You Need a Financial House First

That person staring back at you in the mirror has a personal finance plan that is hard to argue with or ignore. Your reflection is probably suggesting to you what it suggested back at the turn of the calendar year: to save more, spend less and focus on getting your debt in line. Intimidated by what is obviously an imperfection in your financial life, you agree. Again. Something needs to be done.

Those mirror conversations are often forgotten as soon as you walk away from your own reflection. And with good reason. Only when you are looking directly at yourself do you see someone who has made these types of promises before. Once the two of you part ways, the reality of past decisions thwarts many of these well-intentioned pledges to do better. The question isn't what is better - that answer we know - it is more like how can you do better?

Improving your personal finances is much easier than you might imagine. So let's look at why your reflection is suggesting an overhaul in the first place. You can't avoid the idea that retirement or at least the time of retirement is closing in, often quickly. You can't dodge the fact that in order to retire at all, let alone comfortably, you need to set aside larger portions of your paycheck. No one has ever told anyone they are saving too much. Everyone, on the other hand will suggest that you and millions of others just like you, aren't saving enough.

In this scenario, they will tell you to max out your 401(k). To do this, the average American with the average paycheck in the average 401(k) can set aside $17,000. This number for this average person amounts to almost a third of their paycheck. And most will agree, this is an austerity measure that will not happen no matter how much the financial profession points out its wisdom. The over 50 crowd can toss another $5,500 into these accounts in order to play catch-up pushing the total contribution in this "maxed-out" situation to almost half of the average wage earners paycheck.

Knowing you are under-contributing often is the first roadblock in doing what you've told yourself you need to do. Resignation sets in and the next time you are in front of that reflection you quip: "I'll never retire" or "I'll just have to work longer". These will, without any argument help you achieve your retirement goals. But in suggesting that lengthening your work life is an adequate solution, you are subtracting from your retirement life. Think of it this way: If the speed limit is 55 mph and you drive 45, you will arrive at your destination; it will simply take longer as as you watch your fellow cohorts pass you, you will become discouraged and this will begin to weigh on the journey.

So forget the limits. Instead focus on the percentages: five percent (5%) of your paycheck contributed and producing a modest return will net you about 25% of the income you currently own, ten percent (10%) will get you about 50% of your current wage while fifteen percent (15%) will get you very close to 75% of what your current income is. Of course you will need to contribute and do so over a span of at least 20-years. But is much more do-able that the whole number that is the maximum contribution.

But even if that is do-able, as I suggest it is, something will have to give. A recent New York Life survey, done as they suggested, across the kitchen table, portrays the average American as someone who will try and manage their debt better. This is translated into spending less. Debt as we all know works against you in many different ways. More than simply spending what you don't have and exceeding what your paycheck brings, the cost of servicing that debt acts as a direct subtracting to that 15% and any return you might get in your plan.

So not only will you need to contribute more but at the same time, you will need to draw down that debt faster. What that reflection in the mirror is suggesting is often too austere for even the most parsimonious among us. Who looks at themselves in the mirror and says: "this year, I live on 30% less." While this might be excellent practice for the retirement you probably will experience, it is quickly dismissed.

Fourteen percent of those surveyed in the New York Life conversation with an agent revealed you will seek help. What you are doing is trading the reflection for a person who will tell you what you have told yourself. Of course this suggests that this financial professional has access to better tools to do what you have promised yourself to do. Ironically, they don't. For a fee, they will tell you what you already know.

Fear might be a motivator and many have taken to making these threats. But fear also brings a natural human reaction: to run in the opposite direction. Comparing where you are now with where you will be because you have done so little so far is a from of this fear. So is comparing you to your cohorts.

The simplest solution: 5, 10, 15. Contribute 5% to your retirement, 10% to your debts and 15% to your mortgage. A five percent contribution to your 401(k) will not impact your take home pay and will probably meet your companies matching contribution. A ten percent increase in payments to your debts will shave years and hundreds of dollars off of the interest you might pay. A fifteen percent payment towards the mortgage principal will reduce the length of your loan by as much as ten years. Doing this will have you arriving at the point of retirement with no debt and no mortgage.

