning contends that while Wall Street was excited both about tomorrow's elections and the Federal Reserve's announcement that it will support financial markets by buying bonds, it is now worried that it "overdid" things. Such is the way Wall Street works, unfortunately!

Investors see this type of thing goes on all the time: the future direction of stock prices are constantly debated in the media and whether or not the markets have more run to run, or if they've run their course. Browning goes on to write that "but longer term, some investors are starting to question two widely held tenets of election-related investing: that Washington gridlock is good for stocks, and that stocks inevitably rise in the third year of a presidential term, which is next year."

Readers who are part of Generation WISE understand that such thinking is truly worthless in the grand scheme of things. Sure, studies may show that Washington gridlock helps stocks or the political party of the President matters, among other theories. None of this matters over the long-term because we're not timing markets. As long as you're well-positioned for the future with an asset allocation that suits your return objectives and risk tolerance, you won' t have to worry about day to day market fluctuations.

Tomorrow is November 2 - Election Day - but you'd do best to tune out the noise and not worry about what predictive power such a short-term political change has on stock prices; it won't matter for the long-term investor.

Bogle on Target Date Funds

Target date mutual funds, or those whose asset mix changes in order to fulfill a fund's target date investment objective, have been a hot innovation in the mutual fund industry in recent years. After all, it's awfully convenient for investors to buy a target date fund based on their retirement yet (or some other goal), plow money into it and not worry about the legwork.

Unfortunately, this is where many investors are in the wrong because they do not do the necessary legwork and simply take the fund's objective at its word. This is a dangerous strategy because as John Bogle points out, many of the funds may own investments that you wouldn't touch on an individual basis.

After all, if a target date fund has a target date of 2050 or beyond, the fund is likely to be very aggressive given its long time horizon. In order to be aggressive, the fund has to take more risks, sometimes more than the investor in the fund realizes. A better option is to find the target date funds which own a basket of index funds whose allocation percentages change as the target date gets closer. In fact, this is what Bogle advocates and as the "father of index investing", who better an authority to trust on the subject?

Looking Beyond TIPS

On Monday, Treasury Inflation Protected Securities (TIPS) were auctioned for the first time at a negative yield. This means that the Treasury note will only have a positive return if consumer prices jump up more than half a percentage point. TIPS are a way to hedge against inflation because the Treasury securities' par values are indexed to the Consumer Price Index (CPI). With this, you are getting a low risk investment in the form of a Treasury security that also protects you from the ill effects of inflation.

Writing in The Wall Street Journal, Ben Levisohn notes that commodities, currencies and dividend stocks are three other investment areas that may protect you from inflation should the negative TIPS anomaly continue to play out.

I agree with the notion that dividend paying stocks are a good way to fight inflation and by buying a basket of them either individually or via an ETF, you're going to share in future dividend growth which will likely outpace inflation.

The best way to do this when building an individual basket is to buy dividend paying stocks of blue chip, consumer-related names. Basically, companies that make recession-resistant products such as food, personal care and medical items and the like, are all likely to continue to grow dividends faster than the inflation rate which will act as a natural hedge against inflation. Be careful not to put "too many eggs in one basket" and instead diversify around the basket of dividend paying stocks so as to spread out risk. Buying dividend paying stocks to hedge against inflation will likely prove to be a wise long-term investment as the potential for longer-term capital appreciation is there, as well.

Buffett Chooses Successor?

This morning, Warren Buffett, the billionaire investor who runs Berkshire Hathaway has announced the addition of hedge fund manager Todd Combs to his team. Combs, a 39 year old who runs a long/short financial services-focused hedge fund will join Berkshire immediately.

This news is quite interesting because at 80 years old, Buffett is in need of a successor to run the investment portfolio at Berkshire when he is no longer able to do so. Combs is an interesting choice and someone whose name I've never heard mentioned with Buffett's before. It will be interesting to see in what type of capacity Buffett chooses to put Combs, but if he has the Oracle's seal of approval, it's likely he'll play a significant role in portfolio management going forward.

How does this news impact Gen Y? When the world's greatest investor announces a new addition to his investment team and someone that's likely to play a large role in portfolio management at Berkshire in the future, you tend to listen. Even more interestingly, Mr. Combs is only 39 years old - could he be the next big star in the financial world?

The Bogleheads Meet

Investors who follow Vanguard founder John Bogle's investment advice are often referred to as "Bogleheads". There have been books written by Bogleheads, and the faithful followers even congregate at an online message board - www.bogleheads.org - which was an offshoot of the original Morningstar.com "Vanguard Diehards" message board.

Forbes has a great article from Laura Dogu, a writer and leader on the online Bogleheads' forum, which recounts the recent gathering the group had in Pennsylvania. The Bogleheads' are a great group of people following the excellent advice given by one of the champions of the individual investor - John Bogle. The article is worth reading because Bogle's advice is so worth following.

Bad Advice: Creating Your Own Hedge Fund

CNBC has an article on how to build your own hedge fund which tops the list of potentially devastating investment decisions you can make. Hedge funds are investment vehicles typically limited to high net worth investors which can use a variety of investment strategies that the average investment fund cannot. These funds can employ large amounts of leverage, short stock and trade derivatives, among many other things. While we have all heard of the wildly successful funds like Ken Griffin's Citadel Investments or John Paulson's Paulson & Co, there are thousands of funds that fail for each one that revels in exorbitant returns.

Retail investors are at a disadvantage to hedge funds and other institutions because those firms typically have large amounts of capital to move around and with that capital comes speed, efficiency and information flow which helps them make money on their trades. Secondly, the people who run hedge funds are typically brilliant financial minds, and while brilliance does not equate to consistently posting market beating returns, the minds at hedge funds usually understand the nuances of the securities and markets in which they trade.

All of these reasons make CNBC's article - how to start a "poor man's" hedge fund - ridiculously bad. After all, if the financial crisis saw many of the aforementioned brilliant managers blow up given large derivatives exposure, how can the average retail investor navigate the derivatives market successfully? In short, we can but the odds are against us. More importantly, who has the time to bother to trade and understand currencies, commodities and long and short positions? The pros at the large hedge funds do - they employ thousands of experts in each market - but the average investor like you and I certainly have more important things to be doing.

Sure, creating your own hedge fund sounds like a neat idea. The thrill of beating the market as well as the pros at their own game, certainly holds a lot of appeal. However, when you realize that the odds of this occurring, especially with any consistency, are slim to none, why not save yourself the time and aggravation involved in this endeavor and instead just buy index funds?

Are Allocation Funds a Good Option?

