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[But] two stock mutual funds accounted for most of my holdings, and it turned out they had a lot in common. Two of their top five holdings were identical: Citigroup and Bank of America made up more than 4% of the holdings of one mutual fund and more than 8% of the holdings of another. Maybe not as diversified as I thought. And it turns out I'm not alone. Most of us are not as diversified as we should be when it comes to retirement investments. At its simplest, diversification means investing in different types of assets. When it comes to retirement savings, the choices are basically stocks, bonds, and cash and cash equivalents, such as savings accounts, certificates of deposit and money-market funds. Put all your money in a single stock, and you may be exposed to more risk than you realize -- as employees at Enron and WorldCom learned. At the other extreme, invest completely in safer but lower-yielding investments, and you may be earning less than with a more diversified portfolio. But you also need to spread your risks within each asset category. That's why so many investors choose mutual funds. But buying more than one mutual fund may not add much to the diversity of your investments if the funds are investing in the same companies. And sometimes they are, as I found. Edwin J. Elton and Martin J. Gruber, Nomura professors of finance at the Stern School of Business at New York University, have spent a lot of time looking at why this is so. One reason, according to Elton, is that there isn't much diversity among the choices employees are offered in their 401(k) plans. Many companies rely on mutual funds from a single family of funds, and they often offer more than one fund with similar stock-picking outlooks -- for instance, choosing companies with strong earnings and revenue growth. In some cases, the overlap in stock holdings within a fund family is as much as 34% of total net assets, they found. One reason is that different fund managers within the same family (Fidelity, Vanguard, T. Rowe Price, etc.) are often looking at the same economic forecasts and analyst research when they're choosing stocks. The other reason investors may be less than ideally diversified is their own behavior, Elton said. "They tend to chase performance. They tend to overinvest in their own company's stock. They tend not to rebalance." If you picked the top performers at the peak of the market in 1999, [then you were over-weight in tech and] you really regretted it for the following six years," he said. "If you pick the best performers today, who knows where the future will go. Investors should look beyond the numbers to see what the funds own and what their philosophies are. And in an ideal world, they probably would. But a recent study by the Center for Retirement Research at Boston College suggests that many 401(k) participants aren't even spreading their investments among asset types. The researchers found that about half of 401(k) participants "do not follow the prudent investment strategy of diversifying their holdings." In fact, looking at holdings in 2005, they found that 33.3% of 401(k) participants had no stock holdings at all, while 15.8% had almost all their investments (90% to 100%) in stocks. Related Paul Lim, NY Times 2-25 Many investors seem to be concentrating their bets [in their 401(k)'s], especially in a market where some asset classes — including foreign stocks, real estate funds and commodities — have been delivering eye-popping gains in recent years. Consider those red-hot emerging-markets stock funds, which have soared 28% a year, on average, for the last three years. A study last year by Hewitt Associates found that the typical saver who invests in emerging-markets funds in a 401(k) had 16.4% of his money in these high-risk investments. Yet many financial planners warn investors against putting more than 5% into such funds. Even worse, nearly one-third of these investors held more than 20% of their nest egg in emerging markets — and 5.5% were betting more than half on them. Related Paul Lim, NY Times 6-06-06 Performance chasing is the reason why some have overloaded in emerging market funds. "When people pick funds for their 401(k)'s, they focus heavily on past performance," says Lori Lucas, Hewitt's director of retirement research. And emerging markets stock funds have produced eye-popping average annual gains of more than 35% over the past three years, according to the fund tracker Morningstar. Of course, last month emerging markets stocks fell more than 10% – and 401(k) investors turned around and pulled more than $70 million from emerging markets stock funds between May 10 and May 23. Less than 1% of the nation's total 401(k) assets is held in emerging markets stock funds. Hewitt went on to note that lower tenure participants, in particular, have heavy allocations to such [emerging market] funds, drawn to their “recent strong performance history, in the course of making their initial fund selections.” How much? In fact, participants with less than one year of tenure that had balances in emerging market equity funds at the end of 2005 had an average emerging market equity fund allocation of 20.3% - and total international (developed and emerging markets) fund allocations amounted to nearly 40% of equity balances for this group. Indeed, nearly one in ten (8.9%) had half or more of their balances in emerging market equity funds. Participant Reaction and The Performance of Funds Offered by 401(k) Plans Edwin J. Elton, Martin J. Gruber, and Christopher R. Blake - May 11, 2006 A number of studies have examined certain aspects of 401(k) plans. Almost all of these studies examine the behavior of individuals given the characteristics of the plan they are offered. Examples of results of these studies include: 1. Investors tend to spread their investment evenly over the choices they are offered. This is referred to as the “1/N Rule” (Benartzi and Thaler - "Naďve diversification strategies in retirement saving plans" 2001 and Liang and Weisbenner - "Investor behavior and the purchase of company stock in 401(k) plan design" 2002). 2. Investors over-invest in stock of the company for which they work (Huberman and Sengmuller - "Company stock in 401(k) plans" 2003, Agnew and Balduzzi - "What do we do with our pension money?" 2002 and Benartzi - "Naďve diversification . . " 2001). 3. Investors infrequently revise their allocations (Ameriks and Zeldes - "How do household portfolio shares vary with age?" 2001, Madrian and Shea - "The power of suggestion: inertia in 401(k) participants’ savings" 2001, Agnew and Balduzzi 2003). 4. Investors cluster their stock and bond transfers, and they are related to same-day returns (Agnew and Balduzzi 2003). 5. Equity allocations are related to cohort and age (Ameriks and Zeldes 2001, Agnew and Balduzzi 2003). 6. Investor choices are influenced by the default choice they are offered (Madrian and Shea 2001). In an earlier paper, Elton, Gruber and Blake (2006) examined whether the choices offered to participants included the right categories of investments. The authors show that approximately one half of the pension funds they examine do not offer the right categories of investments. That study is posted after this one. Pension fund administrators change the investment choices offered to participants with surprising frequency. This is particularly true with respect to the inclusion of new mutual funds. Across the 289 fund years in our sample there were 215 mutual funds added to the offerings and 45 funds dropped. The pattern of deletions is interesting. First, very often, dropping a fund seems to be part of a more general change in direction for a plan rather than an isolated decision on the performance of a single fund. In only six cases was a single fund dropped from a plan. In the other 39 incidents of dropped funds, two or more funds were dropped from a plan simultaneously. In fact, for 24 of the 45 funds that were dropped, the plan that held them dropped all the funds in the plan simultaneously. Second, in many cases dropping a fund did not seem to be motivated by a desire to pick a better manager of the same type, since 20 dropped funds were not replaced with funds in the same category and, for 15 of those 20 cases, the ICDI category [or asset class] of the dropped fund was completely eliminated from the plan. Many of the additions seem to be motivated by a desire to add a new type of fund. Of the 215 funds added to plans over our sample period, 146, or over half, were selected from an ICDI investment objective category not held by the plan at the time of the addition. Plan administrators add funds that have done well in the past and drop funds that have performed poorly. However, when examining future performance the dropped funds seem to perform no worse than the added funds. Over all funds, the median contribution and transfers to a new fund is about 83% of the contribution and transfers to the average fund. Over all years and funds, for only 28% of the plan years was the contribution and transfer into the new fund above the average for a fund in the plan. If the fund being added was in the same category as an existing fund, then participants put more than 100% of the average in the new fund. When a fund was a net addition, the participants initially put less than 1/N in the fund, though by the third year the amount placed in the fund had risen to more than 1/N. If the fund added was a new category of fund, the allocation was less than 60% of average. Participants are more cautious about investing in new types of funds. The Adequacy of Investment Choices Offered By 401(k) Plans Edwin J. Elton, Martin J. Gruber, Christopher R. Blake - December 2004 This paper analyzes the adequacy and characteristics of the choices offered to 401(k)-plan participants for over 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories, but have a slightly higher rate of return. There are two ways that the choices offered can be inappropriate: offering an insufficient number and type of choices to allow the construction of desirable portfolios, and offering poor-performing investment choices of any given type. In theory, the first type of suboptimality could be alleviated by holding funds outside the plan. However, for over 60% of plan participants, the 401(k) investments are their sole financial assets.