photo by uruandimi

How It Works/Example:

Active management is the opposite of passive management (also known as buy-and-hold investing). Instead of dismissing short-term trends and focusing on long-term profits, active managers believe short-term price movements are important and often predictable. In this vein, active managers often refer to statistical anomalies, recurring patterns, and other data that supports a correlation between certain information and stock prices.

For any given investment, the passive manager is likely to rely more on the fundamental analysis of the company behind the security, such as the company’s long-term strategy, the quality of its products, or the company’s relationships with management when deciding whether to buy or sell. This type of analysis is largely intended to evaluate the investment’s long-term potential, which is the passive investor’s typical investment horizon.

The active manager, however, seeks to detect and exploit short-term trends in a security. This often involves quantitative and technical analyses, including ratio analysis, stock chart analysis, and other mathematical measures that have less to do with the nature of the company and more to do with trading patterns, news, and other market factors. An active manager’s investment horizon can be months, days, or even hours or minutes.

Active managers are more likely to use leverage than passive managers because they are as concerned with mitigating short-term risk as they are about exploiting short-term gains. This in turn introduces more risk into an active portfolio but may also provide higher returns.

Why It Matters:

In general, the constant analysis associated with active management involves more trading activity than passive management. Active trading thus also generally requires more time and education than passive management, and it is important to note that the higher trading commissions and capital gains taxes may translate to higher management fees and return requirements.

The idea of active management is not immune from controversy. Passive managers note that active managers frequently fail to match or beat their benchmarks, and they question the reliability of active managers’ methods for recognizing and predicting trends. But the most notable areas of disagreement between active and passive managers are theoretical rather than mechanical.

Many passive managers espouse the efficient market hypothesis, which says that stock prices are random and already reflect all available information. A cousin of this hypothesis, the random walk theory, also claims it is impossible to consistently outperform the market, particularly in the short term, because it is impossible to predict stock prices. 

Regardless, active management enjoys a large and loyal following among investors, and many active managers have posted returns well above market benchmarks. However, consistently providing above-average returns remains a big challenge.

No matter where they rest on the issue, most analysts encourage even the most passive investor to learn about and understand active management methods, stay current on their investments, and know how to read stock charts.

photo by ucumari

As we recover from the worst bear market since The Depression, many investors wonder how they will ever be able to start or continue contributing to their investments. The following article, taken from the Simple Dollar blog, outlines simple and realistic steps anyone can take no matter their age or financial circumstances.

Investing Isn’t Just for Rich People: Five Ways Anyone Can Reap the Rewards of Investing

Written by Trent at The Simple Dollar

Quite a few readers simply tune out when I mention investments. They don’t believe the topic applies to them at all. “How can I possibly worry about investing when I can barely put food on the table?” they’ll ask.

The answer is simple: virtually every single person has the resources with which to begin investing. It may seem impossible for some to believe, but it’s true.

If you make purchasing decisions in your home, you have all you need to begin investing. Choose some generic items instead of the brands you usually buy and start your investing with the dollars you save.

If you ever spend money on entertainment, you have all you need to begin investing. Instead of renting a DVD at the Redbox, stop by your library, check out a movie for free, and put aside that dollar you save. There are countless other little ways to shave just a little bit here and there without changing your lifestyle.

If you use electricity, you have all you need to begin investing. Air seal your home or put in a programmable thermostat and you’ll see a significant drop in your energy bill, with which you can invest.

It all starts with the littlest of choices.

Here are five simple steps anyone can take with that savings

1. Participate in your employer’s retirement plan. More than 90% of the employers in the United States offer a retirement plan. Many of those plans offer matching funds, in which the employer will make contributions to the plan if the employee does as well. Plus, this money goes in before taxes, meaning for every dollar you put in, it reduces your paycheck by substantially less than a dollar - and it also reduces your income tax at the end of the year. If you have a retirement plan at work and are choosing not to even consider using it, you’re choosing poverty.

2. Start an automatic savings plan. If you’ve found a way to cut your spending by even a quarter a day, you have enough to start. Set up an automatic savings plan and transfer whatever you’ve saved to a savings account each week or each month. Even $10 a month - about $0.30 a day - is a great way to start, as it will add up to $121 or so over the course of a year and continue to earn interest beyond that.