Morningstar.com has a very good article on Vanguard's allocation funds - mutual funds that strive to maintain a set asset allocation over the life of the fund, or tweak it according to the fund's mandate. For example, Vanguard has a series of "LifeStrategy" funds which invest in other Vanguard index funds to achieve a stated goal. The Vanguard LifeStrategy Growth Fund (VASGX) therefore has roughly 85% of its assets in stocks and 15% in bonds and is aimed at investors who have investment horizons greater than 5 years. These funds have grown in prominence because all of the work is done for you at a minimal fee - the fund rebalances itself according to its stated objective and you get the added diversification of owning a fund of funds - yes, a mutual fund that owns more mutual funds.

The Vanguard LifeStrategy Growth Fund owns four separate Vanguard index funds in varying proportions and only has an expense ratio of 0.23%. The risk with allocation funds are that you view them too much as a one stop shop and pin all of your investment goals and expectations upon the fund, which otherwise may be unrealistic. Yes, allocation funds can be a great start but make sure you do the legwork to understand the fund's fee structure, rebalancing policy and what it actually owns. The potential for overlap - owning a fund that's already owned elsewhere - is a lot higher when dealing with a fund of funds - people may not realize what that fund owns in its entirety.

Take the Free Money!

It's been said that there are "no free lunches on Wall Street" and that is indeed very true...except in one circumstance. Granted, this isn't a "fully" free lunch - you're not getting something for nothing - but it's basically free money. So what am I talking about? The answer: taking advantage of your employer's matching 401(k) contribution policy. If your employer matches your 401(k) contribution, you're basically receiving free money. While you do have to contribute something to be eligible to be matched (hence why it's not entirely "free"), there isn't a single sound argument out there as to why you should avoid contributing so as to receive the match.

In a weekend article in The Atlantic, Daniel Indiviglio points out the following:

"When your company promises to match some contribution to a 401(k), it's like giving you a raise. Refusing the match is like telling your company that you don't want extra money. Imagine an example where you make $1,000 per paycheck. Now imagine if your company agrees to match 50 cents per dollar up to 6% of your 401(k) contribution per paycheck. That means you can put up to $60 per paycheck into your 401(k) and your company will also contribute $30."

If your employer offered you free money, wouldn't you take it? If your employer does indeed match your 401(k) contributes, you should max out your contributions so as to receive the highest employer match possible. In doing this, you'll be well rewarded in the future when your retirement goal is attainable at a younger age.

Avoiding 10 Dumb Money Moves

Stacy Johnson at MoneyTalksNews has a great list of "10 dumb money moves". All of them have merit in one way or another but #5 in particular stood out to me:

5. Starting to save large and late rather than small and soon

If you're 25 and you save just 5 bucks every day ... call it $150 a month ... and earn 10 percent, by the time you're 55, you'll have $340,000. If you wait till you're 45 to start accumulating that same 340 grand, you'll have to save $1,700 every month for 10 years. True, you can't earn 10 percent today, at least without risk. But over time and by taking a measured amount of risk, you can.

I can't emphasize enough have important starting early is. Most people don't realize that even if you start with a small amount now, you'll have plenty of years to watch that money compound and you'll ultimately wind up with a lot more than you started with. For example, if you start with $1,000 at age 25 and add $5,000 yearly at an average return of 7% until you retire in 40 years, you'll wind up with $1,013,150.02 - yes, you'll be a millionaire! Granted, that calculation doesn't take into account the effects of inflation, but building a million dollar nest egg to retire on while only starting with $1,000 is quite impressive. The list may point out "dumb money moves" but all of them are easy to learn from and to correct.

Gen Y and "The Scarring Effect"

During recessions, Gen Y college graduates are likely to make 5%-15% less than those starting out during a better economy. A recent Wall Street Journal article noted that, "Notre Dame labor economist Abigail Wozniak calls it 'the scarring effect.' If you graduate in a good year, your career may get off to a strong start. But if it's a bad year, you are essentially scarred in the labor market for years to come."

This is indeed very scary for Gen Y because it means that we as individuals simply cannot control our own destiny. Growing up, we are taught that we can accomplish any goal that we set our mind to. When we are preparing for college, we get to pick our university, our degree program and the types of people that we associate with during those years. What this research is telling us, is that regardless of how hard we work and how many connections we make, it all may not be good enough if the job market is poor when we graduate and we either don't get a job or make substantially less than we would have had the economy been growing.

Unfortunately, this is the state of the labor market for recent college graduates. However, when the economy starts to hum again, it's likely that salaries will increase across the board because the same companies who weren't looking to hire when we graduated will then have to raise their price of labor in order to reach a supply/demand equilibrium.

Pfizer Keeps Making Deals

Mergers and acquisitions always interest me because I like to see the structure of the deal - how much stock and cash are involved, who's acquiring who and why and also because such deals also tend to indicate economic strength or weakness. This morning, drug giant Pfizer (PFE) has announced plans to acquire King Pharmaceuticals (KG) for $3.6 billion in cash. Amazingly, this comes exactly a year since Pfizer's deal to acquire Wyeth last year for $68 billion closed.

Companies that are flush with cash - particularly those involved in health care related fields - are putting more money to work to grow their portfolio of products to cope with the sour economy. In acquiring King, Pfizer gains venerable products in Avinza, a pain drug, and EpiPen the well-known injection used to treat allergic reactions. Interestingly, pharmaceutical companies have worked hard on acquiring both established players (Pfizer buying Wyeth) and biotech firms who may have potential blockbusters waiting in the pipeline (Sanofi-Aventis bidding on Genzyme). Since bringing a new drug to market is quite costly, many times it's easier buying a biotech firm who's already involved in extensive clinical testing of their potential drugs.

This news may seem like your run of the mill big pharma deal, but it also shows that the most cash-flush companies are willing to put large amounts of capital on the line to better position themselves for an economic turnaround.

Understanding Investment Risk

Today, Chuck Jaffe wrote in The Wall Street Journal about a variety of different investment risks and made the case that investors are investing at precisely the wrong times because they don't understand the risks inherent in investing. Ultimately, on average, the riskier an asset, the higher potential return that comes along with it. It's impossible to eliminate all investment risk - even if a portfolio is diversified properly - as you will still face "systematic" risk or the risk that's inherent to the entire market.

Jaffe makes an excellent point in saying that "People will say they can tolerate risk, so long as they don't experience losses. They will settle for a near-zero return in a money-market fund because it is better than posting a loss without recognizing that they are losing buying power—ultimately the same impact as a loss-every day their investments fail to beat inflation."