[Choi, Laibson, Madrian, and Metrick (2004) estimate that for households with annual incomes between $20,000 and $70,000, the median household has less than one month’s worth of income invested outside of their 401(k) plan.] The median number of 401(k) plan offerings is eight. Approximately 12% of the 401(k) plans offer four or fewer investment choices, and approximately 11% offer 13 or more investment alternatives. Many plans restrict their offerings to one fund family. The most common investment choice (offered by 97.4% of plans) is a domestic equity fund. The next most common offering (86.8%) is an alternative such as a GIC or money market fund, where interest is intended to be the only source of return. Other common offerings fall in the following categories: domestic bond funds (71.5%), domestic mixed bond and stock funds (80.6%), and international bond and/or stock funds (75.1%). Forty-eight of the 680 plans [in the study] offered pension participants at least one specialized fund as an alternative choice; there were a total of 56 such choices. Thirty-one of these specialized funds were science and technology funds, six were real estate funds, five were telecommunications funds, four were healthcare funds, four were natural resources funds, four were utilities funds, one was an e-commerce fund and one was a financial services fund. To be adequate a plan need to have funds with exposure in [1] small-mid-cap growth, [2] large-cap growth, [3] small-mid-cap value, [4] large-cap value [5] an international fund, [6] a general bond index, including governments and corporates, [7] a mortgage-backed bond index and [8] a high-yield bond index. For plans holding seven or more funds, we find that about 54% of the plans offer investment choices that span the relevant space investors are interested in. Of course, the glass is also half empty in that 46% of the plans leave investors unsatisfied. Finally, it is not until plans offer 14 or more investment choices (4.2% of all plans) that virtually all plans offer investment choices that span the space investors should be interested in. The major findings of this paper concern the adequacy of plan offerings. We use spanning tests to see if the plan offerings span the space offered by the eight RB indexes [the eight fund types listed above]. Only 38% of 417 plans [plans that had 8 or more options?] span the space defined by the eight RB indexes. This means that, for 62% of the plans, the plan participants would be better off with additional investment choices. In fact, if these plans spanned the 8 RB indexes, participants’ average return would improve by 3.2% per year, which is 42% of the return on an 8-index portfolio with the same level of risk. While significant on a 1-year basis, over a 20-year period (a reasonable investment horizon for a plan participant), the cost of not offering sufficient choices makes a difference in terminal wealth of over 300%. Since, for more than one half of plan participants, a 401(k) plan represents the participant’s sole financial asset, the consequences are serious. Inefficient Choices in 401(k) Plans: Evidence from Individual Level Data Julie Agnew - May 2002 Benartzi and Thaler (2001) predict that participants will choose to divide their non-company stock contributions evenly among the non-company stock options. In this paper, I call this the modified 1/n heuristic. Benartzi and Thaler (2001) test their prediction using a sample of 103 401(k) plans offering company stock and 67 plans that do not offer company stock. They find that the mean allocations of the asset balances for the plans not offering company stock are split approximately 50/50 between equities and fixed income. In contrast, they find that the mean allocation to equities is over 71% when company stock is an option. Looking closer, they find an average allocation of 42% to company stock. The remainder is divided almost evenly between non-company stock equities (29%) and fixed income (28%). This supports the modified 1/n heuristic. Using a new and unique data set from one 401(k) plan by a global consumer product company, with over 73,000 eligible employees, the results suggest that individual characteristics do influence company stock holdings. There are two things atypical at this company: their plan does not offer an employer match and the company offers a defined benefit plan. Individuals in this data sample are predominately male (78%) with an average age of 39 years old. And the participants have relatively long average job tenures (10 years), which may indicate strong company loyalty. Interestingly, the median time employed is approximately eight and half years and is over double the 1996 national median of nearly four years. Participants earned mean 1997 salaries of approximately $46,000. Ordered probit regression results indicate that the probability of over-investing in company stock for the average participant is greater for males, decreases with salary, increases with past company stock performance and is related to the participant’s division of employment. Three main results emerge from the analysis of company stock investments. First, the company stock investment patterns of individuals tend to be multimodal, with 78 percent of the sample centered on allocations of 0, 25, 50, 75 and 100 percent. Furthermore, there is a clear tendency for many of the participants (52 percent) to invest either all or none of their contributions to company stock. Second, over 75% of the individuals invest more in company stock than the maximum limit of 10 percent permitted by law in defined benefit plans. Third, results from ordered probit regressions that control for past company stock performance suggest that the probability of over-investing in company stock for the average participant is greater for males, decreases with salary and is lower for corporate division workers. Consistent with anecdotal evidence, participants in this 401(k) plan show a tendency to over-invest in company stock. The overall mean allocation to company stock holdings in this plan is quite high (49%) compared to the 10% legal maximum defined benefit plans may hold. The large average allocation might be partially explained by the above normal price performance of the plan’s company stock. In this study, the company stock had an annualized stock price return of 20.6% over the 10-year period ending on December 31, 1997, compared to a S&P 500’s annual return of 14.7% over the same time period. Benartzi (2001) shows that firms with relatively high returns over the previous ten years have higher company stock allocations than poor performing firms. [The data showed that] 29% of the men allocate their entire contribution to company stock compared to 26% of the women. The mean allocation to company stock by men is 50% compared to 47% for women. This gender difference is smaller than that found by Robert L. Clark, Gordon P. Goodfellow, Sylvester J. Schieber, and Drew Warwick ["Making the Most of 401(k) Plans: Who’s Choosing What?" 1999]. In their study of several 401(k) plans, men invested an average 41% to company stock compared to 27% for women. However, these gender differences could be a result of different plan designs or varied long run company stock performance across plans. Generally, financial knowledge is considered positively related to compensation. This leads to the hypothesis that employees who earn relatively high salaries or are considered highly compensated should hold less in company stock. Alternatively, compensation may be proxying for an employee’s opportunities for stock based compensation. Generally, greater opportunities exist for higher salaried employees to receive stock based compensation than for their lower wage counterparts. This is the case in this plan where three stock option plans are offered. One plan is open to all full-time employees and the number of options available is based on earnings. The second and third plans are targeted at middle and senior management. The options in these plans are based on reaching performance goals. Thus, higher salaried and middle and upper management employees have more opportunities to earn stock options than lower salaried employees. Research shows that highly paid executives are concerned about diversifying their company stock holdings but are often reluctant to sell their stock based compensation. Twenty eight percent of the under $25,000 category invest their whole contribution to company stock compared to 24 percent of the $100,000 plus category. The reverse trend is observed in the proportion of individuals who invest nothing in company stock. Here, 23 percent of the under $25,000 category invest nothing in company stock compared to 36 percent of the over $100,000 group. This difference in proportions is significant at the one percent level. This supports results from Gordon P. Goodfellow and Sylvester J. Schieber ["Investment of Assets in Self-Directed Retirement Plans", 1997] study of 24 different plans where low-wage earners were more likely to hold company stock than high-wage earners. Ravi Jagannathan and Narayana R, Kocherlakota ["Why Should Older People Invest less in Stocks Than Younger People?" 