Once the plan is in place and you have done this for five years, begin increasing the contribution by a single percentage point each year. This will be much easier to do as the debt you own is paid off and once the mortgage is satisfied, you will find your reflection congratulating you. This is far better than the criticism it once offered.

Are Mutual Funds that Short a Good Idea?

Most investors don't understand the idea of a shorting an investment. The concept is relatively straightforward: an investor essentially bets that a stock will go down and if it does, profits from the fall. Going long does the opposite, wagering that a stock will move higher. This was formally the purview of the hedge fund, those high dollar investor clubs with equally high fees, that sought to use every market strategy available to gain ground for those investors.

As I said, this was formerly something of an investment style that was not available to mutual fund investors. But this is a different investment world and the mutual fund industry, in its own way, acknowledges that trend with a group of funds that offer a defensive footprint in the market. In other words, rather than simply assuming that all stocks will go higher, they believe their research and expertise can locate stocks that move in the opposite direction.

Studying an online MBA with an emphasis on finance can get you up to speed on mutual funds. If you don't have such a background, this information will help you understand shorting your investments.

The question is: is this a good investment for your portfolio and more specifically, how do you avoid the lure of their promise to do better than traditional funds or even ETFs? It's no easy feat launching a mutual fund and even though some appear new, they can take a year or more to hurdle regulatory requirements before the first share is offered.


In almost every instance, when it comes to investing in mutual funds, the basis for your decision rests on not only the tenure of the fund manager, but the length of the fund's performance. This backward looking approach doesn't always serve the investor well when it comes to picking a fund based on what it has done compared to where it is now, nor does this sort of comparison reveal the true nature of the fund's ability to best the overall marketplace, a field now numbering over 8,000 potential offerings.

When times are bad, as was the case twice during the last decade, good years can be wiped from the investors view, replaced with averages that make the fund appear lackluster.

New funds don't have that sort of problem. They're new, with no history and no track record. Just a charter and a manager. So new investors are forced to look at the fund family (which provides research and oversight) and the previous experience of the person(s) at the helm. This is no easy trick and requires a leap of faith. Not the soundest of advice; more like a word or two of caution.

According to Dan Culloton, associate director of fund analysis with Morningstar: "They're [long-short mutual funds] responding to the market fears and frustrations over the past 10 years. A lot of it is just pure-and-simple rearview mirror product management." One hundred and fifty new funds have decided that this is a market worth exploring.

Among the new offerings, seventeen are focused on emerging markets. This particular sector is teeming with potential and just as many problems. It is those problems, which can range from anything like political unrest to poor financial infrastructure are widely thought to be the main drivers in such an investment space. And the risks in some of those bets were indeed high. These new funds (some of which can be found here and do not constitute any recommendation to buy) have done quite well for themselves in the years following the downturn in the US stock market.

There is also opportunities to play both sides of the extremely volatile commodities markets. Many of us have watched with great interest the demand for some commodities and understand the risks involved. Yet we a lured by the potential returns this sector can offer, looking for some way to mediate those risks.

Enter the commodity mutual fund designed to play off of those investor fears, the world-wide demand for many commodities in short supply, and the ability to find profit where other investors may not yet be. And because they short securities as well, they bet some investors will not be there for long (the reasons vary from currency policy changes to the perception that something may be overbought and ripe for a bubble pop). You can find a list here.


But are these funds right for you? Yes and no. Yes if you are looking to fill a small corner of your portfolio, perhaps as little as 5-10%. There are great deal of more traditional investments that allow you to see where the fund has been and where it is headed. These still remains the best tools for making a decision on where to invest your money. And no, if you are easily swayed by the relatively high returns these funds have been providing investors over their short-life spans. That temptation can easily allow you to increase those percentages to too high a portion of your portfolio, eliminating the best diversity plans.

And since a vast majority of us will be using or retirement portfolios (401(k)s and IRAs) to do this sort of investing, special caution is worth considering.

More than Just Mutual Funds: A Peek Inside your 401(k)

There is no such thing as a simple choice.  We may be very familiar with the options available and we may know a large amount of details about those choices.  But when faced with making the decision, we often freeze, unable to decide and even questioning the whole process.