Yes, investment risks encompass a variety of forms but one of the most important that Jaffe highlights is purchasing-power risk. If an investor is afraid to put any money in the market, they will commonly hoard it away in a seemingly "safe" investment vehicle like a savings account, CD or simply withdraw the cash entirely. This is a bad move for a variety of reasons, but the biggest is because inflation will likely erode the long-term purchasing power of the dollars as the interest earned on any bank deposits won't keep up with the rate of inflation. 

In fact, today, 5-year CDs are only averaging 2.40% according to BankRate.com. If inflation is 4% over the next 5 years, you wind up losing 1.60% on an investment that you deemed "safe". Worse still, depending on the policies of your bank, you probably won't be able to withdraw money from your CD without incurring a penalty and you will be locked in at the stated interest rate for the 5-year term. Thus, it's important to understand the risks you face when investing because they can take shape in a variety of different ways.

Economy Sheds More Jobs

The U.S. lost 95,000 jobs in September, much worse than the anticipated drop of 5,000 that was the median estimate of economists surveyed by Bloomberg News. The government continues to cut temporary Census hires and the private sector's employment growth is lagging.

This news tells me that the much-anticipated economic recovery is still faltering. Fiscal support from government stimulus quickly wore off and the unemployment rate, sitting stubbornly at 9.6%, will get worse before it gets better.

Interestingly, while the economy remains deep in the tank, the stock market has performed well. The Dow Jones Industrial Average (DJIA) is nearing 11,000 and stocks' reputation as a leading indicator may indicate a quicker economic recovery than some economists are forecasting. A more likely explanation, however, is that the round of cost cutting that companies initiated in response to the recession has lead to higher earnings all around and subsequently, an expectation for higher profits once these leaner companies start growing again.

Have a great weekend! Enjoy the football games. Geaux Tigers!

ETFs vs. Index Funds: Expenses Matter

The Wall Street Journal recently had an article extolling the virtues of exchange traded funds (ETFs). Basically, ETFs are baskets of stocks that trade openly on an exchange. Most of them are like index funds in that the ETF tracks a specific index by holding the stocks in the benchmark index in proportion to their weight in it. For example, the Vanguard Total Stock Market Index (VTSMX) has an ETF counterpart, the Vanguard Total Stock Market ETF (VTI) which trades all day just like a stock. This can be a good or bad thing. When you send money in to buy a mutual fund, your trade is typically processed at the price at the end of the business day in which your money is received. The constant price changes in an ETF make it appeal to traders who may play the continuous price movements by buying and selling constantly.

However, as a rule, the one time I will recommend an ETF over its index fund counterpart is when the ETF has lower expenses associated with it. For example, the article mentions how "the average ETF expense ratio is 0.6% of assets, compared with an average 0.8% for traditional index funds, according to investment researcher Morningstar." This amount will differ on a firm by firm basis, but the lower the expense ratio, the better. However, make sure that you're not incurring any type of substantial commission by buying the ETF - after all, purchasing an index fund through a firm like Vanguard is free - you will simply incur year end expenses deducted from your fund's assets.

Vanguard Cuts Fund Fees Further

There's some great news out there today for individual investors: Vanguard, the index fund giant, has announced that they are cutting fees further on most of their index fund offerings. They are doing this by cutting the minimum investment required for their Admiral shares. Before the cut, it required $100,000 to invest in the Admiral shares but now it will only be $10,000. Amazingly, the AP report states:

"For example, Admiral shares of Vanguard's Total Stock Market Index Fund will charge $7 in annual expenses for every $1,000 invested, provided an investor has at least $10,000 in the fund. That's down from $18 in annual expenses for Investor shares in the $138 billion fund, which requires a minimum of $3,000."

Yes, that's only $7 in annual expenses for every $1,000 invested or about 0.007%! It's important to remember that these fees are deducted directly from the fund's assets and are not charged so that you have to write a check to cover the expense amount. Overall, this is fantastic news for retail investors who have seen fees and expenses skyrocket in recent years. It's clear that Vanguard "gets it"!

More Parents Raiding Retirement Accounts for College

A study released today by student loan provider Sallie Mae and the Gallup Organization shows that 25% of the nation's parents are now raiding their retirement accounts to pay for their children's education, regardless of the tax consequences. This news is disconcerting on a number of levels, namely that parents don't have enough money saved up elsewhere for college but also because of the large tax burdens that can arise from tapping a 401(k) or IRA prematurely.

Even worse, parents are using investment vehicles that have a dubious track record when it comes to producing the returns needed when college comes calling. CNNMoney reports that "the most common way that parents reported saving for college was with CDs or general savings accounts. Some 50% used those more traditional forms of saving, according to the survey." Adjusted for inflation, these savings accounts aren't going to produce the returns necessary for a tuition payment. Thus, that means that parents using them will have to save that much more, just to be in the ballpark of a tuition payment. The moral of the story? Save early and often for whatever goal you would like to achieve so that you're not stuck tapping funds that should be used only for retirement.

The Difficulty of Decision Making

Shirley Wang at The Wall Street Journal has an interesting article on a psychological issue - the difficult nature of decision making. A lot of the information in the article pertains to investing, as well. Generation Y may find that it's very difficult to make the tough decisions about financial issues because so much seems to be at stake. After all, if you plan incorrectly, have a mix of the wrong investments or the like, you risk financial ruin at a very young age. However, high stakes do not have to mean that decision making should be difficult.

Ultimately, almost everything in the world of individual investment can be whittled down into investment policy - the act of defining long-term financial goals and the means by which to achieve them. Every investor both young and old needs to have a sound investment policy. So, what does that policy consist of? As investors, we must first develop financial goals. For example, a goal may be that you would like to retire at age 55 with a nest egg of $2 million. Secondly, we should outline the appropriate ways to achieve those goals including the investments that we can use to help us get there. Lastly, we should determine the exact investments to put into our overall asset allocation and evaluate them accordingly.

This is a simplified way of creating a sound investment policy but you will find that if you work hard on it now, the amount of work required in the future on it will simply be a matter of tying up the loose odds and ends. Yes, it may be difficult to make decisions. With a rock-solid investment policy, it doesn't have to be.

The Moral of the Story Is...

A few days ago, The Wall Street Journal's Brett Arends penned an article entitled, "You Should Have Timed the Market". Arends bases his assertion on the fact that recent research from TrimTabs indicates that regular investors bought into equity mutual funds during the boom and needlessly sold them when everyone was panicking and selling their positions. As a result, investor losses were pegged at $39 billion.