3. “Snowflake” into a savings account. If you discover useful one-time ways to save or to earn a little bit more money, don’t spend it frivolously on something you want in the short term. Instead, take that little amount - the $10 you found in the parking lot, the $7 you saved buying toilet paper in bulk - and put it right into your savings account. Even better, just start a jar for it, throw that snowflake right into the jar, then take it down to the bank when the jar is full.

4. Save windfalls instead of spending them. What about when something bigger and unexpected comes along? A relative dies, leaving you an unexpected sum. You get a settlement. You win a large cash raffle. Sure, feel free to celebrate with a little of that windfall, but instead of blowing through the whole thing like a snowblower through powder, put most of it into your savings.

5. As your savings grows, buy a CD - and then grow from there. Once you hit your bank’s minimums for purchasing a certificate of deposit, do so. This will earn you quite a bit more interest than you were earning in your savings account, but it will “lock up” your money for a while. That’s a good thing - since you’re not intending to spend it anyway, locking it up is just fine.

Congratulations, you’re an investor. When that CD matures and you couple it with your additional savings, you may have enough to start branching into other investments. Hold onto that money - when opportunity comes your way, you’ll have exactly what you need to jump on board.

All this takes is a dollar a day.

Visit The Simple Dollar to read the entire article.

photo by Philip Klinger

Third Quarter 2009 will be remembered as one of the most eventful periods in stock market history. One year has passed since the weekend that shook the foundations of Wall Street and the global financial system. Lehman Brothers collapsed, Merrill Lynch vanished as an independent entity, and AIG was taken over by the U.S. government. Almost two years have passed since the Dow Industrials hit its all time peak of 14,164.

Beyond the issues facing the global economy, there are many underlying positives that give cause for optimism looking forward.

The following article from The Simple Dollar discusses the stock market rebound and why we are optimistic.

Since mid-March, the S&P 500 is up almost 58% and the Dow Jones Industrial Average is up almost as much. If you opened your retirement savings at the end of the first quarter this year and looked at the numbers with a cringe, it’s likely that if you looked at the numbers right now, you’d feel significantly better.

Why the big rebound? To put it simply, the greater world finally realized that the only thing we had to fear was fear itself. The economy didn’t collapse. Instead, we just find ourselves in the middle of - and perhaps moving towards the later stages of - a rather strong recession.

Naturally, as the economy begins to slowly come out of a recession, the stock market goes gangbusters. Companies are beginning to reawaken and slowly increase production, a radically different picture than the massive cost cutting of the past year. Unemployment is somewhat stable - it might go up a little more, but it’s no longer on the rocket ship that it once was.

In short, we’re getting through this and we see sunlight at the end of the tunnel.

What does this mean for you and me, as small individual investors? Does this mean we should convert all of our investments into stocks and ride the rocket ship?

To put it simply, no, it doesn’t.

Hedging your long-term investments on what you think the stock market (or any investment market) is going to do in the short term is called market timing, and it’s never a good idea.

My philosophy is simple, and it’s one that was taught to me by many, many wise investment writers and investment books: unless you’re a day trader or spend a significant amount of time daily studying the stock market, you’re a long term investor, and long term investors have nothing to gain from trying to time the market.

Simply put, the vagaries and complexities and huge sums dealt with on the stock market each and every day, with so much insider information floating around and individuals playing all kinds of manipulative gains, plus the total uncertainty of day-to-day world events (if you recall, for example, 9/11 was wholly unexpected), makes it a very unsafe place for the typical person trying to save for retirement or for another long term goal. Instead, their reward is to simply look at the stock market as a long term place to put their money for a long term investment with a payoff date more than ten years down the road.

It’s all about your goals and your risk tolerance. It has nothing to do with what’s going on today, tomorrow, or next week.

Don’t let yourself be swayed by huge positive returns in the short term - or huge negative returns in the short term, either. Just stay the course with what you’re doing. If you find that the stress of such swings makes you nervous, redirect your future contributions to something with lower risk, like bonds.

Otherwise, just let things ride. Tomorrow might bring a huge unexpected event that we can’t see coming - or that some CEO is keeping under wraps for now. Given time, the stock market will correct itself from that, but over the short term, it’s basically little more than gambling unless you have the time and resources to devote yourself to truly careful study - or you’re investing with a small sliver of your portfolio that’s there solely to play around with.