1996] suggest that young investors have a long stream of future income. As individuals age, this stream of future income shortens diminishing the value of their human capital. Therefore, they suggest that individuals should offset this decline in the value of their human capital by reducing the risk of their financial portfolio. Zvi Bodie, Robert C. Merton, and William F. Samuelson ["Labor Supply Flexibility and Portfolio Choice in a Life Cycle Model" 1992]'s model leads to a similar prediction. On the extreme ends, [the data in this sample found that] 19% of those between 55-64 years old invest their entire contribution to company stock compared to 31% of the participants under 35 years old. This trend is reversed and significant in the proportions investing nothing in company stock. The final hypothesis is based on Gur Huberman [Familiarity Breeds Investment, 2001], who coined the phrase “familiarity bias” to describe the tendency of investors to invest heavily in what they know. He suggests that this is a reason for high company stock holdings in 401(k) plans. However, Benartzi (2001) presents conflicting empirical evidence that shows that the impact of familiarity on company stock holdings is insignificant when past company stock performance is included in the regression analysis. [But in this sample] the proportion of participants investing their entire contribution to company stock has a marked decline with time employed. Thirty four percent of those with less than two years experience invest their entire contribution to company stock compared to 22% of those with greater than 26 years experience. It is not surprising that these results are similar to the age findings because these variables are most likely highly correlated. One other study quoted by Agnew is of interest. Cori E. Uccello ["401(k) Investment Decisions and Social Security Reform" 2000] found evidence that suggests that investors tend to invest their retirement savings in the same fashion as their non-retirement assets. Plan Design & 401(k) Savings Outcomes Choi, Laibson & Madrian - June 2004 Hewitt Associates (2001) reports that 14% of companies utilized automatic enrollment in 2001, up from 7% in 1999. In three studies by James Choi, David Laibson, Brigitte Madrian, and Andrew Metrick [“Passive Decisions and Potent Defaults.” - 2003, “Optimal Defaults and Active Decisions: Theory and Evidence from 401(k) Saving.” - 2003 and “For Better or For Worse: Default Effects and 401(k) Savings Behavior.” - 2004] they show the dramatic impact that the choice between these two different 401(k) enrollment protocols has on 401(k) participation for three different companies that switched from a standard enrollment regime to automatic enrollment between 1997 and 1998. Under a standard enrollment regime, 401(k) participation is low initially and increases with employee tenure at a decreasing rate. Under automatic enrollment, however, participation jumps to between 86% and 96% of employees once it takes effect (between one and two months after hire in these companies) and increases only slightly thereafter. At low levels of tenure, the difference in participation rates under the standard enrollment and automatic enrollment regimes is substantial, with a difference of more than 50 percentage points at all three companies at 6 months of tenure. As participation increases with tenure under standard enrollment, these differences diminish but remain sizeable even after considerable periods of time. Vanguard in a study done in 2001 found that automatic enrollment increases participation rates by 9 to 17 percentage points, depending on whether automatic enrollment applies to only newly eligible employees or to all non-participating employees as well. Several studies have used cross-sectional data to document a positive correlation between the availability of an employer match and 401(k) participation, including Andrews (1992), GAO (1997), Bassett, Fleming and Rodrigues (1998), Papke and Poterba (1995), Papke (1995), Even and Macpherson (2003b), Engelhardt and Kumar (2003), and Huberman, Iyengar and Jiang (2003). Several studies have also documented a positive correlation between the level of the employer match and 401(k) participation, including Papke and Poterba (1995), Engelhardt and Kumar (2003), Huberman, Iyengar, Jiang (2003), Mundell, Sunden and Taylor (2000), and Clark and Schieber (1998). Choi et al. (2002) found that the magnitude of the estimated effect is quite large, with a 25% match leading to roughly a 40% increase in tenure-specific participation rates. our assessment of the literature is that there is less certainty about the extent to which increasing an already positive match rate leads to further increases in 401(k) participation. Leslie E. Papke [“Individual Financial Decisions in Retirement Saving Plans: The Role of Participant-Direction.” 2004] found that having the ability to direct the asset allocation of contributions to an employer-sponsored savings plan leads to a large 36 percentage point increase in the probability of participating. By extension, one might think that having a greater number of funds available should make participation in the 401(k) plan even more attractive. Iyengar, Huberman and Jiang (2003), however, document a strong negative relationship between the number of funds offered in a 401(k) plan and average participation rates; increasing the number of funds offered by 10 leads to a 1.5 to 2.0 percentage point decline in the firm-level average 401(k) participation rate. The explanation offered is that increasing the number of options available to participants overwhelms them. Huberman, Iyengar and Jiang (2003) find a 2.5 percentage point higher probability of 401(k) participation in firms for which company stock is an investment option. Another 401(k) plan feature designed explicitly to increase employee contribution rates is an automatic contribution rate escalator. The prototypical implementation of this type of escalator is the “Save More Tomorrow” (SMarT) plan developed by Shlomo Benartzi and Richard Thaler (Benartzi and Thaler, 2004). Under SMarT, participants consent to allow their contribution rate to increase in the future if they take no further action; in other words, they opt into a default of rising contributions. The striking results of the first experiment with the SMarT plan, in which employees signed up for future contribution rate increases of 3 percentage points per year, are reported in Benartzi and Thaler (2004). At the company studied, employees who elected to participate in the SMarT plan saw their 401(k) contributions increase by 8.1 percentage points over 3 years, from 3.5 to 11.6% of pay. In contrast, employees who elected not to participate in the SMarT plan had higher initial contribution rates but increased their 401(k) contributions by only 4.3 percentage points over 3 years, from 4.4 to 8.7% of pay. A final 401(k) plan feature designed to make participation more attractive is the option for participants to take out a loan against their plan balances. A GAO study from 1997 found that participation rates in plans that allow for loans are 6 percentage points higher than in plans that do not allow for loans. The GAO found that average annual employee contributions in 401(k) plans with loan provisions are 35% higher than in plans that do not offer loans. Similarly, Sarah Holden and Jack VanDerhei [“401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2000.” 2001] analyzed participant-level data and found that on average, a participant in a plan offering loans contributes 0.6 percentage points more of his or her salary to the plan than a participant in a plan without loans. In contrast, Cristopher R. Cunninghan and Gary V. Engelhardt [“Federal Tax Policy, Employer Matching, and 401(k) Saving: Evidence from HRS W-2 Records.” 2002] found only mixed evidence that access to 401(k) savings through loans or hardship withdrawals has any impact on employee contributions. Automatic enrollment defaults affect not only participation status and contribution rates, but also asset allocation. The difference in asset allocation between the two regimes is just as dramatic as the difference in contribution rates, and the persistence of the default asset allocation is similar to that of the default contribution rate. The economic significance of automatic enrollment’s impact on asset allocation depends on which default fund employers choose. Empirically, most companies with automatic enrollment have chosen a conservative default - either a money market fund or a stable value fund. There are two other plan features that could potentially affect asset allocation but on which little actual evidence is available. The first is automatic rebalancing. Another interesting plan feature is the inclusion of a managed investment option, where a professional money manager chooses the allocation of investments. Recent research by Benartzi and Thaler (2002) suggests that many participants would prefer an investment allocation chosen by others to the investment allocation that they themselves choose. It is unclear at this point, however, how the inclusion of such an option would affect asset allocations in a plan. The answer depends upon the popularity of such an option (if it were not the default) and the difference between the investment manager’s choices and what participants in the program would have chosen for themselves.