Arends points out that TrimTabs, "calculates that mutual fund investors bought into the Standard & Poor's 500-stock index at an average of 1,434. That's close to its record high of 1,565. If investors had invested at random times instead, their average purchase price would have been 1,171."

The conclusion shouldn't be that we should time the market. Yes, we should buy when everyone else is selling. As was famously said, you should buy stock when "there's blood in the streets". However, by tacitly agreeing to market time, you are setting yourself up to head down a very slippery slope. By engaging in this, you'll soon see that you find yourself jumping into and out of equities at precisely the wrong times because your emotions play such a big role in investing.

For example, suppose you've held a stock for a few years and have done extremely well with it. You have done the appropriate research and realize that the stock is still undervalued and so you continue to add to your position. When the company releases a poor earnings report, should you sell because everyone else is? Of course not! It's almost always a bad bet to follow the herd and to let your emotions get the best of you. You should always have the courage to stick to your convictions until the underlying fundamentals prove otherwise.

Instead, rather than "timing" the market as Arends advocates, it's a better idea to dollar cost average (DCA). With this, you simply buy into your investment (index fund, stock, etc.) without paying any attention to the price. This is helpful because you'll find that over the long-term, your average purchase price will be quite small and it will make up for any of the problems you would have had if you had tried to time your purchases based on the prevailing "wisdom" in the market. Dollar cost averaging beats market timing - always.

Warren Buffett & Jay-Z Talk Business

Billionaire investor Warren Buffett and music mogul Jay-Z both met at a diner in Omaha recently to discuss business, getting started early and how to cope with change in today's markets in a discussion with Steve Forbes. Forbes magazine has some of the transcripts and there's certainly a lot to be learned from both people.

Buffett, arguably the world's most successful investor, has made a career of buying and holding great businesses at discounted valuations through his holding vehicle, Berkshire Hathaway. Jay-Z is a rap artist turned music mogul who now runs Roc Nation - a music management and publishing company that has all hands in the promotional aspect of a musician's career. This interview is great reading for all people but would especially appeal to, and benefit, Gen Y.

Gold Prices & Gen Y

I'm always interested in all types of investment and economic indicators. Watching gold futures prices hit an all-time high yesterday told me that most people are still worried about inflation (gold, as a hard asset, protects against this evil) as well as general economic malaise. 

It's amazing how we can get conflicting economic numbers and statistics telling us a recovery may be near and then see gold prices skyrocket to over $1,300 an ounce. To me, that means investors are still skittish and we have a long way to go before we're going to see serious economic growth again. The signals gold is giving us proves that all types of indicators are important when watching the economy. I've been following these indicators now more than ever because the longer the economy takes to recover, the longer jobs growth will take to recover,  which in turn has drastic implications for Generation Y.

Why Timing the Market is a Bad Idea

Over the weekend, The Wall Street Journal's James B. Stewart wrote an article entitled, "How to Time the Stock Market". Naturally, I'm skeptical of any system that pledges to consistently "outperform a simple buy-and-hold index approach" as the article states. With that said, Stewart goes through a system which he describes as follows:

"Here is how the system works: When the market is dropping, I buy stocks at intervals of 10% declines from the most recent peak. When it is rising, I sell at intervals of 25% gains from the most recent low. These figures are roughly one-half the historical average losses of 20% in bear markets and gains of 50% in bull markets since 1979. They are round numbers and the math is easy to do in your head."

Here's the problem: there's an emotional aspect to this "system" that will ruin most investors who engage in it. Not all people will be as disciplined as Mr. Stewart is in implementing his system and the result will be severe underperformance for investors who do not have the discipline to stick to the system and instead incur high fees and trading costs which eat profits.

Worse still, if any of your stocks have rapid movements and you're forced to buy/sell often, you'll incur short-term capital gains taxes, which, depending on your tax bracket, can be as high as 35%! This will quickly destroy any of the value such a market timing system would have for you. Lastly, who has the patience to market time? It's unlikely that Gen Y wants to be bothered with setting up models to help them determine which stocks are rising and falling from valleys and peaks. More importantly, we have bigger obligations like school and work to deal with. With that said, it's best just to buy the entire market via an indexing strategy that's low-cost and won't keep you up at night.

Flurry of M&A Activity May Help Gen Y

This morning's flurry of M&A activity - Unilever NV (UN) purchased Alberto-Culver (ACV), Southwest Airlines (LUV) bought AirTran (AAI) and Wal-Mart (WMT) acquired a South African consumer goods company - indicates that an economic recovery may come sooner rather than later. After all, the aforementioned companies are excellent barometers for the overall economy because Unilever and Wal-Mart both sell consumer goods and Southwest is in a very cyclical industry. In fact, the biggest news may be that Southwest - one of the leaders in the airline industry - was willing to put up $1.4 billion to buy AirTran, even as other rivals are cutting routes and in some cases, filing for bankruptcy.

To see these companies putting up billions to acquire other firms is a sign that they are comfortable with getting rid of some of the cash on their balance sheets that they had hunkered down with to help combat the recession. Any large outlay of a cash by a firm for an acquisition at this point of the economic cycle is a sure sign that they are confident enough in their ability to generate cash from operations going forward to help fund it.

With that said, this news also has plenty of importance for Gen Y because the potential for an economic recovery means that the job market may recover sooner rather than later. Granted, the recent employment reports have indicated prolonged sluggishness remains, but the confidence on the part of large companies in expending billions of dollars to buy other firms suggests that the next logical step will be the creation of new jobs both at those companies and across the broader economy.

Economic News is Getting Better

This morning's durable goods report - the report regarding the investment companies make in capital assets like machinery, equipment and the like - showed that for the third time in four months, businesses were getting more optimistic about investing in capital assets. The AP recount of the report says that "The 4.1 percent increase to capital goods in August signaled a rebound in business spending after orders fell 5.3 percent in July." As a result, the S&P 500 is up about 1.60% on the strength of the report.

It's hard to read too much into daily economic reports because each one measures a drastically different area of an incredibly large U.S. economy and because we're so often given conflicting reports about what the actual state of the economy is. Suffice it to say, the news is getting better, albeit slightly, so going into your weekend, remain optimistic that the economy is one step closer to picking up steam.

Where are Gen Y's Billionaires?

Today, Forbes magazine released its annual list of the richest 400 people in America - the much-anticipated Forbes 400 list. This list is the standard by which most extremely wealthy Americans tend to measure themselves. Granted, much of a billionaire's empire is hard to value given that wealth can be tied up in illiquid private securities or other assets, but Forbes does a pretty good job overall of estimating wealth.