When it comes to investing, there are many options. If you decide to invest in the stock market, you could do it yourself, talk to a financial planner or let a wealth manager manage your money.

Most people think wealth managers, financial planners, money managers, brokers, etc. are all the same. Part of the problem is that titles for financial sales reps are completely unregulated. This means that brokers, annuity salesmen and insurance agents are all free to call themselves advisors, financial consultants, financial planners or whatever they want.

Listen to this short video presented by wealth managers at Paragon Wealth Management about how to find the best financial advisor to manage your money.

If you watched television or listened to the radio six months ago in early March, it felt like the world might be coming to an end.  As we expected, the March lows were the market bottom.  Since then, the economy has moved back from the precipice and has gained 50%, retracing a good portion of the losses since last fall.

The following article from Yahoo! FINANCE outlines critical factors to keep in mind for post-recession investing.

Rules for Post-Recession Investing

by Rob Gordon and Jason Whitby

Despite the pundits’ pronouncements of green-shoots or signs that the economy is on the mend, many investors remain scared and understandably sensitive to the previously unimagined threats to capital market stability. In many cases, not only have they reduced their equity exposure to levels that will not help them beat inflation, many have pulled out of the publicly-traded markets entirely, and remain on the sidelines.

Return to Investing
If you are planning to retire on the assets you have accumulated or are accumulating, you need to get exposure to the equities markets and you need to do that sooner rather than later. Global equities markets work and you deserve your share of the positive long-term returns generated by them.

Generally, market declines cause panic, to quote a study by DALBAR - a leading developer of measurement systems for intangibles, such as customer behaviors, in the financial services industry. A 2003 study by DALBAR found “motivated by fear and greed, investors pour money into equity funds on market upswings and are quick to sell on downturns.” The report goes on to say that in the past 19 years, the average equity investor has earned 2.57% annually compared to 12.22% for the S&P 500 Index. This study clearly illustrates the “reactive” nature of today’s investors and just how much it costs them in return. It’s important to recognize how much emotions influence investing decisions most often to investors’ detriment.

Keys to Excellent Returns
As investors slowly emerge from their fear-induced stupor, it is important to review important principles which have provided excellent risk and inflation-adjusted returns over the last 50 or more years. With these foundational principles in place, the investor will be ready to participate in the global capital markets.

• Don’t Forget About Your Risk Tolerance
  Return statistics are perhaps the most quoted numbers in personal finance and investing. Quantitative measures of risk or volatility are undoubtedly the least quoted. When you look at your risk tolerance, consider three factors: capacity to take investment risk, need to take investment risk and desire to take investment risk. There are many questionnaires and other tools online that attempt to help investors measure these variables. Use them as a sanity check for your own measures given your previous investment experiences.
• Draft and Sign an Investment Policy Statement (IPS)
  Institutional investors, like pension funds and university endowments, have a document which defines the types of investments allowed in their portfolios. Good fiduciary investment managers have an IPS for each of their clients. An IPS takes all the relevant inputs and creates your own personal investment plan and diversified asset allocation. Essentially, the IPS helps you stick to the plan and tells you what to do when in doubt.
• Keep The Investment Decisions Simple
  With an IPS in hand, you now have specific marching orders to populate your portfolio with actual securities. Index mutual funds and exchange-traded funds (ETFs) reduce costs and provide broad exposure to specific asset classes.

These are foundational steps in the construction of your portfolio. The next question is, “How should you get back in?” This question essentially refers to the two primary options: put it all in at once or stage the money in over time. Which is best?

All at Once
For investors who have just experienced one of history’s most challenging economic periods, this option must seem the least interesting. However, in a world where market timing does not add additional return and where the expected returns are positive, it makes the most sense. Any averaging-in strategy will keep money out of a rising market. Nevertheless, averaging techniques remain very popular in the financial press and in practice. The reason for this is primarily because it feels good.