Just get behind someone at a fast food drive-up window and wonder how long does it take to order from a menu that rarely changes. Your 401(k), the defined contribution plan that many of us have, puts us in the retirement planning drive-up lane and forces us to make a choice.

Few people ever decide to drive on through without making a selection.  Once in the line, you are sandwiched in by the person in front of you, the car behind you and the prohibitive curb. This is your 401(k). This is your 401(k) menu.  Order now, pick-up at the second window, pay at the first and be satisfied with your choice in large part because there is no going back, no changing your mind or adding something else on to the pick you have made (without exiting your vehicle, which defeats the whole purpose).

This is where almost every 401(k) plan in this great nation fails.  Once you have been put in the drive-up lane, you are stuck. You are essentially given a select number of choices, many of which are easy to determine how much they cost in part because your plan is now loaded with index funds, which basically resembles your dollar menu.  Cheap and (portfolio) filing without a lot of extras.

Then the seniors portion of the menu, also bland (and bond-like), suggests that you can get value from your invested money by making sure you get your dollar back - or at least in theory. The kids menu has gotten smaller over the years your plan has existed because there is fear that if this portion of the menu were too large, you might find the restaurant liable for (actively managed mutual funds) choices that were too expensive and fraught with risk.  They could throw in a toy but you would want proof that you could purchase this item without ever being dissatisfied.

So they offer you menu items that you wouldn't expect.  These are items that would be better suited at a sit-down establishment where the big spenders go - not because they want to spend more, they just want to think they are more sophisticated than the general population.  This is the ETF (Echange Traded Funds) choice.

And then we have the value meals.  This portion of the menu dominates the process and in effect, bogs most of the line down if there should be someone who is indecisive. These are your target date funds, a combination of mutual funds tucked under one banner which suggest that you can pick a year in which to retire and the item you choose will not only be worthwhile, but will also fulfill its promise.

Everyday, folks drive up to their 401(k) plan and are forced to make a choice.  Everyday, your 401(k) plan is scrutinized by regulators. Everyday, 300,000 advisers go out to the field and, well for lack of a better word, advise.  That's 300,000 different drive-up windows, sponsored by just as many employers for millions of employees.  A daunting task indeed.  Which is why you are dissatisfied with the choices: you think that there is a better drive-up window someplace else.

Of those 300,000 advisers, the vast majority of them, according to Fred Barstein, the president of 401k Exchange "half have one employer plan. Half of those have at least three plans. Fifteen thousand or so, or about 5%, have at least five plans. Then there's the 5,000 or so elite advisers, who have at least 10 plans, $30 million and at least three years experience."  Mr. Barstein, who is also columnist for the Employee Benefits Adviser site, suggests that the fees that these advisers charge have dropped significantly in the past several years, which is good for the participants but makes it doubly difficult to make a living doing this sort of work.

Not only is the competition stiff, the drive towards least expensive and lowest risk has sliced the revenue stream in half. You might think this would be good for you, the 401(k) plan participant. Turns out, it hasn't been as good as you thought it was.  In this particular scenario, these sorts of plans have become more generic, less customized and inelegant.

When an adviser approaches your employer, the sell goes something like this: You want almost zero liability, almost zero costs, and near zero effort on your part and I, the adviser, will do this by offering target date funds and perhaps a huge basket of index funds and, if we can figure out how to squeeze one in, an annuity.  None of these offers your employees any guarantees, the adviser might suggest ,except for the annuity, which illustrates a distribution of retirement income and unfortunately comes with a cost (a trade-off of sorts).

Is it any wonder why you sit at the drive-up menu for longer than you should?  All of the choices look the same. And then there is the problem of getting you to order the product best suited for you. Here is where they suggest a sort of buy one get one free (or the matching contribution). By the time you get to the drive-up window, you may been sitting in line, waiting your turn for almost a year.  Then to get the other half of the buy one, get one free offer, you may have to wait an additional period of time (a vesting period that can be more time than you planned on staying with the company to get).

