Generation Y Investor » Commentary

Composure: The Key To Risk Tolerance

Stephen Kline — Tue, 03 Nov 2009 01:42:13 +0000

I’ve already mentioned in a few posts that it’s vital to have an asset allocation that matches your time horizon and risk tolerance. Figuring out your time horizon is simple enough, but things get a little more difficult when it comes to assessing your risk tolerance. Some advisors will point you to a standard questionnaire that is suppose to measure your ability (or inability) to handle risk. The problem with these quizzes is that they try to measure an individual’s emotional response to varying scenarios with intellectual questions. How you respond to a question about a hypothetical portfolio loss of 50% is probably quite different then how you actually responded last year when the markets were plummeting day after day.

The following article examines how the best gauge of risk tolerance is actually the level of composure one has when something unexpected occurs: Tune In, Chill Out

“People say they’re willing to lose 20%, then they lose 2% and they panic. A more meaningful indicator is composure — your short-term, emotional reactions to unpredictable and uncertain events, such as the market’s ugly sell-off on Friday. How will you handle yourself in the heat of battle? Far too many investors discovered in 2008 and early this year that losing money in quick, sharp cuts was more than they could bear. Those thoughtful risk-tolerance quizzes got shredded when stocks went into free fall. Panicked investors sold what they could, often at any price.”

Some comments on Buffett’s, “Be fearful when others are greedy, and be greedy when others are fearful” quote…

“There’s a good reason why there aren’t more Buffetts among us: Buffett is not only more risk tolerant, he’s more composed. When the shooting starts and money is on the line, Buffett comes across as cool and unemotional. And he fires back. Think Clint Eastwood with a calculator.”

On how you can increase your composure…

“First, commit to an investment policy with a long-term or big-picture focus that recognizes there will be major pitfalls along the way. This is your battle plan. The most effective policy statement lays out objectives. These include return goals — how much money you’d like to make — and the potential obstacles to that happy outcome. In this way, you get a sense of how emotions dictate your actions.”

“Second, divide your wealth into different mental accounts with varying degrees of risk. Investors should not be diversifying asset classes; they should be diversifying risk.”

Senate Plans to Extend, Then Phase Out Homebuyer Credit

Stephen Kline — Tue, 27 Oct 2009 00:06:06 +0000

Leaders in the Senate are currently working to extend and then systematically phase out the $8,000 first-time homebuyer credit. The credit which was originally destined to expire on November 30th, has helped to boost low-end home sales across the country. Under the proposed extension, buyers closing on their homes prior to April 1st would receive the full $8,000 tax credit. The value of the tax credit would then drop $2,000 each quarter until it expires at the end of next year.

Whether or not this extension gets passed, it will be interesting to see how the housing market acts over the next 6 months. One could argue that even if the credit is extended, it has already used up the majority of its impact. If you think about it, first-time homebuyers who were interested in taking advantage of the credit have most likely done so by now. So the benefits of extending it are probably quite minimal. I’ll be looking out for some deterioration in home sales / prices in the upcoming months. As I’ve stated previously, credits like this one and cash for clunkers boost current demand by pulling future demand forward.

If we get through the next few months without a significant lull in housing activity, it would be a very positive signal that we’re seeing a true recovery; as opposed to a temporary improvement caused by government intervention.

Where do you see the housing market going in 2010?

Art Cashin… The Man, The Myth, The Legend

Stephen Kline — Sun, 25 Oct 2009 14:47:23 +0000

You’re probably familiar with Arthur Cashin if you watch CNBC regularly. For those unfamiliar, Art is the head of floor operations for UBS and a daily commentator on CNBC. Art is usually on in the morning and provides us with his market insights that are backed by 50 years of experience. Say what you will about other CNBC commentators, but Art Cashin is the real deal. He’s worked through every financial crisis in the post war period and lived to tell about it. He’s also seen bubbles in everything from junk bonds to tech stocks. His words of wisdom are definitely worth paying attention to.

That’s why today I’m bringing you some highlights from a recent interview he conducted with Bob Pisani. The interview is lengthy, but it’s available in both print and video. It’s worth reading or watching the whole session if you’re interested and have the time. Here are some highlights: A Conversation With Art Cashin, UBS

Here they discuss the prospects for inflation…

PISANI: So where do we go here? The feds have flooded the markets with liquidity and yet, it seems to be pooling into areas like banks where it’s not doing an awful lot of good for the moment. At some point, something’s gotta happen though, right?

CASHIN: Yeah. But here’s where it gets dangerous. The good news out of the bad news is because that money has no velocity, we have no inflation. And the Fed talks about taking away the punchbowl. Now once that money gets velocity, once it gets lent or spent, then you can have inflationary pressures build.