Averaging Into the Market Over Time
If you accept that you need exposure to the equity markets, there is a high probability that you will consider averaging into the market versus making a lump sum investment. Given that likelihood, what is the best way to average into the market? Quite simply, it depends on larger financial planning concerns like your need for cash and outstanding obligations. Beyond that, the options are innumerable: contribute a set amount; a set percentage of the remaining balance; a fixed dollar amount; a variable amount based on fluctuations in the market; a variable amount on a random schedule and on, and on. Here are a few important considerations as you consider your strategy:

• Formalize the plan by writing it down.
• Be careful of executing too many trades thereby incurring very high transaction costs. The research overwhelmingly states that the benefits are marginal at best and most likely are negative, so don’t erase the emotional benefit by piling on hundred or thousands of dollars of trading fees. No-transaction fee mutual funds can be beneficial in this area.
• Be careful of dollar-cost averaging up. If the market is rising, you will be buying higher and higher levels. Remember, the market has had, and we expect that it will continue to have, a positive bias as global economies continue to rise. If you divide your investment into too many pieces, you will end up investing the money over an ever longer period of time and therefore increasing the probability of dollar-cost averaging up.
• Try to divide the investments among the least correlated assets. For example if you are going to invest $10,000 into five different investments, try to pick U.S. large cap, international large cap, commodities, real estate and maybe fixed income.

Conclusion
No one really knows when it is “safe” to get back into the markets, or whether the market is experiencing a dead cat bounce, sucker rally, V-shaped recovery or W-shaped recovery. You will not receive an email, phone call or other advance notice saying, “Now is the time!” More than likely, when the news is rosy and you start feeling safe about getting back in, you will have done irreparable damage to your ability to keep pace with the market. Do your best to keep emotions out of your investments and jump in.

photo by businesspictures

photo by adam.dras

Over the past year investors have been affected by what some describe as “the perfect storm“.  On Wall Street the S&P was at 666 at its low, now it has rallied 58% from that point. For those that have weathered the storm it’s time to assess what lessons can be learned.

Below are excerpts from an article on CNNMoney.com by Penelope Wang.

The worst financial meltdown since the 1930s began, you’ll recall, with a bang. Early September 2008 the housing crash led to the federal government’s takeover of mortgage giants Fannie Mae and Freddie Mac — whose dividend-paying stocks were a cornerstone of many retirement portfolios.

The five following lessons from the Crash of ‘08 will help you strengthen your finances going forward — and should limit the damage in the next crisis, wherever and whenever it may come.

Lesson 1: Asset allocation still works — just don’t expect a guarantee.

In the wake of the crash, you may have concluded that asset allocation — the traditional strategy of diversifying among stocks, fixed income, and cash — is a bust. After all, your U.S. and foreign equities and all sorts of bonds lost money last year.

“The basic principles of asset allocation need to be revised,” says MIT finance professor Andrew Lo. He and other experts argue that since market volatility is rising, you must now own other assets — such as hedge-fund-like investments — in addition to stocks and bonds to manage risk. And you must be prepared to shift your mix tactically from time to time. “You need to be proactive and adjust as the market changes,” he says.

And if you look at the numbers, you’ll see that proper diversification did you considerable good in this meltdown.

Lesson 2: The world is riskier — and will stay that way.

Remember the Great Moderation? The phrase describes the recent quarter-century period when economic growth looked limitless and the long-term risk in stocks seemed to be disappearing. Between 2003 and 2007, for example, the Chicago Board Options Exchange Volatility Index (VIX) — a well-known gauge of how risky investors think the market is — hovered in the 10-15 range. That was down considerably from the index’s historical average of about 20.

Risk, of course, returned with a vengeance. Last October, at the height of the banking crisis, the VIX hit an all-time high of 80. Today the VIX has fallen back to around 25. The question is, should you brace yourself for more nerve-jangling spikes? Yes, according to many investment pros, including Yale finance Professor Roger Ibbotson, founder of Ibbotson Associates.

Revisit your investment mix to make sure you’re taking on an appropriate amount of risk in light of your financial goals and your tolerance for more market shocks.

Lesson 3: Real diversification is harder to achieve than it looks.

The best way to avoid too much exposure to any industry or asset — especially frothy ones — is to drill down in your portfolio to see what you actually own. Another idea: Stick to index funds. As noted, an S&P 500 or total stock market fund can’t keep you from getting caught up in the market’s momentum. But it’s always clear what index funds own, because they mirror well-known benchmarks for which information is readily available.