Robert Frank at the Wall Street Journal points out something that should be obvious to anyone taking a good look at the list - there's a lack of young money. Indeed, the nouveau riche that was long talked about does not seem to be coming into fruition. Instead, we're seeing a continuation of old money and what Frank describes as "a hardening of the plutocracy". Yes, facebook's "Big Three" made it onto the list and the youngest member of the Forbes 400 is 26. Ultimately, though, it's clear that Gen Y is making little headway in reaching the upper echelons of wealth in this country. As Frank concludes, there were "no new billionaires from tech, or the Green Economy, or biotechnology or any other revolutionary product or industry" in the list.

Given the fact that any millennial who becomes a part of the list would have had a drastically shorter time frame to build such a vast amount of wealth, it may be a little while before their empires register on the Forbes 400 scale. By that time, perhaps they will constitute a new plutocracy.

The Billionaire Who Bought Burger King

Yesterday, Bloomberg had an interesting article on Brazilian billionaire Jorge Paulo Lemann, the 71-year old investor behind investment firm 3G Capital which just purchased fast food giant Burger King for $3.3 billion. Lemann's story is inspiring because he has had an entrepreneurial spirit his whole life, having founded an investment bank in Brazil at age 32 that was dubbed the "Brazilian Goldman Sachs". Besides his role as a banker and his recent acquisition of Burger King, Lemann was also an active player in InBev's purchase of Anheuser-Busch as he owned a substantial stake in InBev (and still does). 

WSJ: Financial Planners Pursue Gen Y

Today's Wall Street Journal had a refreshing article on how financial planners are actively pursuing both Gen Y and Gen X accounts "banking on their ability to help today's young investor become tomorrow's "big" client." This is great news for Gen Y because it means that certified financial planners - those with the official CFP designation - will continue to offer services to us at attractive rates. Since millennials are just beginning to receive steady streams of income from their first jobs/careers, CFPs are looking at us as attractive targets because they realize how much wealth we have the potential to accumulate over a lifetime. By becoming our advisor early on in life,  the CFP realizes that they more wealth they help us build, the greater advisory fee they will earn when our assets grow.

CFPs are a great resource because it's very difficult for most investors with little time or energy to manage their assets appropriately. Investors should stick with fee-only advisors - those who are paid a flat-rate rather than via commission like a stockbroker may be. This helps align the CFP's interest in formulating an investment policy with your own interest in building wealth because it eliminates potential conflicts of interest arising from commission-based advisors who prefer to see you more active as that activity helps generate revenue for them (but not necessarily for you).

The only disconcerting part of the article came when I read the following, "Young investors tend to be focused on their immediate financial needs, he says, such as buying a house for their growing family or booking their next vacation. Retirement is important, too, but it's not foremost in these clients' minds."

It's never too early to think about retirement, and by saving and planning for it today, you eliminate any potential problems or headaches you may experience down the road if you decide to wait too long to get started.

College Football's Most Valuable Programs

It's Friday so I've decided to offer up some light weekend reading. Last year, Forbes listed the "Most Valuable College Football Programs" which includes my very own LSU Tigers who come in 7th out of 20. The greater Baton Rouge area rakes in about $8.2 million every home game weekend and the team is valued at about $86 million based on revenue generation and the ability to generate fan spending. Not too shabby at all!

Tomorrow is our first home game of the year against Mississippi State and I couldn't be more excited. As the number one tailgating spot in all of college football, even though it's not game day just yet, it's still time to get ready! As we love to say, Geaux Tigers!

So, This Professor...

Over the weekend, The Wall Street Journal had an interesting piece on new exchange-traded fund (ETF) offerings based on the theories and academic research of university professors and other academics. The article cites University of Pennsylvania's Jeremy Siegel as being a co-founder of Wisdom Tree Investments in 2006 which issued ETFs focusing on dividend paying stocks. Another example given was SummerHaven Investment Management LLC which last month started a commodity ETF driven by the research of Yale University's Geert Rouwenhorst.

When I saw this article, my interest was piqued because I had heard of WisdomTree but hadn't looked into their offerings much. After reading on their website that the LargeCap Dividend ETF follows their own fundamentally weighted index, I began to understand the problem with their lackluster returns. Besides their heavy weighting in financial stocks during the crisis, the use of the term "index" with the word fundamental preceding it scares me off. After all, the purpose of an index is to include a broad-based representation of a large group of assets without any bias towards fundamentals. In this case, including an entire universe of dividend-paying stocks, rather than those that simply meet a pre-determined fundamental threshold may have been more appropriate.The slippery slope towards a manager taking an active role in stock selection under the guise of indexing is possible.

I greatly respect Professor Siegel and his work. His focus on dividends is one that I can agree with completely. After all, dividends are ultimately what drive returns on stocks. However, I'm quick to shy away from any ETF or index fund offering that has too flashy of a personality behind it (yes, Siegel even publishes a newsletter) or invests according to a fundamentally-weighted index. Index fund and ETF investing should be boring and the goal is to invest in both to capture the returns of an entire universe of securities, not an "index" of cherry-picked securities.

Retirement on Hold? A Lesson for Gen Y

Today, CNBC reports that a new study by Boston College's Center for Retirement Research says that Americans are $6.6 trillion short of what they need to retire. Yes, you read that right! Trillion.
So, what can we blame this on? For starters, a declining stock market and falling home values have hindered the plans of many Americans near retirement age who no longer have the inflated value of those assets to tap into. Investors have seen their 401(k)s, IRAs and a bevy of other retirement accounts pummeled in the last few years as the financial crisis put downward pressure on debt and equity of all stripes.

The CNBC article says, "The $6.6 trillion figure is based on projections of retirement and income for American workers ages 32-64. The study's authors say they arrived at the amount using conservative assumptions, including a 3 percent rate of return on assets and no further cuts in pension coverage or increases in the Social Security retirement age." While the market may return better than 3% on average (probably closer to 7% after inflation) over the next couple of decades, it's better that this type of study displays just caution given the extreme dislocation we've seen in the financial markets since 2007.

If anything is a call to action for Gen Y investors, this is it! "Right Here, Right Now", the hit 1990 song by British rock group Jesus Jones had a great line that's quite applicable to today's Gen Y investors. Indeed, we can say that like Jesus Jones, we're "Right here, right now, watching the world wake up from history."

Many Gen X'ers and Baby Boomers are coming to the realization that their retirement assets are not what they expected. This is the perfect time for Gen Y investors to start socking away even more money into savings and investment plans. We are lucky to be so young in that we can learn from the financial mistakes of older generations! The writing is on the wall courtesy of the Boston College report. It's time to save and invest even more to realize our retirement goals.