If I fly over Bob Pisani’s house and I drop a trillion dollars in green pictures of dead presidents down on his lawn and he’s so nervous he picks it up and puts it in his garage, that’s no inflation. Nothing’s really happened. But when he starts to spend it or if he starts to lend it, then money’s got what they call velocity. And inflation could explode suddenly. No sign of it now, no sign of a great fear, although there’s a new debate in the fed, but no sign of it now.

On the recent stock market rally…

PISANI: Why has the stock market done so much better than you thought it would?

CASHIN: When you get phases like this…if you remember the dot com bubble, you had to be in. You went to cocktail party. We talk about fear and greed and supposedly the fear of losing money. Let me tell you, in doing this nearly 50 years, one of the most powerful fears and motivators of people in Wall Street is the fear of being thought stupid.

When you go to that cocktail party and they say, ‘Hey Bob, you playin’ this rally? You’re really long?’ [You think] ‘No, I’m kind of skeptical about it’ and you think you’re gonna be the butt of jokes. People actually risk money not to be thought stupid.

On the causes of the credit crisis…

PISANI: Would you agree there were many sources of this crisis?

CASHIN: Oh, absolutely. And not the least of which was no defined responsibility in the securitization. If I put together a package and I sold it to you, that was your problem. So I didn’t do the due diligence to make sure that this guy could pay for that mortgage or could pay for whatever. So that also was a key part.

But the Fed, not to give them a big enough excuse, but they, like all of us, have certain things they watch. And this time they got stuck with the dog that didn’t bark. Greenspan was looking for signs of inflation. That’s when he’d know when to rein things in. That’s when he’d know to come off the very low interest rates that he had. But he didn’t get it. And he kind of misread the signal. ‘Gee, why am I not getting inflation here?’

It’s productivity. People are producing much better. The point that he missed was inflation was overseas. We had people working for lower wages, no demand for higher wages. We exported the problem. The dog never barked because everything occurred so far away. And that’s why they never raised rates. And that’s why it left things wide open to the kind of bubble that we had.

Don’t Ignore Risk

Stephen Kline — Fri, 23 Oct 2009 21:19:30 +0000

I’m always reading articles and listening to “financial gurus” who tell individuals ***with extra money*** not to pay down low interest rate debt. Instead, the expert advises paying the minimum on mortgages and student loans so the difference can be invested in stocks. In theory, this will give the individual greater returns, as the stock markets historical average of 10% trumps prepaying the lower interest debt. On the surface this advice sounds logical, and perhaps even financially sophisticated; however, proponents of this method are completely ignoring risk.

By taking extra money and investing it in the stock market, one is forgoing a risk-free return on their money in favor of an investment that’s inherently risky. This isn’t necessarily a bad thing, provided that the investor understands that the potential for greater returns comes at the expense of increased risk to their hard-earned capital. Only by dialing up the risk do we up the potential for higher returns. This is the reason comparing the long-term return of stocks to the risk-free return of prepaying a loan is unwise. Instead, I suggest comparing the loan prepayment return to that of another risk-free investment such as a treasury bond or CD. When you make an apples to apples comparison you’ll see that prepaying the loan isn’t such a bad choice.

Remember, most of the truly disastrous financial mishaps in history were caused as a direct result of ignoring risk. If risk was accounted for properly on Wall Street and Washington we wouldn’t be in our current situation. Always be sure that you understand the risks before making a financial decision.

***This post is referring to individuals who are already fulfilling their financial obligations (i.e.: they have no high-interest debt, have an emergency fund, and are already contributing to retirement accounts.) Thus they are asking what to do with additional free cash from earnings or perhaps even a windfall such as an inheritance***

How Not To Invest For Retirement

Stephen Kline — Thu, 22 Oct 2009 23:00:55 +0000

Successful investing isn’t easy. In addition to having a basic level of financial competency, successful investors must also exhibit a high degree of discipline and emotional control. Without all three of these characteristics an investor’s returns are likely to disappoint. After all, one can be as financially astute as Warren Buffett or George Soros; however, if he or she lacks the emotional control and poise to go against the herd then they’ll never have great success.

As a case study, I bring you the story of The Simkin family: Getting back on the retirement horse

“Jason and Patty Simkins, both 40, have saved next to nothing for retirement in the past year. They were rattled by the rocky market, which caused the value of their portfolio to tumble 40% at its low point.”

“So when Jason switched jobs last fall… he neglected his new 401(k). Saying, “I didn’t want to throw money into it if it was just going to be lost.”

“But now they’re disappointed to have missed out on additional gains from the market’s rebound.”

“Realizing they need to catch up on retirement (and, with two kids, save for college), they’re ready to put a toe back in the water.”

I think all of us can relate to The Simkin’s story. Last year as the markets were being pummeled day after day, even the most iron-willed of us surely contemplated exiting the markets, or at the very least stopping our ongoing contributions. The problem with this, as the Simkins indicated, is that they’ve consequently missed out on the juicy 60% returns the market has put in since bottoming. Now, only after this enormous rally, are they looking to restart their retirement plan contributions. This my friends is not the modus operandi of successful investors.