Of course, owning different stock funds — be they actively or passively managed — won’t adequately diversify you, since most equities are positively correlated. Translation: They tend to move in the same direction. And correlations among assets have been growing, as global markets are now intertwined.

Lesson 4: Recognizing a bubble is hard. Hedging against one is harder.

“To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong,” said then-Federal Reserve chairman Alan Greenspan in 1999. He should know how hard that is: He failed to detect two of history’s frothiest markets — in tech stocks and in housing.

The one sure hedge: a healthy dose of cash, an asset all but forgotten during the boom. Don’t ignore it now.

Lesson 5: You can’t time the market, but you can time yourself.

Every year that passes is another year you get closer to retirement. Over time this will require you to dial back the percentage of your nest egg that you hold in equities.

Then there are circumstances specific to you and your family. Sure, your allocation may have been right when you last rebalanced your portfolio. But what if your employer has run into financial problems recently and you fear losing your job? What if your spouse is coping with a medical emergency, or you’re now financially responsible for an aging parent?

If you’re dealing with these kinds of situations, it’s more important to preserve your principal and build up some additional cash reserves than to earn the highest possible returns. In that case there’s nothing wrong with shifting some of your equities into safer, more liquid investments.

This is not a repudiation of asset allocation, but a recognition that your life has changed. And it’s that kind of timing that will guide your portfolio safely through good times and bad.

written by Kyle Allen, financial advisor at Paragon Wealth Management

photo by spakattacks

What does the word “change” really mean?

In my opinion change is almost always a good thing.

We grow and become stronger when we experience changes whether they are good or bad.

Good changes are welcomed. For example, getting a better paying job with benefits or losing weight.

Bad changes aren’t always welcomed. They can blindside us and take us in directions we don’t want to go.

This is when we need to stop and take a look at the big picture.

Take the stock market for example. It changes regularly for both good and bad. We have experienced the ups and downs before and realize in the long-run things will work out even when it gets as bad as it has the past few months. That is hard to see if you are only looking in the short-term.

Similar to the stock market, football has both good and bad changes. I am a big football fan. This year’s Heisman Trophy race was very interesting. The three finanalists were all well qualified, and it was a close race. When they announced the winner of the coveted trophy, some interesting things happened. 

Tim Tebow, the Florida Gators’ quarterback, received the most first place votes. Yet, he still finished 3rd in the overall race. How could that be possible?

If you look at the race you’ll understand that the winner was well qualified, but Gator fans didn’t understand.

The same comparison could be made for the Texas Longhorns. They were left out of the national championship game. Longhorn fans had a hard time understanding this “change” in their plans.

We are all like the Gator and Longhorn fans when it comes to the stock market. We want so badly for things to go our way. When the market does well we cheer and think everything is great, but when something bad happens, our cheering stops, and we want to leave.

This is when we as football fans or investors must look to the future.

A big win for Texas in their bowl game can help their recruiting season and set them up for the future. Gator fans and Tim Tebow can focus on the future, which is winning the national championship in January. Both teams are only helping themselves by looking forward instead of backward.

Whenever we have change in our lives, we must look forward. By keeping our plans in focus we eliminate some of the emotional decisions that lead us even further in the direction we don’t want to go.

Like these football teams, we as investors also have some great opportunities ahead of us in the stock market.

While you might be a little anxious about new changes in the market, you can be optimistic in believing the next big changes will be full of opportunity by focusing on what we can do to position ourselves for the future.

Written by Dave Young, president of Paragon

photo by zoonabar

It has been a difficult year in the stock market for investors to say the least. Some investors have lost up to 60 percent of their portfolios or more. This bear market has been unlike all the others we’ve seen throughout history.

Below is a list of some of the most well-known investors. Consider their situation this year:

–Warren Buffet, considered an icon of wise investing, lost almost half the market value of his accounts between the middle of September and the middle of November.

–Bill Miller, one of the only managers to beat the S&P 500 for the past 15 consecutive calendar years through 2006, is down almost 60 percent year to date through December 3rd.

–Dan Fuss of Loomis Sayles is a renowned bond manager. Bonds are traditionally very conservative and are used to stabilize portfolios. His highly regarded bond fund is down an incredible 28 percent through December 5th. He said this is a “once in a 50-year” buying opportunity.