The Importance of Delayed Gratification

This morning I read an interesting article entitled 5 Ways to Teach Your Kids About Money. Since this blog is for Gen Y investors, it may seem like there are few if any practical applications for us when it comes to financial advice given to children. Looking a little deeper, there are certainly areas where we can learn from the article.

The biggest piece of advice from the article that I think is quite beneficial to millennial investors would be #4: Delayed Gratification. Few, if any younger investors (millennials, included) are satisfied with delayed gratification. I tend to think that the Baby Boomers and generations before them are able to delay gratification because they grew up during wars, severe economic recessions and vast periods of inflation that also included a lackluster job market. In short, they were taught to save now and enjoy the fruits of those savings later.

When it comes to Gen Y, we tend to want all of the benefits of an activity now. While this may not be unrealistic given how much our economy and business landscape has changed, it doesn't necessarily bode well as the recipe for a successful investment plan. Instead, if we take time to recognize that by saving and investing today, the odds are very good we will have a secure financial future to look forward to our generation will be vastly better off!

There's Nothing Certain in Life Except...

The old adage goes, "There's nothing certain in life except death and taxes". Today, I'd like to say that there's nothing certain in life except death and tax law changes!

2010 has proven to be a politically volatile year and much of the debate around the country today centers on tax policy. As it stands, President Bush's tax cut package in 2003 is set to revert on January 1, 2011 so that everything from higher marginal income tax rates, as well as dividends and capital gains tax rates are all set to increase if Congress doesn't act before the end of the year to extend them.

From the Gen Y investor's standpoint, the news is very disheartening because both dividends and capital gains taxes could be on the rise. Today, the top tax rate on capital gains is 15% (and most likely less for millennials in lower tax brackets) and this figure would rise to 20% in 2011 if nothing is done to extend the tax cut, or make it permanent. On the other hand, dividends taxes are currently maxed out at 15% and will rise to 39.6% next year if nothing is done by Congress.

Why This Matters: A capital gain occurs when you sell a capital asset for a higher price than you purchased it. When you do this, you trigger a taxable event that will result in a payment to the IRS the April after you sold your asset. On the other hand, dividends are distributions made by a company out of their net income. In the U.S., companies experience double taxation of dividends - when they earn their income and when shareholders report their personal income (even though the amount is from the company's after-tax earnings).  Higher capital gains and dividends taxes discourage investment because more of the capital that should be flowing to you is instead flowing to the government. This in turn hurts economic growth because less capital is in the hands of investors who could use it to stimulate economic activity with spending.

With upwards of 60% of American households now owning stock, bonds, mutual funds or the like, higher capital gains and dividends taxes will affect all classes of people. Millennials will be hit especially hard because our long-term investment horizons will now have less of a capital base to compound upon as we pay more in taxes. For example, assume that you pay taxes at the highest marginal rate and earning $5,000 in dividends this year. Come April, you will cut a check to the government for $750 so you take in $4,250 after-tax. Next year, you would only take in in $3,020 as you will have to pay a 39.6% dividend tax!

What to Do: While the tax changes going into next year are still quite uncertain, if you are sitting on a large capital gain or two, consider selling some of your position so that you will pay a lower rate on that gain this year. However, make sure the capital gain can be classified as long-term (the security is held over 1 year), otherwise, you may have to pay even more. As for the potential dividend tax increase, it may be a good idea to hold any serious income-producing investments in a tax-free Roth IRA so that you will be shielded from a potential tax increase going into 2011.

Watch for High-Fee Advisors (Even if Indexing)

Index fund expert Richard Ferri has an excellent article on Forbes.com where he points out that of the 20,000 or so fee-only advisors who manage portfolios for individuals like you or I, roughly 3,000 or so advocate index investing.
 

Ferri in turn lambastes some of those same fee-only advisors for being hypocrites:

"Unfortunately, many passive advisors talk the talk but don't walk the walk. They preach low-cost, but it doesn't apply to their own advisor fee. Many passive advisors will berate the brokerage industry and the fund companies for charging high fees, and then stick their clients with the same high fees for investment advice and portfolio management."

Basically, if you're investing with a fee-only advisor to avoid the onerous brokerage commissions and transaction costs associated with a stockbroker or pay-as-you go financial "advisor", then you should expect to pay a reasonable, flat fee. Ferri explains that, "A fair fee for servicing a $1 million client should be no more than $5,000 annually, which is 0.50%, and that includes basic personal finance advice."

I agree with him here and any fee nearing 1% seems outrageous to me. After all, in a portfolio that's almost entirely indexed, you'll likely have most of the legwork done once your investment policy is implemented, provided you re-balance yearly and stick to a passive strategy.

Passive investing is key because you can invest in a cost-efficient, headache-free manner. There will be no reason to constantly call your advisor inquiring about a falling stock position or what to do if you feel that you are overweighted in a certain asset class. Provided you formulate an investment policy that works well for you, the advisor's job will be to provide a quarterly and/or annual review and to manage the portfolio (which will take up less time with an indexed portfolio). Thus, Ferri is right - there's no reason to pay an exorbitant fee to a fee-only advisor who advocates passive investing since there's little further value added in the process!

How to Post Good Results in a Recession

Today, fast food giant McDonald's (MCD) announced that their U.S. sales metric was up 4.6% in August as consumers flocked to the Golden Arches to buy McDonald's new frappe and fruit smoothie lines. As an investor, this news interests me for two main reasons: 1). In July, McDonald's saw U.S. sales rise 5.7% so they are continuing to post great sales figures even in the face of extremely slow economic growth 2). Both consumers and investors are "buying what they know" when they purchase the new menu items at McDonald's, as well as shares of its stock.

McDonald's is a great example of a company that produces goods that are price inelastic - consumers will not change their buying habits when it comes to Big Macs, frappes and the like even though prices increase. These goods are seen as convenient and McDonald's has been tremendously successful at integrating their new line of McCafe items to compete with the likes of Starbucks and the other big coffee chains.

The old investing adage goes "buy what you know"; basically, this theory says that you should stick to investing in companies which make products that you both understand and use on a daily basis. It seem as if the recession led investors to do just that, as McDonald's is up 56.4% (excluding dividends) since the heart of the financial crisis in September 2007. On the other side, consumers are doing the same thing in devouring McDonald's new McCafe line and buying large numbers of hamburgers and french fries as today's U.S. sales numbers indicate.