Buy bonds today? Why would you, when one of the smartest players in that market — Bill Gross of Pacific Investment Management Co. in Newport Beach — is holding 43% of the assets in his huge Pimco Total Return bond mutual fund in short-term money market instruments rather than in bonds? That's certainly not a ringing vote of confidence in longer-term fixed-income securities. Nor was a report last week from Morningstar headlined "Just How Safe Is the Bond Market?" The conclusion was that investors who were used to thinking of bonds as a safe place to be ought to steel themselves for a potentially bumpy ride this year — for example, if the housing market's woes cause more nervousness about mortgage-backed securities. Anyone who has shopped for bonds recently can relate to the discomfort. Bonds just don't pay much. Although the Federal Reserve has sharply raised short-term interest rates since 2003, longer-term rates haven't come up a lot since then. The annualized interest yield on a 10-year Treasury note was 4.67% on Friday. The average corporate junk bond pays barely 7% a year. Plenty has been written about why long-term interest rates are depressed. In the end, it must come down to too much money chasing too few bonds, worldwide. Whatever the cause, if this is the hand you're dealt, what do you do with it? Many Wall Street pros say you pass for now. You can earn nearly 4.9%, annualized, in a money market mutual fund, with virtually no risk to your principal. If you're looking to put money to work for the next decade or longer, some financial advisors suggest that you focus on stocks instead of bonds, even if retirement is on the horizon. Wait a minute, you may be thinking. Aren't stocks far riskier than bonds? Generally, that's true. U.S. blue-chip stocks dropped nearly 50% from their peak in 2000 to the market's bottom in 2002. Odds are that you're never going to suffer that kind of real or paper loss in high-quality bonds. In the short term, anything could trip up stocks: Iran's nuclear ambitions, another jump in oil prices, a hedge fund blowup, a wayward asteroid headed for Earth. So bonds do play a capital-preservation role in a portfolio, and no one would advise that older investors give up on them altogether. But there's another kind of risk — the risk of losing purchasing power to inflation if your portfolio doesn't grow fast enough over time. David Kelly, an economist at Putnam Investments, believes that many investors have become overly risk averse about stocks since the 2000-02 bear market. "People are haunted by that ghost," he said. One result, he contends, is that too many people now "overpay for bonds and underpay for stocks." In other words, investors are willing to accept lousy yields on bonds because they fear that stocks are too expensive to buy. Yet the average U.S. blue-chip stock sells for 16.6 times estimated 2006 operating earnings per share, according to Standard & Poor's. That is not much above the historical average price-to-earnings ratio (since 1935), and is well below the P/E ratio of 22 that was the average over the last decade. It's a common refrain of money managers today that they find the U.S. stock market to be priced just about right — neither expensive nor cheap compared with underlying earnings. By contrast, it's hard to find a professional investor who doesn't believe that bonds are expensive. Ed Keon, investment strategist at Prudential Equity Group, says the surge in corporate takeovers by private equity investors over the last few years demonstrates that bonds should be sold and stocks should be bought. That's what those investors are doing, he notes: They're borrowing via bonds to buy stocks. In the stock market, "the lack of buying by the public has created opportunities for the private equity buyer," Keon said. If bond yields do rise, they'll become more appealing for new investment dollars and offer more competition for stocks. Until then, if all you can earn on a bond is a fixed 5% or less in annual interest over the next 10 years, it isn't asking a lot of the stock market to beat that return. Median Net Worth by Age [and what it takes to beat the median of the top 10% and 25%]
Admittedly, all this is a little counterintuitive. To build a portfolio you're comfortable with, you probably prefer to go investment by investment, picking out those stocks, bonds and mutual funds that strike you as most comforting and familiar. But if you can tear your gaze away from each investment and focus on your entire portfolio, you will find that the best way to earn high returns with low risk is to add seemingly unsavory investments, such as foreign bonds, commodities and small companies from developed foreign markets. The reason: These oddball investments will sometimes post gains when your blue-chips are suffering - and suffer when more mainstream investments are gaining. The overall effect is to reduce risk by smoothing out your portfolio's performance. What about boosting returns? Investments like emerging markets, REITs and foreign small-company stocks should post healthy long-run returns (though the short-term outlook doesn't seem nearly so promising, because all three sectors have fared extremely well in recent years). But even investments with lower expected returns, like gold stocks, commodities and foreign bonds, can give a surprisingly large boost to your portfolio's overall performance, thanks to the so-called rebalancing bonus. What's that? The idea is to set target portfolio percentages for your various holdings, allocating maybe 5% of your money to gold stocks, 5% to foreign bonds and so on. Every year or so thereafter, you should bring it back into line with your target percentages. This forces you to lighten up on highflying investments that may be due for a fall, while adding to those that are suffering and could be set to bounce back. Because gold stocks, commodities and foreign bonds will likely perform quite differently from the rest of your portfolio, they should offer plenty of opportunities to rebalance. That, in turn, should enhance returns, as rebalancing compels you to buy low and sell high. So which oddball investments should you buy? The answer is, all of them - provided you can get them without incurring a heap of investment costs. For instance, you can tap into gold stocks fairly cheaply through no-load, low-cost mutual funds like American Century Global Gold and Fidelity Select Gold. Both have expenses below 1%. There are a heap of reasonably priced real-estate funds. There is even a low-cost emerging-market stock fund, in the form of Vanguard Emerging Markets Stock Index. But in other mutual-fund categories, the choices aren't great. Foreign-bond funds like American Century International Bond and T. Rowe Price International Bond have expenses of around 0.8%, which seems a little steep for a bond fund. For a low-expense foreign small-cap mutual fund - consider WisdomTree International SmallCap Dividend Fund. For commodities - an ETF like iShares GSCI Commodity-Indexed Trust and PowerShares DB Commodity Index. To the list of oddball investments that are good diversifiers, there's one other category worth considering: Long-term bonds. Taking a small stake in long-term bonds can be a smart move if you're approaching retirement and want to hedge the cost of generating retirement income. Suppose that, upon retirement, you plan to build a laddered bond portfolio, buying individual issues with an array of different maturities. If interest rates fall sharply between now and when you retire, you will have to sink a lot more into bonds to generate your desired retirement income. But falling interest rates won't be a problem if you own some long-term bonds, because the drop in rates will drive up the price of your 20-year and 30-year bonds and thus you will have extra money to put toward your bond ladder. Similarly, upon retirement, you might be planning to invest, say, $50,000 in an immediate fixed annuity that pays lifetime income. The amount of income you will get for a $50,000 annuity purchase will decline if interest rates tumble between now and when you retire. But once again, you can hedge that risk by buying long-term bonds. If interest rates fall, your long bonds will leap in price -- and you will now have more money to sink into the immediate fixed annuity.
The reason earnings are under pressure, according to Bridgewater Associates Co-Chief Investment Officer Greg Jensen, is higher costs. Having wrung all they could easily get out of their existing plants and workforce, companies are now in the position of having to invest more if they want to keep growing. That means companies are seeing less of their sales trickle down to the bottom line. Standard & Poor's estimates that S&P 500 earnings came to 8.5% of revenue in Q4, down from Q3's 9.6%, the most significant decline in net profit margins since 2001. Companies can either accept slimmer profit margins or try to give them a boost by raising prices. The first option would lead to slower earnings growth, the second to higher inflation -- either of which could give investors fits.
The lockup requires the investor to answer one basic question: Do I like this fund enough to be locked into it for another year or two? More than 5% of all hedge funds have been liquidated each year for several years, with the attrition owing to investors deciding that they don't want to lock their cash up with the same fund again. A hedge-fund manager who sees a bunch of shareholders making a no-confidence vote when it's time to re-up for another year may simply pull the plug before most of the cash heads for the exits. Mutual funds not only have no lockup, but they practically encourage inertia and mediocrity. With no pressure to make a hold-or-sell decision -- and with management free from worry that investors will rush the exits -- shareholders often settle for mediocrity. An annual portfolio review is good, but it doesn't force action, the way accepting a yearlong lockup would. Acting as if your fund has a lockup period is helpful on two fronts. It forces you to think long term and not touch your holdings during the commitment period, and it makes you weed out laggards. Investors often stick with fallen angels -- funds that once had good performance but that have fallen on hard times -- hoping for a return to past glories, a bounce back to break even, or simply because the fund has been good to them in the past. Inertia is easy because the shareholder can always get the money out tomorrow or the next day. Locking in for a longer period is different; it quickly makes you testy about below-average performance. "If the public had a lockup in their mutual funds -- if they had to sign something that forced them to evaluate what they are doing and make long-term decisions -- they'd fare better," says James Owen, managing director of Austin Capital Management, a hedge-fund firm that invests in other hedge funds. "If you're not confident about a fund -- if it has disappointed you once -- you're out the door before you get locked up again. With a long-term commitment, you don't settle for funds that failed you in the past." Because mutual funds don't have a lockup, the average investor should put one in place on their own. When you next review investment performance, add in one little factor: Unload any fund that you wouldn't want to be chained to for the next 24 months. By having to stick around that long, you'll scrutinize funds much more closely. Anything that you can't be comfortable with for that long shouldn't keep its place in your portfolio.
