Want to Retire Poor?

I had been putting off writing this blog post for a while now; thanks and no thanks to procrastination I might be writing a little bit off. But the information I wish to share in this post has been modified based on some experiences I had with certain young professionals during those times. In fact, I had decided earlier to write on how to set up the personal retirement account system known as 401-k within the US. But given these experiences, it is my intention to dwell on some common pitfalls you should avoid when you get that 401-k form (new or modification) next year.

It is more evident year in year out that rather smart people are falling behind on their retirement planning. It is even more incredible that professionals like accountants and engineers whom you will think are better number crunchers fall into these common traps as much as any of us. I saw a program on the 401-k time bomb on PBS and was even alarmed when some very smart buddies of mine asked me to help look into theirs with the free advice that come with it. Alarming is a benign word to use to describe how many people are making avoidable mistakes that includes but not limited to:

1. Postponing Enrollment: Let us just say it is the biggest mistake of all. 3 out of 10 workers are still not enrolled. Lottery and change in the sofa is unlikely to take care of your retirement if you fail to do so. Enroll now.
2. Walking away from a Pay Raise: Some don’t contribute up to their company match (typically between 4-10%). It is like telling your boss you don’t need a pay raise and forfeiting the tax benefits and future income on such contributions. At the minimum, contribute up to the company match.
3. Contributing Little: Truthfully, contributing up to match alone is unlikely to assure you of a nice retirement in Monument Valley. Depending on your current & planned retirement lifestyle, a little percentage or more won’t hurt.
4. Spreading It Too Thin: The pains of the market decline have made many to take the message of diversification too far. Even with already diversified mutual funds, some employees just put money in each and every fund in their plan. There is no easier way to under-perform the market. Invest in not more than 5 funds.
5. Being Conservative: Why will a 20 or 30 something years old invest in 1% bond? It is called being scared. Investing in perennial market outliers like bonds, money market or even the broad market is like putting your money under the pillow in a high inflation world. Take some risk.
6. Feeding the Broker: Why will you invest in a managed fund that charge 2% fee for a mediocre return when a low fee index fund that mimics a sector/fund family is available? Check that expense ratio in the report.
7. Throwing Darts: Investing without a plan is very unlikely to make you rich. Have a plan and stick to it. It is a known fact that certain sectors outperform the rest of the crowd. If you are young, mid-cap fund, small cap funds and global/international funds is always a plus for your 401-k
8. Walking Away: Now that you have a plan, leaving it that way is not an option. Like flowers, your 401-k needs to be tendered to. A once in a year review won’t hurt.
9. All Eggs in One Basket: Truthfully, 401-k is one of various ways to save for retirement. The more flexible Roth IRA and real estate, even gold should be in the mix.

Monday morning Quarterbacking & Bragging

Any investor who does do some Monday morning quarterbacking periodically is a loser. I had not taken stock since the middle of last year. In my post concerning strategy, I enumerated the new strategy for the new half of the year and set a pro-growth target. The summation of that post was a strategy to preserve cash and grow rapidly. In the end, I would say it was largely successful in the virtual portfolio- It was Up 20% since June. Comparative analysis to other fund managers reveals that my BMF portfolio outperformed 84.1% of funds in the month of December, 63.3% from September and 67.5% of funds counting from the month of June. The fund is up handsomely this year (by 3.5% compared to S&P Index 0.5% good enough gains). The basic materials, financial services (especially publicly traded stock exchanges) and some good positioning and sectoral circling proved very profitable for the fund.

Going forward, most gains will accrue from Private Equity acquisition as we can see already with the feverish pace of acquisition going on in recent weeks. I envisage consolidation in the basic materials sector and one has already happened to a stock I picked up late last year: FRK. Companies that are likely to benefit from the cheap money in the hand of these corporate raiders will usually be in the 2 to 10 billion dollar range in Enterprise value i.e. debt plus capitalization; it would be foolhardy to count on the size of TXU acquisition or the type supposedly being broached for DOW chemicals.