Then there is the super-fast lane where you are essentially put on a bus, driven through without access to the window at all.  The driver, your employer in this example, orders what they believe is best suited for you - take it or leave it. In this situation, you will be dropped into a target date fund and told that you can opt out (go hungry) or stay in and believe that this menu choice is probably the best one for you because someone thought it might be.  That someone is the adviser.

Now Mr. Barstein does suggest that at its rawest, it is about selling. Selling a plan involves training, partnering and a constant source of information. Much like fast food drive-up windows, who might consider your health as a passing interest in order to get you to come back, increase their bottom line with a salad and offset fears that their choices are not the best ones available (doing it yourself will always be more satisfying but more time consuming as well), your 401(k) plan is designed to fill you up.

The adviser and the plan sponsor hope you drive off happy and satisfied.  As long as you drive off and don't sue them.

Do You Know Where Your Muni Bond Fund is?

The vast majority of us who own municipal bonds, do so inside of a mutual fund.  But munis may be in a bot of trouble with more on the horizon.

We want to believe it simply isn’t so. Municipal bonds or munis, those hometown or home state, often tax exempt debt instruments which are favored among the retired, the soon-to-be retired or those looking for a conservative but well-paid return may be facing a little headwind. But truth be told, you should have noticed.

When you buy a municipal bond, you are essentially buying a project believed to be worthwhile for the city, county or state issuing the debt. They are rated in much the same way as a corporate bond is with a single exception worth noting. If a municipality issues a bond and has difficulty paying the coupon, they often simply raise the local tax rate to cover the shortfall. But like all sorts of funding, the increased tax revenue that would pay for the bond payment shortfall is also in short supply.

More on municipal bonds and risk here.

Mutual Fund Fees

There was a time in the not-so-distant past when mutual funds were not highly regarded. They did provide the average investor with the opportunity to purchase their segment of the stock market with the guidance of a fund manager and comfort of knowing that others felt the same way you did. After all, they were giving this fund their money as well.

But not all investors were thrilled with the arrangement and in the day before the internet, the only way you could find out if your fund was charging too much for their services, was to dig. Not all of us were inclined to do so. We were average investors.

More...

Do You Invest with Responsibility?

Earlier today, on MomsMakingaMillion radio, I discussed the topic of socially responsible investing.  I have written about this topic numerous times and will continue to do so as the effort to invest where the right thing is being done continues to expand.  Once it was all about ethics and morality.  Now it is including shareholder advocacy and community involvement.

Here is a transcript of the interview I had with Kat Bellucci.


Kat Bellucci: A lot of us have become very aware about what we eat, what we buy and what kind of a footprint we leave. And then, when we invest our money, we often don’t consider that the companies we are buying in our mutual funds might be the very businesses we would avoid in the marketplace.
Well ladies, its time to take a look at taking your investments down a path that suits your concerns about the world around and the world your children will inherit?


Paul Petillo: Most investors are narrowly focused.  They want to make money.  But some investors want to make money without destroying the environment, without violating their personal values and possibly even helping others in the process.


While these types of investments have been around for decades, the cost of doing this sort of investment was not always cheap.  The sorts of investments first came across my radar when my daughter, a free spirit who was interested in investing asked me: “are there any mutual funds that are ethical?”


What she was really asking was whether the companies that the mutual funds invested in were screened for more than just performance.  While we would like to believe that all mutual funds are ethical; what about the companies they invest in?


Kat: So what describes ethical?


Read the full interview here at Target2025.com

Mutual Funds Explained: Prepping for the Third Quarter and Beyond

No market appreciates the beginning of a new quarter when it coincides with a holiday. No market enjoys bad economic news either. So, as earning season begins on Wall Street, a time of speculation, expectations and often dashed hopes and dreams, I want to take a moment and cover some of the behaviors that investors need to come to grips with.

Our sister blog has been reviewing some of the investor habits that are worth noting. You have just watched the recovery of many of your mutual funds, especially of you were not in index funds but allocated in growth both domestically and abroad.

Before You Buy: Why Investors Do What They Do

Loss Aversion begins the discussion with "Falling squarely into the realm of behavioral finance, numerous academics have sought to model a realistic estimate of how investors react in certain circumstances, whether those reactions were realistic given those circumstances and how financial decisions are evaluated and eventually made."