CORPORATE PROFIT GROWTH While earnings growth among French and British companies is on part with earnings in the United States, overall corporate profit growth in Europe is expected to exceed that of domestic companies this year, said Mike Thompson, managing director of global research at Thomson Financial. For example, earnings for the Dow Jones Stoxx 600 index — a benchmark representing equities in 18 European markets — are expected to climb 8 percent this year, according to Thomson Financial. That’s ahead of the 7 percent growth anticipated for the S.& P. 500. In Japan, meanwhile, corporate profits are predicted to jump around 14 percent in 2007, according to Mr. Young. That’s comparable to the projected earnings growth rate for the emerging markets. LOWER VALUATIONS In general, valuations are still lower outside the United States. Despite the run-up in the price of foreign shares lately, there is “still substantial relative value overseas,” said Simon L. Davis, co-portfolio leader for the Putnam International Equity fund. To be sure, “valuations have narrowed, because obviously the emerging markets have had a strong run, as have the developed non-U.S. markets,” Mr. Davis said. But many international stock markets in continental Europe still trade at far cheaper prices than the domestic market. Based on estimated 2007 earnings, for example, German and French stocks are trading at a price-to-earnings ratio of around 13, on average, according to Thomson. And the FTSE 100 index of blue-chip stocks on the London Stock Exchange trades at a mere 12.4 times estimated earnings for 2007. By comparison, domestic stocks have a P/E of around 15.4, based on the S.& P. 500. THE DECLINING DOLLAR The dollar is still expected to lose value in the coming months. After weakening in 2006 against the euro, “most people don’t see a lot of reason why the dollar would appreciate” this year, said Mike Thompson, managing director of global research at Thomson Financial. One reason is that the Federal Reserve stopped raising short-term interest rates last year and appears to be in a holding pattern that could leave rates steady for the remainder of 2007. Central banks around the world, meanwhile, still seem to be tightening their monetary policies. That means money parked in dollars in the United States will earn about as much as it did last year, while investors who hold their money abroad could see a bump up in yields. And should the dollar continue to lose value against global currencies, domestic investors will be rewarded by moving some cash overseas, even if the underlying stock markets in those countries don’t gain much ground. That’s because, whenever the dollar loses value, it serves as a tailwind for Americans investing overseas. Each share of foreign stock that Americans own will become worth that many more dollars when the securities are eventually sold and repatriated back to the United States. A NEED TO DIVERSIFY In recent years, individual investors have been building up their foreign holdings dramatically, but many portfolios are still out of balance. At the end of 2002, only 2.7% of 401(k) money was held in foreign stocks, according to Hewitt Associates. That represented around 4.5% of a typical worker’s stake in stocks. Today, 9.2% of the average 401(k) is held in foreign stocks, representing about 13% of the typical investor’s stock allocation. Given that more than half of the world’s stock market capitalization resides in companies based outside the United States, that’s still a modest amount. So don’t be surprised if many investors continue to build their foreign equity stakes, especially as they become more and more comfortable with investing their money internationally. But keep in mind that while investors in general may still be underweighted in foreign equities, many individuals already have too much. Alec Young, international equity strategist at Standard & Poor’s Equity Research, said investors should probably keep about 15 percent of their total portfolios in developed-market foreign shares, with an additional 5 percent or so in emerging-market stocks. Once you achieve those levels, “you have to rebalance regularly,” he said. In other words, if your foreign stake grows to 25 percent of your total holdings, be prepared to sell into the rally and take some of that money off the table, Mr. Young said. He stressed: “These assets should be thought of as long-term core holdings, not some hot asset class to chase.”
The problem with well-worn ideas in financial markets is they tend to stop working, and that might be happening with sector pickers now. Lately, the difference between the best- and worst-performing sectors hasn't been nearly as stark as it used to be, said Julius Baer Investment Management portfolio manager Brett Gallagher. The difference in annual returns between the top and bottom sectors in MSCI Barra's world stock-market index has averaged a little more than 30 percentage points over the past three years. Over the five-year period that ended in 2002, that average was about 60 percentage points. While tech's boom and bust was a big part of that, Mr. Gallagher said the annual-return difference between the second-best- and second-worst-performing sectors similarly narrowed. "If you're making sector bets, the reward for being right is a lot smaller," he said. But within each sector, Mr. Gallagher found that the differences between the best- and worst-performing stocks haven't changed much over the past several years. Of course, these trends could reverse. But the upshot if they don't is fund managers should worry less about hot sectors and spend more time picking great companies.
Recent research by Dresdner found that only six very big companies make up the top decile, or 10th, of the market value of the Morgan Stanley Capital International Europe Index. What's more, the six -- Royal Dutch Shell Plc, HSBC Holdings Plc, BP Plc, Roche Holding AG, Total SA, and GlaxoSmithKline Plc -- have an average weight-adjusted P/E ratio of 11.2. The top 30 percent of the European stock market's value consists of 26 stocks with an average weighted P/E ratio of 11.9, according to Dresdner. Now for the kicker. The bottom 10 percent -- which contains 293 stocks -- is trading at 16 times projected earnings. `Despite having a low P/E multiple, the actual number of stocks in the index trading on attractive valuations are few and far between,' says Andrew Lapthorne, a Dresdner Kleinwort quantitative strategist in London. Ditto the U.S., where just four companies -- Exxon Mobil, General Electric, Microsoft and Citigroup -- make up the top decile of the Standard & Poor's 500 Index. And a mere 19 companies with an average P/E of 14 comprise the top 30 percent of the market's value. By contrast, the bottom 10 percent consists of 206 companies with an average P/E of 16.2, according to Dresdner. `It's important to understand just how much the mega-cap companies are depressing valuations,' Lapthorne says. `At the aggregate level, stocks look cheap, courtesy of some large-caps. At the individual level, they're expensive.' Still don't think stocks are pricey? The median trailing P/E ratio in Europe is at a 12 percent premium to its 15-year historical average, Lapthorne says, while its U.S. equivalent stands 9 percent above its historical average.
Siemens Medical Solutions is going a step further in selecting a name for a new personal health-card product based largely on search-related data gleaned from Yahoo and Google tools. The product name hasn't been finalized, but "the search volume research is driving the decision. Then there is the matter of product research. Thomas McDermott, owner of 4 Aces Golf, is using query-volume data to help decide which brands of golf clubs to carry in the online golf store he plans to open by this summer. A former Google sales executive, Mr. McDermott says initially he can only carry a handful of brands of clubs and that he is looking to find the brands with the strongest consumer-search interest to help his business quickly get off the ground. At National Instruments, the company recently released products used by automotive engineers to test the quality of cars. Partly based on its search research, National Instruments decided to release an additional version of the product compatible with a specific automotive data protocol. "Search helped us validate that this was a big enough market space," Mr. Ljungdahl says. Brett Crosby, a Google senior manager for its Analytics service, which helps companies track user activity on their sites and the success of their online ads, applauds that approach. "If people aren't listening to the way customers are voting through search for what they want on their Web site and the products they want them to build, they're not listening to their customers," he says. People conduct hundreds of millions of search queries daily, many looking for goods or services to buy. Businesses in the U.S. this year will spend an estimated $8.3 billion to have their ads displayed alongside the results offered up by search engines, according to eMarketer Inc. Now, some companies such as National Instruments are figuring that what users type into search boxes offers insight into what people are actually interested in buying. Businesses are learning to use Web-based services from Internet companies Yahoo Inc. and Google Inc. and other independent tools to evaluate the volumes of searches conducted on any given keyword. While few businesses say search data are their only source for product research or decision-making, some say it plays a useful role. Companies that buy search-related advertising through Google and Yahoo can access the online keyword tools, which enable them to enter specific terms and see estimates of consumer search queries or clicks on related search ads for a given time period. Yahoo has a free online tool accessible to anyone as well at http://inventory.overture.com/d /searchinventory/suggestion/. Microsoft Corp. has a free prototype service that offers historical monthly search volumes and forecasts for a few months, as well as an age and gender breakdown of those searching (http://adlab.microsoft. com/ForecastV2/KeywordTrendsWeb.aspx). Google offers a free service called Trends (trends.google.com) that lets users see graphs of relative query volumes over time for any given keywords, and even compare relative query volumes for several keyword phrases. Other so-called keyword-research services include Wordtracker from Rivergold Associates Ltd., which has a free version of its service that estimates daily query volume for terms and related keywords (freekeywords.wordtracker.com). Some other Web sites (http://www.digitalpoint.com/tools/suggestion/ and tools.seobook.com/general/keyword) let users research keywords, drawing from the Yahoo and Wordtracker data. Trellian offers a free version of its service called KeywordDiscovery (http://www.keyworddiscovery.com/search.html). Companies use such keyword tools to help tweak the marketing of their products. Some try to buy advertising linked to the most popular keywords entered by users in searches related to the companies' businesses. Others look for the words consumers most often use in relation to their offerings and create marketing content that could be picked up by search engines. Businesses also often use software to analyze users' activities on their own Web sites to help decide what to sell and how to more effectively present it. There is evidence that data about consumer searches could prove valuable to businesses in other ways. As part of an experiment, Google analyzed search-query volumes related to movies released in 2005 and compared them with opening weekend box-office revenue for each movie. The company found that it could predict with 82% or higher accuracy based on consumer search activity as early as six weeks before the opening whether a film would top $25 million in receipts its first weekend. While Hollywood studios already have other ways, such as consumer surveys, for helping predict blockbusters, the Google experiment shows how an automated approach could be brought to the issue. Google believes there are potential applications of similar analyses in other industries, such as using search-query activity to anticipate consumer demand in order to staff call centers appropriately.