In any case, both of the acquisition mentioned shows that the sector most likely to benefit from this consolidation will be Energy, Basic Materials, Utilities and Industrials. Anything dirty in short -the principles driving these acquisitions are as political as economical. Most of these companies produce the filthy stuff and seeing that the Communists (sorry the Democrats) are now in charge of Congress and are more likely to win the presidency next year they rather go private and not be subjected to the same level of scrutiny they face now. Add this to the supply side argument that due to more creative financing options out there and derivatives Private Equity have more access to cheap money and the demand sided argument that companies are now risk averse and more profitable.

All in all, this is a good time to be invested in Mid-Caps and even if you don’t like stocks, pick up a couple of Mid-Cap ETFs as that group will most definitely benefit from the inrush of Private Equity fund guys in the coming months. The Blackstone IPO should also be a good money maker- if you have a need for common stock in your retirement portfolio this will be a very good addition.

Financial services should continue to experience tremendous growth upsides courtesy of accelerated profit margins in the corporate World- but watch out for a possible leveling off not fall off of these profits. This will not likely be reflected until first quarter 2008 and so it should not matter a lot this year. Real Estate will continue to experience great pains but Investor Optimism should make it a reasonable cash cow for patient souls who can handle great pain. As usual, if you are not playing with the House's money- stay off the airlines and automotive sectors: they are for the brave and rash.

P.S: A 401-k series for the Class of 2007 will begin in the next updates

Correction and Psychology of the Market

The Large drop off on Tuesday, 27th February should not make you panic. In fact, the drop was logical and effectual. Check out Jim Jubak’s Article and Cramer’s Take on why it happened. A combination of China, Technology and natural market tendencies to correct an upswing led to the DOW losing more than 400 points (and about 500 points intra-day). This should not make you panic, rather it should lead to an evolution of a new strategy. Basically, what will happen is that big money (institutional investors) will not abandon the market they simply will rotate into new areas. The new areas that will work is Consumer Product. Hence these dividend rich cash king like Procter, Altria and Pepsi will always work when the economy is expected to go down in flame. As you realize, I did not say we are entering a recession like godfather Greenspan (the harbinger of evil) said on Monday preceding this downturn, I rather said the expectation of recession.

Market trends are about psychology than reality. Generally speaking the market does poorly entering summer time because optimism is largely lacking- and this summer is going to be gruesome and it started early already. With the Christmas behind us and Valentines Day gone past- there is little to cheer consumers or investors so expect a crummy market at least up until July when the patient will be richly rewarded. I still expect the market to swing back in favor and this gloom is just your opportunity to get in cheap to what you always liked- just make sure you spot the bottom right.

Hence, the fear of China will punish any sector levered to the Chinese these are: oil/gas producers (refiners should still do well- as we enter the driving season), miners and basic materials sector, and commodities exchanges. The commodities exchanges should fare badly for a short time and then they will bounce back. The miners will get punished the most and should not return until the mid-summer time while the oil/gas producers will trend towards flat than down. Hence, circulate out of these sectors or at best be underweight in them. An unlikely beneficiary of a bearish psychology will be the brokers and non-commodities exchange. Greater trading due to sector circulation/reallocation and/or just sheer panic will allow these folks bring more money into the house since they make more money when you trade and/or panic. The big five brokers should continue to do well: LEH, MER and GS are my favorites.

The greatest mistake however, will be not taking advantage of this sell off to establish position in very good companies. Timing the bottom will be as crucial in this game as staying off the way of a roaring bear. The strategy is yours to fashion.

Must Own: JNJ, PG, PEP, MO, ATT, NYX, LM, LEH

How to Spend Your Next Tax Return (Part 2)

The idea of investing in your IRA is very obvious: you are investing in yourself and your future. Early tax return time i.e. February through March also happens to be a very good time to invest. Just after the holiday stock optimism, a cloud of the unknown sets in on Wall Street which generally drives stocks down at this period of the year. This is a good time to buy but you must do so early. Wall Street generally starts feeling the impact of IRA money pouring in from late tax returns in late March which spurs the market before the general May downtown.