Millennials Shun Stocks...To Their Detriment

Yesterday, CNNMoney highlighted a recent report by the Investment Company Institute that concluded, "Today, only 22% of investors under the age of 35 say they're willing to take on a substantial level of risk" and therefore prefer investments like low-yielding certificates of deposit (CDs) and government bonds over stocks.

Nothing could be more disheartening to me as a Gen Y investor advocate because this means that Gen Y lacks fundamental investing knowledge that will result in long-term financial success. First and foremost, investing in stocks via a diversified basket of index funds should not be considered "substantially risky" - in fact, if millennials approach this correctly, they could erase almost all non-systemic risk inherent in their portfolios. Yes, all forms of investing carry some type of risk, but stock investing via index funds mitigates a large amount of that risk because the portfolios are well-diversified, low cost and eliminate the potential for individual investors to make bad individual stock picks.

Secondly, by parking their capital in CDs and government bonds, millennials are foregoing precious years of investment compounding that could be occurring and instead will see much of their interest gains erased by inflation should they stay in these securities for the long-term. Think about it this way. If you start out with $10,000 and the stock market returns 7% on average for the next 50 years, you will end up with $294,570 before expenses and taxes. If you instead invest that $10,000 in a combination of CDs and bonds and only earn 2% on average over the next 50 years (after inflation), you will end up with $26,916! The difference is stark!

Lastly, this story indicates to me that most respondents were completely scared out of stocks due to the recent financial crisis. Instead, just the opposite should have occurred: investors should have taken the opportunity to add to their existing index fund positions at a vastly lower entry point than what they initially bought in at. Sure, there will be some bumps along the way as we saw beginning in late 2007. In the future, we will experience prolonged downturns, recessions and events that we may never have anticipated. However, what hasn't changed is the fact that the stock market remains the greatest wealth creator available to individual investors provided we utilize it appropriately and keep costs low.

Gen Y still lacks the basic investing knowledge required to establish a secure financial future. This article and the study by the Investment Company Institute that it highlights should spur Gen Y into action but helping them recognize their own mistakes. Now is the time to be investing for your future - via index funds and a well-diversified portfolio of dividend-paying stocks - not by parking a large amount of cash in a savings account.

Beware of Correlation Risk

I've long touted the benefits of diversification - spreading your "eggs" (assets) over many baskets (asset classes/securities) so that the destruction of one does not bring down your portfolio of "eggs" as a whole. One thing Gen Y must keep in mind is that there can be plenty of correlation risk in the assets that you hold. When the financial crisis hit in late 2007, investors realized that when both the financial markets and economy take a dramatic turn for the worse, a majority of assets are going to suffer together. As a result, they will likely move in tandem for a decent amount of time before the correlations begin to fade as the problems clear up.

Thus, take today's post as a quick reminder to avoid buying too many assets that have strong correlations. By this, I mean that it's a good idea to spread your money around a variety of different asset classes whose correlations may not be that strong. For example, if you buy the Vanguard Total Stock Market Index (VTSMX) for exposure to domestic equities, it may not be a bad idea to add an international index fund which traditionally has lower correlations with domestic equities. As we saw in 2007, this strategy won't always be perfect, but as a disciplined long-term investor, it will help shield you from any short-term blip dragging your broader asset allocation down for the long-term.

One of Wall Street's Worst Creations

Yesterday, The Wall Street Journal highlighted "130/30 mutual funds" that were popular leading up to the financial crisis in mid-2007 but have since fallen out of favor with investors, given their high amounts of leverage and lackluster track record.

I remember hearing about these funds back in 2007 and thought they defeated the purpose of what mutual fund investing should be: a low-turnover, disciplined implementation of an investment policy predicated on achieving long-term returns. Instead, 130/30 funds aim to invest $100 by going "long" in stocks, hoping they will rise, and shorting - betting against - $30 worth of stocks using borrowed shares. It gets much worse, though! The funds then take the proceeds from their $30 of shorts and go long $30 more worth of shares to make a total of $160 in bets on various stocks in two vastly different forms. You don't need me to tell you why that much leverage can seriously hurt you should the market turn sour.

Worse still, these expensive funds have had terrible risk-adjusted returns and investors are fooling themselves if they think that these funds offer anything more than a clever marketing ploy. For example, the MainStay 130/30 Core C (MYCCX) is just one of the options investors have should they choose to add the 130/30 model to their portfolio. It won't be fun trying to recoup the high expenses and 1% load, though. In light of these fees, this fund would need to earn 3.35% per year just to break even!

If the active portfolio managers of your typical mutual fund fail so often at beating a benchmark index, what makes people think that a juiced-up and riskier version of this costly model will succeed? It doesn't and it won't. The Journal says that, "From March 6, 2009, through Aug. 13 of this year, when the S&P rose 47%, the seven funds that weren't liquidated or merged out of existence gained an average of 41.2%, compared with 43.4% for their long-only siblings." That begs the question: What exactly are investors paying for?

Time to Dollar Cost Average?

Welcome to September! In watching this morning's pre-market futures action, I was taken with how much of a jump there was in the Dow & S&P 500 futures, even in the face of bad economic news on the home front. Will one month change confidence that much? This morning's sour domestic economic news was that the latest ADP payroll survey reported that 10,000 jobs were shed last month. If we were still in August, that type of news might hammer the market because investor confidence remains weak over the economic uncertainty.

Instead, in a sign of just how global our economy is, encouraging reports out of China and Australia about economic growth there have propelled stock prices this morning. Perhaps this morning's rally, however short, signifies that longer-term asset buyers are returning to the market (we can only hope!)

While I shy away from making any calls on the attractiveness of assets, it's hard not to point out that right now, conventional wisdom is very negative in the equities markets - many people think stocks are likely to fall further from the early July lows we saw on the S&P. The P/E on the S&P 500 ETF, the S&P 500 SPDR (SPY), stands at 13 indicating the equities are cheap on that basis. So, what's my advice? Now is as great of a time as any to dollar cost average (DCA) into an index fund portfolio that you are holding for the long-term.

Something is Going on Here...

This morning, The Wall Street Journal highlights the fact that a basket of 18 companies reaching their peaks in the past month are all makers of goods considered necessities should financial calamity hit. The Journal points out that, "the bunker portfolio, while vastly oversimplified, does reflect investors' preference for companies with products that are relatively immune to economic swings, and whose conservative strategies are suited to these uncertain times." Indeed, most of the companies hitting highs are producers of inelastic goods - those whose demand will remain stable even if prices increase.