Investors are also guilty of narrow framing. "Coupled with loss aversion, narrow framing represents a look at how investors perceive their chances at wealth but only when they see it as the sole component. This is a discussion about risk."

Many of our beliefs about investing revolve around another bad habit: anchoring. Investors "may be investing in their retirement plan or simply making an economic (better yet, one with financial implications) decisions, but we often, as studies have shown, begin from some point of what we know. This is referred to as anchoring."

Mental accounting affects how we invest as well. "Mental accounting really becomes a problem, almost without noticing it has, is when you separate different elements of an investment. Some are willing to pay higher fund expenses in return for a riskier fund that has done well in the past."

Diversification is not what you think it is. "These feelings of "wrong-ness" are often the result of events beyond our control. Non-economic influences can derail the best efforts of an investor along with weather, military actions, even the health of the President. As Markowitz suggests: "Uncertainty is a salient feature of security investing".

In the first part of 2008, billions of dollars were being invested in a market near it top. In the second half of 2008, billions were withdrawn. This is herding at its best and worst. "It is okay to look at the winners and losers, for mutual funds they are posted quarterly while stocks are posted daily. It is also okay to want to align yourself with the winners while foregoing the losers. It is only called herding when the winners see a large influx of new investors because of past performance, an indicator that is usually disclaimed as not indicative of future results. But the actual act of buying into any investment with the hope that the current top is not actually a top but a lower rung on an ever-rising ladder."

And then there is regret. "One of the basic assumption in investing is risk. Risk is subject to a great deal of bad investor behavior and most notable of what occurs in an investor's mind is regret."

Nothing has impacted your investment style and direction and is in fact least suited to do so, than the media. "Has the hype in the media over the last several months had an effect on how your invest in your retirement plan? The answer is most likely, yes. And the reason is the media presentation of investor news and nowhere is this done better than on television."

And lastly, there is optimism, that feel good, I want to invest emotion that often gives us reason to engage in all of the previously mentioned investor behaviors. "In an essay written in 1903, titled Optimism, Helen Keller calls optimism "the proper end of all earthly enterprise. The will to be happy animates the philosopher, the prince and the chimney sweep." And while I don't want to throw water on those thoughts, optimism has a dark side when it comes to our investment behavior."

So before you get back into a market (that I hope you never left), take the time to examine the investor in the mirror.

The Deep End of a Dark Pool

There was some speculation that the financial markets in this country would suddenly stagnate after the most recent downturn. The innovation of products that used an ever-increasing and more complicated methodology to make money would stop, paving the way for dull and boring, over-regulated markets that offered so much oversight as to slow the growth of the country. To hear some Wall Streeters talk, the end of an era was upon us.

Not so fast.
Financial markets and those that look for ever smaller ways to extract a decimal from these tough times have rediscovered a product called dark pools. These are ways to trade electronically using the money from a bank, doing so without publicizing the trade until well after it had been executed and even more sinister, allowing traders to see in advance what orders are being placed.

In other words, while we rely on live quotes, these dark pool traders are able to purchase an equity without needing to publicize what the actual quote was. These types of pools have been around for over a decade but were largely underused. There were simply too many other tools of the trade to be utilized while the Bush administration's crippled S.E.C. looked the other way. As long as the market escalated, there was little or no need to decimalize each trade.

But that has changed and the numbers of large and institutional traders that now tap this type of trading platform has increased at a frightening rate of 17% over the last year (from 58% to 70%). While you may say to yourself, what mutual funds, pension funds and hedge funds do to enhance their return is okay by you, some of which you may have an interconnected interest in, the idea that the equity markets may not be fair to all players is not right.

Individual investors have known of these disparities for some time. Beginning of the day and end of the day volumes and volatility have increased to the point that many people could never predict where the market is going to end the day. (Exchange Traded Funds have been to blame for frenzied trading as well.)