Roth IRA remains by favorite investment vehicle especially if they are filled with ETFs (five at the maximum) and below are five classes of investment vehicles and examples of what you should purchase with your next tax returns probably in equal twenty percent measures:

International Fund: A sizeable portion of your portfolio should be devoted to international exposure. You will miss out on explosive international growth if all your investments are directed internally to the Americas- emerging and developed markets can form part of your strategy. CRIB i.e. China, Russia, India and Brazil comes to mind. Understanding the risks is also important in the choice of global investments- for example investment in China and Russia is an investment in commodity growth, while India and Brazil is more service oriented. Currently I love Honk Kong ETFs or may be Australia. These are well positional developed markets with the transparency advantage which have stocks that can take advantage of their proximity to the red hot China and Indian markets. I love EWH (which I own and which contains Honk Kong traded stocks with good exposure to the mainland) and EWA (its Australian Equivalent).

Core Growth Fund: It is necessary to have a core growth portion of your portfolio around which the rest of your portfolio is built. This should be a representative cut of the total market probably an index tracker, like the Russell 1000 or S&P Growth index. This portion of your portfolio will be a steady hand in the storm and should over time constitute a bulwark of your explosive portfolio. An investment in growth and capital gains is an attractive option for younger people. Older folks can substitute this class for a core value play. Currently I like IWF, IWZ (which I own) and RPG.

Small Cap: The worst kept secret on Wall Street is that over time, small cap stocks outperform all other classes of stocks. It is pretty obvious that this will be the case if Wall Street keeps being a growth chase addict; small caps stock have the most headroom for leveraged growth which can come by huge capital gains, market share gains and indeed a buy out by a bigger, threatened competitor. This could me cash machine for owners and without the headache of having to rebalance your portfolio an ETF is the easier way to invest in small caps. Current PWY, RZV and PZI look very interesting to me. By the time you read this, I should own at least one of the three.

Sector of the Future: After playing regional, style and capitalization classes, and the next best hunt is sector classes. In here, you will need to do some homework or rather make a good guess of what the future holds. It simply involves choosing a sector you perceive holds the most promise for the future. To some it might be biotechnology (look into PBE, XBI) which considering the ageing population will be a combo way to play growth, technology and healthcare. To others it might be nanotechnology (look into PXN) and to others it might be alternative energy (PBW is one of the best out there now). Depending on which way to go, it might be necessary to time your entry into this ETF to coincide with a downturn or slowdown in such sectors since you are essentially looking to secure long term gains not ride the current momentum.

Stock of the Future: This is my only non-ETF play in a model IRA portfolio. This is a common stock of a company you have a hunch about. This might be a stock on a rally, one that is beaten down and essentially is in the hand of a guru. This is the next BERKSHIRE HATHAWAY INC and you are basically seeing if the company is in the hands of the next Warren Buffet or Jack Welch of GE. Imagine if you had bought one BRK.A stock at $200 in the early eighties, you did be sitting on $80, 000 plus today. That is humongous! Of all the five classes, this will require more homework than any other. You will not only need to effectively know the company by poring through annual reports and filings as well as website and may be even cold calling their offices, it might require to have an insight into the strategy, managerial style and personality of the man on top. Essentially this is a focused long term value investment in one man, his brain, and his health. Shun companies with old men beckoning on retirement, those that like to spend extravagantly and companies with shaky financials. Cash is king when selecting this stock, because a major weight to your bet is that this company will essentially become a conglomerate if it is not one already which will mean acquiring its way into new businesses. Currently, Sears Holding (SHLD) under Eddie Lampert has every smell of it- yes, I own SHLD and I am not ashamed to say it. Get yours.

To conclude, before investing it is necessary to understand the risks in each of the investment classes, market trend, and your own risk tolerance and how this investment allocation strategy will fit your retirement age target. For example I will personally reduce investment in international funds and substitute the ETF in the sector of the future for income generation fund like a Real estate Investment Trust portfolio if I am five years to retirement. This will also impact my stock of the future, because at ten years to retirement let us be real you don’t have that much of a future ahead- okay, just joking.