Value Line’s stock-ranking system is one of the oldest in widespread use. Every week since 1965, the company’s flagship publication, the Value Line Investment Survey, separates about 1,700 of this country’s most widely followed stocks into five categories, according to their anticipated potential over the next 6 to 12 months. Value Line puts its best bets into what it calls Group 1. The very-long-term performance of Value Line’s ranking system has been superb. According to calculations of The Hulbert Financial Digest, Value Line’s top-ranked stocks beat the Dow Jones Wilshire 5000’s total-return index by an average of 2.6 percentage points a year over the nearly three decades for which the digest has data: mid-1980 through 2006. These calculations assumed that all trades were executed immediately after changes in Value Line’s rankings were made public, taking into account transaction costs like bid-asked spreads and discount brokerage commissions. Value Line’s record in its earliest years was good enough to impress even Fischer Black, then a finance professor at the University of Chicago and a champion of the idea that the stock market can’t be consistently beaten. Professor Black, whom many investors subsequently came to know as co-author of the Black-Scholes options pricing model, would concede that Value Line’s record was an exception to his previously held belief. It is doubtful that Professor Black, who died in 1995, would have reached this conclusion had he been able to focus only on the performance of Value Line’s Group 1 stocks during this decade. In 2006, those top-ranked stocks lagged the Dow Jones Wilshire 5000 by nearly 13 percentage points. In fact, their poor performance last year was more than enough to erase the market-beating gains of the previous four; for the five years through 2006, Value Line’s top-ranked stocks trailed the overall market by an average of 0.2 percentage point a year. By contrast, over the previous years, those stocks outperformed the market by an average of 3.3 points a year. Marked as the relative falloff has been in the performance of Value Line’s top picks, it’s not clear that it amounts to anything more than bad luck, according to David R. Aronson, an adjunct professor of finance at Baruch College. Professor Aronson is the author of “Evidence-Based Technical Analysis”, which discusses how to use the “scientific method and statistical inference” in judging investment strategies. Upon analyzing monthly returns of Value Line’s Group 1 stocks back to 1980, as calculated by The Hulbert Financial Digest, Professor Aronson found that their performance in recent years “is consistent with normal random variation in historical performance.” He concludes that there is no statistical basis for saying that “the Value Line ranking system has deteriorated.” In an interview, Professor Aronson acknowledged that his conclusion might surprise some people. If five years of mediocre performance aren’t enough to show that a strategy has stopped working, how many are enough? The answer is complex, he said, because it depends on the pattern of returns both before and after the strategy’s performance takes a turn for the worse. But he said it was entirely possible that 10 or more years of mediocre performance would be needed before the evidence would justify abandoning a strategy. For Value Line followers, the implication of Professor Aronson’s argument is that they should stick to their guns. Not surprisingly, Value Line offers similar advice, though Samuel Eisenstadt, its research chairman, concedes that the ranking system’s performance “since 2000 has not lived up to our expectations.” And for investors in general, Professor Aronson’s argument has profound implications. One lesson is that in most cases, except when there is evidence of criminality or sheer incompetence, we shouldn’t switch advisers or strategies because of a few years of mediocrity. To anyone who recoils from such a long-term commitment, he said: “The investor has no choice if he wants to scientifically approach the question of picking advisers and strategies. The alternative is to flit like a moth from flame to flame, an approach that is destined to fail over the long term.”
And ignoring dividends is hardly the only problem. When we look at the S&P 500's return for the current decade, there's an implicit assumption that folks invested a heap of money on a single day at the start of the decade. But most of us don't invest that way. Instead, we add to our portfolios over time. Imagine you had invested $1,000 in Vanguard 500 every year for seven years, starting at year-end 1999. As of year-end 2006, your $7,000 total investment would have been worth $9,028, or 29% more than your cost. In all this, there's an even bigger assumption. We're presuming the S&P 500 is a good proxy for how our investments have fared and a good benchmark against which to compare ourselves. But that's hardly the case. The S&P 500 is an appropriate benchmark for people in large-cap U.S. funds. But if you own other funds, you should be using another benchmark. If you're trying to get a handle on U.S. stock performance, skip the Vanguard's S&P 500 fund and instead look to Vanguard Total Stock Market Index Fund, which, thanks to stellar gains by small stocks, has notched 13.8% in the current decade, modestly ahead of Vanguard 500's 7.3% return. But many American investors have significant holdings of foreign shares. Suppose you started the decade with 70% in the Vanguard Total Stock Market Index Fund and 30% in Vanguard Total International Stock Index Fund, which owns a mix of developed and emerging markets. Through year-end 2006, your stock portfolio would have clocked a cumulative 22.2% gain. Of course, there's more to financial markets than just mainstream U.S. and foreign stocks. Imagine that, at the start of the decade, you had wanted some exposure to hard assets, so you bought small stakes in Vanguard's precious-metals stock fund (now closed to new investors) and its REIT fund. If you had 60% of your stock portfolio in U.S. shares, 30% in foreign stocks, 5% in REITs and 5% in precious metals - and these four stock funds accounted for 90% of your total savings and that the other 10% was allocated to Vanguard Total Bond Market Index Fund, then your seven-year cumulative gain would have been 54.5%, or 6.4% a year. That's a far cry from the S&P 500's 3.5% cumulative share-price loss. What if you had rebalanced back to your initial portfolio allocations at the end of each year? While rebalancing often bolsters performance, it would have hurt results during this stretch, reducing your seven-year gain to 45%. Taken together, the data offer four valuable lessons. First, they show the power of diversification. Second, compare your results to the appropriate benchmark. Third, don't give up on rebalancing. Finally, despite all the hand wringing over stocks during the current decade, it hasn't been that bad a period for investors.
Advocates of ETF-only portfolios are also getting a boost from a recent push to issue more bond ETFs, where previously there were few. In recent months, TD Ameritrade launched a service called "Guided Amerivest," which offers clients with $50,000 or more access to counselors to help assemble ETF-only portfolios. But just because you can doesn't mean it's smart. Investors who bet the farm on ETFs may be taking on substantial risks. Thanks to the explosion of new offerings, many ETFs lack a long-term track record. Those that track narrow slices of the market can be more expensive than the average ETF, and also volatile. In certain investment categories, investors may see better returns with traditional mutual funds. In some cases, conventional index-tracking mutual funds have lower fees and may track their benchmarks more closely. Some key investment areas are still underrepresented by ETFs, including municipal bonds. In certain asset classes, like bonds or small stocks, many advisers believe investors are better off with funds run by active money managers -- whose job it is to sniff out undervalued stocks and bonds to invest in -- rather than funds that simply try to track an index. Many advisers worry that bursts of stellar performance from narrowly focused ETFs will blind investors to the risks. In many single-country ETFs, for example, "a handful of large companies dominate the ETF, so you incur a fair amount of single-company risk," says Marvin Appel of investment advisory firm Appel Asset Management and author of a book on ETFs. For example, just three companies account for more than a third of the assets in iShares MSCI South Korea Index Fund. Many advisers recommend using a combination of ETFs and traditional funds. One approach: Use broadly diversified ETFs to build core stock holdings, and actively managed mutual funds for smaller allocations to other asset classes like bonds or emerging markets, where actively managed funds have a better shot at beating the indexes.