Now this subject of who and how these dark pools are being used seems to be getting a little light shed on it from the new chair of the S.E.C. Mary Shapiro. In a recent keynote address at the 2009 SIFMA Market Structure Conference, James A. Brigagliano Co-Acting Director, Division of Trading and Markets U.S. Securities and Exchange Commission wondered if "there is any compelling reason for dark pools to object to improved post-trade transparency." Acknowledging the need for these trades to be dark prior to execution as part of the success of these pools, he couldn't see why "some form of improved post-trade transparency would be likely to interfere with their business models."

The Downside of Speed.
This darkness is however not complete, coming in different shades. Often called indications of interest, these so-called messages done in advance of the trade itself, offering a look to other traders of a trade about to happen, whether it be executed or canceled may resemble a quote too closely.

Because these trades are able to get done very quickly, these "actionable order messages could create the potential for significant private markets to develop that exclude public investors" according to Brigagliano suggesting that because of this "the public does not have fair access."

Mr. Brigagliano has no real beef with the huge block trades that are conducted between institutional investor, often trading in excess of 50,000 shares. But smaller order systems could make the general investing public less likely to want to trade if they feel as though some select individuals get orders processed at a better price based on a quote the general public was unable to see. If that were to happen, the markets would essentially freeze.

He is correct in assuming that "any practice that significantly detracts from the incentives to display liquidity in the public markets could decrease that liquidity and, in turn, harm price discovery and worsen short-term volatility."

At the heart of this reform is a newly energized SEC. So far, they are looking at regulation with a realization that too much regulation would have long-range effects that we would have to live with for years to come and the lack of regulation they inherited needs revamping. Cleaning up the dark pools is one of the ways they hope to do this. Expect Wall Street to resist.

Any transparency is better than none and Ms. Shapiro is making this a focus of her approach to getting the investor’s trust in the US equity markets back on track. The "gaps" in regulation have allowed too many innovators to slip through with products that might make money for some, but threaten the long-term goals of some investors and challenging the trust of others.

Bond Funds Make PPIP-ing Noise

I must first begin by bringing you up to speed on a couple of terms that have been added to our financial lexicon. TARP was introduced last year as a way to finance troubled banks, keeping the largest financial institutions afloat while they worked out their problems. Dubbed TARP (Troubled Asset Relief Program), money was more or less forced on banks to instill not only confidence in the system but to give the lenders money to get the credit markets moving again.

The TARP program has shown signs of success. Critics have attacked the banks for not lending enough of the money or making the standards for lending far too tough for the average borrower. Some banks have attempted to give the money back, somewhat prematurely and long before they have shown that the problems on their balance sheets have been addressed. Another version of this program is about to be extended to smaller banks and commercial lenders.

One of the other challenges facing the Treasury is the problem assets that caused this financial meltdown. By soliciting private equity money to help and guaranteeing or matching private investment, the Public Private Investment Plan or PPIP was developed. While the economy is showing the initial signs of recovery, there are still a great deal of mortgage backed securities (MBS) and asset backed securities (ABS) floating around on various balance sheets with a need to be priced and sold. PPIP is offering private investors (more specifically, some of the largest fixed income mutual funds and hedge funds in the investment world) the opportunity to purchases these at a reduced risk.

Along with PPIP the Term Asset-Backed Securities Loan Facility, or TALF, will give some investors the opportunity to purchase securities that may prove to be bargain basement priced. Once these big investors (PIMCO, BlackRock, or Western Asset Management) begin to see some profits, the trickle down effect will take hold.

Who might this trickle down effect help? Right now, it is difficult to tell. There is still a long way to go yet if the program works, some funds that use bonds to offset risk might see some recovery in their portfolios. because these funds will likely be sold as closed end funds and not necessarily priced for the average investor, target-dated funds might find the opportunity to good to pass up.

According to Morningstar, the risks are still very real and may even be underestimated. They reported that "If asset managers get the impression that the government is unwilling or unable to guarantee contracts of mortgage-backed securities or protect asset managers from attempts to claw back some of the profits made through PPIP, we wouldn't be surprised to see managers back away from the program en masse."

When reviewing your fixed income portfolio, look for transparency on this particular side of the coin. The risk may be worth taking. But just as possible, it might not.