–Icon Funds, a value-based mutual fund manager, put out a report stating that stocks are 60 percent undervalued.

–High Yield bonds actual default rates are currently at 3.1 percent. However these bonds are currently priced as if the default rate was 17 percent.

Not to understate the obvious, but investment markets are difficult. They do whatever is necessary to cause the most grief to the largest number of people.

Usually when the markets are strong and moving up, everyone decides to get in and buy. This is not the best time to jump into the market unlike what people may think.

On the other hand, when markets are bad and going down, everyone sells and doesn’t want to go in. It is the opposite of what you would think, but that is usually a good time to invest.

Occasionally, you get market conditions that are horrible (like now) and investors are acting irrationally in extreme panic. At this point in the cycle, investors begin to sell at any price. This is the stage when investors begin effectively “giving away” their investment in order to get out of them.

Historically, this has been a phenomenal time to invest and buy new positions. Moving up from extreme lows is when fortunes have been made after previous bear markets.

I believe investors are positioning themselves in the wrong place at the wrong time once again. As evidence, simply look at the record amount of money that has been moving out of stocks and into cash, money markets, bank Cd’s, and fixed annuities. At a time when 30-year treasury bonds are paying a record low 3 percent yield, in a quest for safety, investors are running as fast as they can to lock in those low yields… at just the wrong time.

Looking forward over the next three to five years investors have a choice:

–Invest in money market funds; bank Cd’s, fixed annuities or treasury bonds. These will guarantee returns in the 2 to 4 percent range. Your money is locked up at historically low interest rates for 3 to 7 years with significant surrender charges if you change your mind.

–Invest in a well diversified, strategic portfolio made up of beaten down bonds, stocks and real estate. Our portfolios are currently positioned to capitalize on areas of the market that historically recover the fastest (visit our website, Paragon Wealth Management, to see examples of recommended portfolios).

This panic has pushed stocks down to the same levels they were 11 years ago. We won’t know until after the bear market has ended that it is over, but we do know that returns after previous bear markets have been exceptional.

Feel free to leave comments or call us at 801-375-2500.

Written by Nathan White, CFA

photo by caspermoller

“Tread carefully” is the mantra for this market because one day you are tempted to sell everything and run for the hills, and the next day you can’t believe what a great buying opportunity it is! In this environment it is best to identify quality assets, let the price come to you, and do it in small increments. Placing a large bet can lead to quick insolvency, and many are tempted to put too much capital at risk. On the other hand if you don’t buy anything as the market goes down you are also throwing away a tremendous opportunity.

These are truly amazing times. There is so much irony and doom and gloom, it can make your head spin. The smart investors are buying. For example, Warren Buffet with his smart savvy hedge funds, and I can’t believe I am going to say this, the government!

There are so many quality assets on sale, but the irony is when everyone is panicking even those assets continue to fall. Smart investors, because they have never overextended themselves during boom times, are able to take advantage of these deals and wait out the short-term volatility. That is the irony of economic busts, deals abound but the majority of investors don’t have the capital to take advantage of it!

Consider real estate. Now is the time to buy. As a buyer you can negotiate some unbelievable deals, but only if you can get a loan, which is almost impossible for anyone right now. Unless you have the cash on hand, it is nearly impossible to take advantage of the situation.

The same is true in the capital markets right now. There are great deals on quality assets, but no one can buy unless they have cash because banks aren’t lending. That is why you only see the likes of Buffet, certain hedge funds, and the government being able to buy assets in the current environment.

Over the last three or four days, I’ve received a bunch of emails from readers asking me why I’m not talking breathlessly about the chaos at Freddie Mac, Fannie Mae, and IndyMac. I’ve read dozens of long explanations of why this is disastrous and why it’s the worst thing people have ever seen, and I’ve read many, many people shouting that they should completely get out of all investments right now and put their cash in a little green box buried in their back yard (or some similar crazy scheme).

Here’s my take: I think there’s almost nothing to worry about, and if you’re actively selling any broad investments right now, you’re actually making a giant mistake.

Here are five reasons why you shouldn’t be panicking right now.

One: Panics happen every few years

Right now, we’re having panics in the banking and housing sectors. A few years ago, corporate accounting was destroying everything. Remember the tech sector collapse of half a decade ago? The savings and loan failures before that?