Psychology I can't be right all the time. Sometimes discipline works against you in the short run. Don't fall in love with any stock. Check your ego at the door. Don't let the fear of missing control you. Take full responsibility for both good and bad trades. Have a plan, know why you own a stock and under what conditions you will sell it. Logic has nothing to do with what the market may do in the short run. Euphoria over gains is the most powerful poison in trading and investing. Even playing it safe can cost you. Stick to your guns - this is a long-term game. Don't let "noise" scare you off. Don't panic. Don't be afraid to be early on emerging trends. Hang in there. Things are usually neither as good, nor as bad, as the crowd thinks. Your best stocks can become your worst stocks when you get greedy. Don't trade for the thrill of trading. Don't be afraid to go against the popular trends. Patience is a virtue. The Market Don't hold stocks whose management is stingy with information. When dogs rise in price, they are still dogs. Momentum can last a long time but can stop in a heartbeat. Goods in limited supply can only appreciate. Look for the leaders, buy the leaders, and stay with the leaders. The fundamentals don't lie. There are only a few stocks that really worth going after at any one time. Dividends pay off. Valuation is always subjective. School of Hard Knocks Buying on impulse usually doesn't pay. Trying to time the market is a fool's errand. Experts are not always right. Consider the downside of any investment first. Sometimes luck is better than skill. Trading Know your entry and exit points prior to investing. Move into new positions slowly. Buy enough shares to make the trade worthwhile. Being timid is a recipe for underperformance. Trade the most favored sectors in the market. Trading less is better. Take your losses quickly and your winners slowly. Never ever hold a loser. When everyone else is heading for the exit doors, it is time for me to start heading towards the investment. Don't turn a short-term disappointment into a larger intermediate-term loss. Stick to plan and get out when gains expectations are met. Shoot first and ask questions later. Timing the trade is key. Add to winning positions. Don't be afraid to pick up oversold merchandise when it goes on sale. The trend really is your friend. Hold on to a climbing stock even if Wall Street is screaming a sell. A good stock will run longer than imagined. Always stick with your gut. Trust my system regardless of my feelings. Pick one stock/sector and learn it well. Don't overstay your welcome. Read beyond the headlines and think. Selling at the price at which you would no longer purchase the stock is a good philosophy. Be in touch with where the money flows. General Information Don't put all your eggs in one basket. Keep some money in international markets. Always have some extra cash in reserve. Use more than one confirmation indicator. Insider buying is important. I can't watch the market as closely as a pro therefore I should participate more conservatively. I am not right if the market disagrees with me. Tips are useless. I'm not smarter than the market. Go to Vegas if you want to gamble. Everything the media tells you has already been discounted by the market. Its OK to pay taxes. Once I decided to follow the numbers rather than my personal "feelings," I was able to start making successful trades again. No matter how much or little you make - share your profits with the needy. Monthly Employment Stats
In the service-providing sector, health care employment was up by 18,000 in January, following a gain of 43,000 in December. In 2006, health care employment increased by an average of 28,000 a month. In January, employment continued to trend up in hospitals, ambulatory health care, and nursing and residential care facilities. Professional and business services employment continued to trend up in January (+25,000), following large gains that averaged 69,000 in the prior 2 months. Within this industry, employment in architectural and engineering services rose by 9,000 over the month. Food services employment was up by 21,000 in January. Over the past 12 months, the industry added 347,000 jobs. Employment continued to expand over the month in transportation and warehousing; the industry has gained 116,000 jobs over the year. Elsewhere in the service-providing sector, employment was essentially unchanged over the month in both wholesale and retail trade. Employment in financial activities was about unchanged; within the industry, insurance carriers lost 6,000 jobs. In information, employment was little changed following a large increase in December. In the goods-producing sector, construction employment was up by 22,000 in January. Employment gains in nonresidential building (9,000) and in nonresidential specialty trade contracting (19,000) more than offset small declines in residential construction. Since its peak in February 2006, residential specialty trade contracting has lost 104,000 jobs while its nonresidential counterpart has added 126,000 jobs. Manufacturing employment continued to trend down over the month. Job losses continued in motor vehicles and parts (-23,000), in furniture and related products (-4,000), and in textile mills (-4,000). Computer and peripheral equipment lost 6,000 jobs over the month. An increase in plastics and rubber employment reflected the return of workers from a strike. Elsewhere in the goods-producing sector, mining employment was essentially unchanged. The average workweek for production and nonsupervisory workers on private nonfarm payrolls fell by 0.1 hour to 33.8 hours in January. Weekly hours for factory workers declined by 0.2 hour to 40.8 hours, while factory overtime hours decreased by 0.1 hour to 4.1 hours. Since peaking in July, the factory workweek fell by 0.7 hour. The index of aggregate weekly hours of production and nonsupervisory workers fell by 0.1 percent in January to 106.7 (2002=100). The manufacturing index fell by 0.8 percent to 94.4. Average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls increased by 3 cents, or 0.2 percent, in January to $17.09. This increase followed a gain of 7 cents in December. Average weekly earnings fell by 0.1 percent in January to $577.64. Over the year, both hourly earnings and weekly earnings rose by 4.0 percent.
Quick Facts, Stats & Opinions The History of Three Market Indicators Jaclyne Badal, WSJ 2-04 The Super Bowl indicator has been correct in 32 of the 40 games, giving it an accuracy rate of 80%. A game-day factoid: There have been seven other years when two original NFL teams faced off in the Super Bowl. Six times, the market, as tracked by the Dow Jones Industrial Average, went up. Some say the "predictor" is a simple coincidence. They say it works because there are more teams that count toward an NFL win than an AFL win (now 20 to 12), and stocks go up more often than they go down (with the Dow industrials rising in 65 of the last 100 years). Almost as ubiquitous as the Super Bowl indicator is the January barometer, which says a gain for stocks in January signals a good year for the market. When the Dow advances in January -- as it did this time with a 1.3% gain -- the next 11 months were above average in 62% of the years since the index's first full trading year in 1897, according to The Wall Street Journal's Market Data Group. But this year, the January barometer is in conflict with another calendar-watching indicator, relying on the market's course in the first five trading days of the year. Those initial days of 2007 saw the Dow industrials slip 0.4%. The Dow has advanced in the third year of every presidential cycle since Franklin D. Roosevelt led the U.S. into World War II. (If you go back to the Dow's inception, the accuracy rate is 81%.) Since this is year three of George W. Bush's second term, the stock market is due for a boost. Merrill Lynch economists noticed that retail goods primarily purchased by women are showing a much higher rate of inflation than those purchased normally by men. “We actually calculated a female and male inflation rate and the former is now running at 3.6% year-over-year while the latter is running just 0.2%,” writes Merrill economist David Rosenberg. It may be due to lower jobless rates and higher degrees of consumer confidence among women, which is “showing through in better pricing results for firms that have a high concentration in products and services aimed at females.” (David Gaffen, WSJ 2-26) Barring some sort of catastrophic occurrence from the remaining 12% of S&P 500 companies yet to report, this will be the record 14th consecutive quarter for double-digit earnings growth, according to Thomson Financial. The tally is impressive across most facets. On average, companies are reporting earnings 5.4% above the consensus, above the long-term historical average of 3.3% and the 4.2% average from the previous eight quarters. A total of 67% of S&P names that have reported have pulled an upside surprise, in-line with the past eight quarters, and overall growth is clocking in at 11.2%. The strength isn’t limited to the top 500 names, either. In the Dow Jones universe, 3000 companies have reported earnings — year-over-year growth in net income is at 22%, which isn’t as strong as the third quarter’s 29%, but it beats the second quarter’s 12% growth rate. (David Gaffen, WSJ 2-26) As pressure grows for the government to pick up more of the nation's health-care tab, new data show its contribution is already at 45%. Overall, health spending in the U.S. is expected to double to $4.1 trillion by 2016, consuming 20% of the