However, the important thing to note about this group all hitting highs at the same time is not that the underlying companies represent a "Who's Who List of Armageddon Protection Purveyors" (that's a mouthful!). More importantly, it's that they are all true defensive stocks and have histories of paying and increasing their dividends.

As the article hints at, when the economy dips further into recession and the business cycle continues to pound cyclical names, the best area to look at are the steady dividend payers, hence the rise in The Journal's sample portfolio. In fact, the article says that "many of the star performers are steady dividend stocks: At least half of the companies on the list have increased their dividends this year, including Cummins, Dr Pepper Snapple and Airgas." Investors flock to safety when they sense that there's uncertainty in the market and one of the safest places to look among equities for safety are companies that pay a dividend and raise that dividend consistently. Outside of large amounts of free cash flow, a rising dividend is one of the few surefire signs of financial strength at a company.

Interestingly, the only stock on the list that's down year-to-date - JM Smucker - is still up roughly 70% from the bottom it hit during the peak of uncertainty in the financial crisis.

The End of the P/E Ratio? Not so fast

Today, The Wall Street Journal reports on the "Decline of the P/E Ratio", first discussing the reason for the dropping P/E of the overall market (uncertainty) but more importantly, why the P/E is no longer as prominent as it once was. I take exception to the argument that the P/E ratio is no longer relevant and I think the article proves my point. The Journal states that:

"With profit and economic forecasts becoming less reliable, investors are focusing more on global economic events as they make trading decisions, parsing everything from Japanese government-debt statistics to shipping patterns in the Baltic region."

While this trading mentality will no doubt affect short-term prices, the long-term determinant of stock prices remains the earnings that a company can generate. When a company generates earnings over the long-term, it can raise its dividend and it will be a more worthwhile investment.

How do Japanese government debt stats and shipping patterns in the Baltic region affect stock prices over the long-term? They really don't. While markets are becoming more globally-oriented by the day, there is little to no benefit in that information for long-term investors. While short-term investors may be able to exploit such data by trading on that news, the cost of doing so and the lack of expertise most people have in such areas will quickly erase any advantage the trader thinks he has. On the reverse, the long-term investor should be concerned with one thing and one thing only: earnings.

The P/E ratio can be either forward looking (forward P/E based on earnings estimates) or historical (trailing P/E based on EPS in the last 12 months), it holds a wealth of information. After all, with one figure, we are able to gauge both what the market expects a company to earn in the future and how much its willing to pay for $1 of earnings. For example, if XYZ Corp. is trading at a forward P/E of 22, then investors are willing to pay 22x for $1 of XYZ's earnings. Naturally, faster growing companies will have higher P/E ratios than slower growth ones.

The P/E ratio is far from dead. In the end, earnings matter. The P/E ratio is not a means to an end, but it's a good road map because it bridges the gap between a stock's price and earnings expectations based on each trading day.

New GDP Report & Its Trade Data

The revised estimate of Q2 GDP, a broad measure of U.S. economic growth, was released this morning by the Commerce Department. The report was anything but rosy with almost all engines of economic growth either tapering off or growing well below their intended targets. Worse still, because everything from business and consumer spending to the trade imbalance remain weak, it's likely that this will continue to put pressure on the unemployment rate.

The unemployment rate runs countercyclically with a lag, meaning that when the economy is starting to exit a deep recession, the rate can still increase for awhile before it begins to decrease, so we are potentially looking at rates of unemployment near 10%. For some historical perspective, in 1933, in the midst of the Great Depression, unemployment stood at 24.9%! Now, of course, the U.S. economy is a lot larger but this "Great Recession" is indeed still a lingering problem.

However, what worries me the most from the new data is the new, bigger trade imbalance. The trade imbalance (or deficit) occurs when you import more than you export.  Ideally, you would like to export more than you import because goods produced in your country and shipped elsewhere count positively in your nation's GDP report. In Q2, the Yahoo! article points out that, "imports surged 32.4 percent, the most since 1984. That overwhelmed a 9.1 percent increase in exports." This has been the trend for a long time now and likely will continue to be as the U.S. relies less on manufacturing and buys cheaper goods elsewhere. While this is great for international trade, it just means that other areas of the economy will have to make up for this figure in the GDP calculation - that doesn't appear to be happening just yet.

Investing Bubbles & The Media

Fortune recently highlighted what they view as six separate investing bubbles in the making, including the Chinese economy, gold and U.S. Treasury bonds. All of the talk of bubbles can be particularly scary since the bursting of the housing bubble has been one of the primary causes of "The Great Recession" we're currently in.

While I don't have an official position on each of the bubbles Fortune lists, I do think that any time the euphoria and enthusiasm for a particular investment officially gets "called out" by the financial press, it may be time for a reconsideration of whether or not those investments are fairly valued. After all, you normally see the media write glowing stories about assets as they inflate, inflate, inflate until their bubbles burst. When the financial press begins looking at things more closely and pointing out the inflated valuations of those assets, the end of the run may be near. Caveat emptor!

Economics and Investing: Pay Attention to All Data!

Today, the WSJ's Economics Blog has highlighted how an even slower economic recovery would feel. Daily, we are hearing reports of more and more economists who believe that we are going to experience a double-dip recession due to little or no jobs growth, the lack of any real pickup in home buying/construction, reduced consumer confidence & spending and limited business activity. In addition, the blog says that "New orders for non-defense capital goods excluding aircraft plunged 8.0% in July, wiping out the gains of the previous two months." All of this is sure to put a damper on whatever economic optimism is out there.

However, this news is important for Gen Y's because economics is an area that we often overlook, both out of disinterest and the notion of it being boring. After all, why would you want to eagerly follow something that's been labeled the "dismal science"? If there's one thing I have learned from my college econ classes, it's that you have to question all of the data all of the time and you can never believe only one set of numbers.

All of this economics talk helps validate the importance of behavioral economics. I talked about behavioral finance last week but the discipline also applies to economics. It's common for us to overlook or gloss over certain facts or data that's presented to us, either because we're just not interested or it doesn't help validate our case. For example, if we're optimistic seeing that the economy is humming along with GDP growth growing briskly, jobs being added monthly and wages rising then should we necessarily believe that a drop in durable goods orders forecasts a recession? No! But this also hammers home an important point: Never simply look to one data point to validate or invalidate a forecast we may have. You have to look at everything as a whole.

The same is true with investing in stocks - just because one data point (lagging sales growth, for example) might tell us that a stock isn't an attractive investment, it doesn't necessarily mean that this is the case because there's always more to the story. However, when we see multiple data all pointing towards one thing - a further downturn in the case of today's economy - then we should probably take heed.