These booms and busts happen for one reason and one reason alone: most investors are sheep. They follow whatever has been hot lately, and they run away whenever there’s a bad sign. These processes are rarely rational - in the 1630s, people bet their entire life fortunes on tulips.

It took only a glance at housing prices over the last decade or so to see that there was a big bubble going on. This bubble turned out to be mixed in with the banking industry which was funding this bubble. Now we’re seeing that bubble collapse. In a few years, when all of those ARMs adjust, people will be running around yelling “PANIC” about some other sector.

Two: The talking heads shouting “PANIC!” make money from “PANIC!”

If you run out right now and sell your stock, guess who makes money? That’s right, brokers and fund managers. These people want churn. They want you to buy and sell so they can make profit on the buying and the selling. The people who are on CNBC and TheStreet.com shouting “PANIC!”

If I was a broker or an investment manager and I knew that if I shouted “PANIC!” I could make myself a mint, I’d be tempted to shout “PANIC!” I probably wouldn’t do that because it would actually not help my clients, but there are other philosophies out there. Some believe that alerting their clients to “PANIC!” can help them avoid losses. Others could actually care less about the clients and just want to profit.

There’s big money to be made in “PANIC!”

Three: Stocks are not short term investments

Unless you’re day trading (and thus making an effective career out of very short term movements), stock investments should never be short term investments. The stock market is extremely volatile over the short term - annual losses of 20% or more in stock investments are somewhat regular occurrences.

So why invest in stocks? Over the long run, the gains exceed the losses over the stock market as a whole. Here’s a quote from David Swenson, the author of the excellent book Unconventional Success:

To the extent that history provides a guide, the long-term returns for stocks encourage investors to own stocks. Jeremy Siegel’s two hundred years of data show U.S. stocks earning 8.3 percent per annum, while Roger Ibbotson’s seventy-eight years of data show stocks earning 10.4 percent per annum. No other asset class possesses such an impressive record of long-term performance.

The stock market returns very well on average. The only problem is that it’s an average of some very nice positive numbers and some very painful negative numbers - that’s the nature of an open market.

Why should one believe the stock market is going to go up in value? THIS IS THE END!
Stocks will continue to go up in value over the long term for one simple reason: worker productivity. Companies over time will earn more money per employee because each employee is able to produce more value. As long as humans are innovative creatures, coming up with new technologies and ideas, then companies that implement those ideas will increase in value.

Four: Down markets are never a time to sell

At some point, the stock market will return to its previous level - there has never been a twenty year period of loss in the overall stock market.

Since the stock market is down this year, and we believe that the stock market will eventually match the previous high, now is not the time to sell. Now is the time to buy.

Let’s look at it visually using the S&P 500 from about 2000 to about 2007:

Obviously, it’s great to sell at the top - you’ll make a killing. The problem is that one never knows exactly where the top is. The market will start to drift downward and many people will think it a normal fluctuation. After a while, the talking heads on CNBC and other financial papers will begin to notice that it’s going downward and start shouting “BEAR! BEAR!” to get people to “SELL! SELL!” so they can make a profit on transaction costs. Most people still don’t move right away - it takes a little while for the “panic” to build.

Eventually (as marked above), it becomes conventional wisdom that things are disastrous - that’s where we’re at now, well into the down trend. Now, if we believe that at some point in the future things will eventually return to their original level and we can clearly see that things are way down from their original level … why would you sell? Instead, it looks like a time to buy to me.

Five: If this event is making you worried about losing everything, then you’re not appropriately diversified.

My last point is for those people who have a ton of money in the damaged sectors right now. If you’re afraid that you’re going to be losing “everything” in this down situation, then the problem isn’t the stock market. It’s your investment strategy.

Diversification is what saves you from a bubble blowing up in a particular sector. Many advisors suggest having 5% of your total assets or less in any one sector simply to a void this. That way, even if one sector loses everything, you lose at most 5% of your money - a 20% drop in one sector means only an overall 1% loss for you.

In other words, don’t put all of your eggs in one basket and you won’t panic quite so much when a basket falls to the floor.

Throughout all of this tumult, I’ve lost a fair amount of money in my retirement account. Right now, I’m contributing significantly more money per week than I was three months ago. And I feel fine. I hope you do, too.