nation's gross domestic product, up from the current 16%, according to a new federal study. By then, the study predicts, the government will be paying 48.7% of the nation's health-care bill, up from 38% in 1970 and 40% in 1990. (Jane Zhang and Vanessa Fuhrmans, WSJ 2-21) Many ETF providers are stuffing the development pipeline with offerings that track slimmer market segments and use increasingly sophisticated approaches. There are ETFs for water companies, environmentally friendly firms and corporate spinoffs. "What I am seeing is a rapid shift from ETF evolution to ETF pollution," said Richard Ferri, chief executive at Portfolio Solutions LLC. This proliferation could backfire, financial advisers warn, especially if stock prices take a break from their hot run. The ETF industry then could face consolidation and products dropping off the vine for lack of assets and trading volume. ETF assets in the U.S. increased by 38% last year to $417 billion, with 156 new offerings bringing the total number of funds to 359, according to State Street Global Advisors. (John Spence, WSJ 2-21) The way we track time is changing with the times. Market researchers say more people are carrying electronic devices that also tell time, whether a phone, an iPod or a BlackBerry. In a survey last fall, investment bank Piper Jaffray found that nearly two-thirds of teens never wear a watch - and only about one in 10 wears one every day. Experian Simmons Research also discovered that, while Americans spent more than $5.9 billion on watches in 2006, that figure was down 17% when compared with five years earlier. (Martha Irvine, AP 2-16) The Dow Jones Industrial Average has gone without a 2% decline for seven months, the longest stretch since 1954. And it's been about four years since either the Dow or the S&P500 index suffered a 10% correction, which is only the second time that's happened, according to Ned Davis Research. (Jonathan Burton, WSJ 2-11) Economic volatility is remarkably low, too, which helps explain market behavior. During the past 24 years, there have been four quarters in which gross domestic product swung five percentage points or more from one quarter to the next. In the previous 24 years, there were 37 such swings. The less the economy zigs, the less investors zag. (Justin Lahart, WSJ 2-13) “The more megapixels a camera has, the better the pictures?” No. A camera’s lens, circuitry and sensor — not to mention your mastery of lighting, composition and the camera’s controls — are far more important factors. (David Pogue, NY Times 2-08) The peg ratio for the US market is now 1.83 times. Since 1988, there have been 11 occasions when the ratio has risen as high or more. Each time, the market has fallen subsequently over six and 12 months. The average fall over six months was 8%" (Ian Harnett, Financial Times) Investors have a total of $5.3 trillion invested in U.S. stock funds, including $950 billion in international stocks, according to AMG Data Services, a research firm that tracks fund flows. Although that only accounts for 18 percent, that total is growing rapidly. Six years ago, only about 8 cents of every new dollar flowing into U.S. stock funds was invested overseas. Now, that number is hovering around 77 cents. (Tomoeh Murakami Tse, Washington Post 2-04) The S&P found in a recent study that few funds ranked among the top 25% or 50% of their peers managed to consistently maintain their performance. In the past five years, only 13.2% of large-cap funds, 9.9% of mid-cap funds and 10% of small-cap funds were able to remain ranked among the top half of funds for the entire period. The top 25% ranking proved even more daunting a challenge, with only 3% of large-cap and 2.5% of mid-cap funds staying in that zone for five straight years. Stats for small-cap funds were even more grim: None was able to hold onto a top 25% ranking for the entire period. Srikant Dash, an index strategist at Standard & Poor's, suggests investors instead use rankings to screen out the worst-rated funds: "There is persistence but the persistence is at the bottom, not at the top." (Tim Paradis, Associated Press 2-04) In August of 2005 lawmakers agreed to start daylight saving time three weeks earlier – on the second Sunday in March – and end it a week later, on the first Sunday in November. The change starts this March 11th, and it has angered airlines and sent thousands of technicians scrambling to make sure countless automated systems switch their clocks at the right moment. Unless changed by one method or another, many systems will remain programmed to read the calendar and start daylight saving time on its old start date in April. It's one thing to arrive an hour late for church on the first day of daylight saving. It's another for a security system to log the wrong time of crucial events, for pilots to misunderstand takeoff times or international communications components to stop synchronizing. But such scenarios are possible without fixes to vast numbers of the nation's technical systems. The challenge carries faint echoes of the Y2K scare, when governments and corporations feared computer systems would go berserk the instant that 1999 flipped to 2000. But it has received nothing near the same level of attention. (Washington Post 2-04) Hedge Fund / Private Equity News Briefs Following extensive simulated backtesting, Merrill Lynch is touting the launch of its first index to replicate hedge funds with the hopes that it will outperform the real thing without the attending costs and risks. In the lead-up to the launch of the Merrill Lynch Equity Volatility Arbitrage Index, the investment firm found that the simulations outperformed most of the major global broad-based investable and non-investable hedge fund benchmarks. In fact, ML discovered that in the simulation, the replicated strategies returns were negative in only three quarters over the past 18 years. The key, says Merrill Lynch, is playing by the rules. "Using rules to avoid the cost of active hedge fund management is the same principle that helped passive indexes (such as ETFs) gain market share from actively managed funds," Heiko Ebens, who heads ML’s Americas Equity Derivatives Research team, said in a statement. Ebens went on to say that "mechanically executed arbitrage strategies historically have outperformed active hedge fund benchmarks, not only because of the reduction in fees, but also due to the quality of the investment strategy." The new index will create the synthetic hedge funds by executing strategies similar to those employed in active hedge funds, rather than the more controversial method of attempting to replicate hedge fund benchmarks by means of a "dynamic portfolio of liquid assets," according to Merrill Lynch, noting that its chosen approach "does not aim to track hedge fund returns, but rather invests in the same assets." More replicating indices are on the way. (Hedge Fund Daily 2-09) High hedge fund fees have increased the industry’s share of global management revenues, even as its percentage of the total assets remains minuscule. According to a research report from Merrill Lynch, hedge funds grabbed 28% of all revenues last year, up from 20% the year before, while its share of global assets is just 3%. (Hedge Fund Daily 2-07) Hard times that have befallen two hedge funds have resulted in a changed redemption policy at both firms. London-based Sandringham Capital Partners has notified investors that there will be no redemptions in February, or March and April for that matter. According to a letter obtained by Opalesque, investors looking to pull their money from Sandringham this month are out of luck. Poor performance—which the letter says is due largely to "high level of concentration of stocks as well as with a high proportion of smaller capitalisation, and less liquid position" -- over the past several months is the culprit, Red Kite Management had the wind knocked out it in January, with the metal trading hedge fund losing as much as 15%, mainly because of tumbling copper prices. To stem the tide of possible redemptions requests, the firm has introduced a policy extending notification for withdrawals from 15 days before the end of the quarter to 45 days. (Hedge Fund Daily 2-06) The younger the millionaire, the more likely they will invest in alternative investments, according to Northern Trust’s Wealth in America Survey 2007. The poll found that that 27% of millionaires between the ages of 27 and 41 invest in hedge funds, private equity and the like, while only 17% of baby boomers (ages 42-60) invest in them, and 11% of that age 60 and above do. "Younger investors, presumably still working, can afford to invest a larger proportion of their portfolio in an illiquid, non-income-producing asset class" says John Skjerm, chief investment officer of Northern Trust’s Personal Financial Services division. He notes that older investors, especially retirees, "place a premium on liquidity," as they rely on their investment portfolios for at least part of the income needed to support their lifestyles." In other findings: [1] 40% of those polled don’t invest at all in alternatives, while 45% have 10% or more of their portfolio in them. [2] Among those who invest in alternatives, 53% cite "improved portfolio diversification" as their main reason, while 34% are looking mainly for potentially higher returns. [3] 31% of households with $10 million or more in investable assets allocate money to alternative investments; only 7% of those with under $10 million invest in them. (Hedge Fund Daily 1-25) Home Page Previous Factoid Top Sites
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