Instead, I offer the following plan to passive retirement investors…

First, familiarize yourself with the concept of asset allocation. Once familiarized, develop a diversified asset allocation that coincides with your risk tolerance and time horizon. (note: you’re probably less risk tolerant than you think)

Second, contribute to your retirement accounts using a dollar-cost averaging plan. This entails investing a fixed amount of money on a monthly or per paycheck basis. These contributions should match the asset allocation you created in step one.

Third, every quarter check up on your portfolio and revisit your asset allocation. Are your current holdings in-line with your plan? If not, rebalance your portfolio so it isn’t too aggressive or conservative.

Finally, once every year you need to reexamine your risk tolerance and time horizon. If they’ve changed, chances are you need to modify your asset allocation.

There you have it. Following these simple steps will give you a disciplined financial plan that you can implement in an emotionless manner. Give it a try and your odds of being a successful long-term investor are high.

Buffett’s Thoughts On Wall Street Pay

Stephen Kline — Wed, 21 Oct 2009 00:57:24 +0000

A year has past since the credit crisis wreaked havoc on the world’s financial system. During that year of reckoning, firms on Wall Street that were lucky enough to survive (or should I say get bailed out) reduced annual bonuses by nearly 45% from the prior year.

Fast forward one year and my have things changed. Now, a mere 13 months since facing death, these same firms are set to payout a near record $26 billion in year end bonuses. Many feel this is outrageous…some argue it’s not. I however am going to defer to my man Warren Buffett who says: Wall Street Pay Must Have “Downside”

“You have to put in something where there is downside to people who really mess up large institutions.”

“Too many people have walked away from the troubles they have created for society, not just for their own institution, and they have walked away rich.”

“What you have to change in Wall Street, is you have to make sure that in addition to carrots, there are sticks.”

“And it can’t be a one-way street where they are making ungodly amounts of money when things are good and then they move on to someplace else for a while when things are bad.”

I believe that Buffett has a reasonable take on Wall Street pay. As a capitalist, I have no problems with large salaries and multi-million dollar bonuses. However, I do have a problem when such pay packages are doled out by companies who took a taxpayer funded bailout. There has to be a better way of insuring that failure goes unrewarded and that those who act unethically get punished.

October 2009 Is Eerily Similar To October 2007

Stephen Kline — Mon, 19 Oct 2009 23:19:55 +0000

Those who don’t learn from history are doomed to repeat it, that’s how the old cliché goes. As the major stock indexes continue their march higher, some find that these iconic words of caution are particularly relevant in our current environment. The argument can be made that the fundamentals unfolding presently are uncannily similar to those of October 2007 when the market topped out and went on to plunge 50%.

From Minyanville: October 2007 Shows Us How This Rally Ends

“I reexamined the bubble peak of October 2007 and “surprise, surprise” — it’s déjà vu all over again. If you recall, in October 2007 the US dollar was tanking and oil was ripping higher. The talk was about how the dollar had nowhere to go but down.

Sound familiar? It should because the dollar is tanking again and the talk is how the whole world is turning away from the dollar as the world’s reserve currency. Gold today is also making new highs just like it was back in October 2007, on the back of a weaker dollar.

The stock market in October 2007 was making new highs as the dollar tanked. It feels like déjà vu to me because today we have the dollar tanking, oil and gold breaking out, and stocks making new yearly highs.”

I posted these thoughts not to scare anyone, but to remind us not to be complacent. It’s perfectly fine to enjoy the fruits of the recent rally; however, with each upward tick of the Dow and S&P 500, I see more and more people who seem to be forgetting the lessons 08/09 should have instilled in them. Remember to stay humble… for if you don’t, the market will do it for you.

Gen Y Investors View Investing As Fun

Stephen Kline — Thu, 15 Oct 2009 23:32:13 +0000

Apparently the majority of 20-something investors view the process of investing as fun. This is quite an interesting finding seeing as though we just lived through one of the biggest market busts in history.

Kimberly Palmer of the U.S. News & World Report writes: Gen Y: Investing Is Fun, Not Scary

“Online brokerage company Scottrade is out with some surprising findings about 20-something investors: It turns out they consider investing an enjoyable activity. Unlike older generations, they’re more likely to manage their money on their own and to feel confident that they will recover their losses from the recession. In fact, one in three of those surveyed said they invest because it’s fun, an increase from about one in four last year.”

“Other experts and surveys have suggested that the financial crisis has left Generation Y permanently scarred — untrusting of banks and financial institutions, and less likely to invest in the stock market as a result. But this survey suggests 20-somethings aren’t all retreating to their apartments to stuff bills in dark places. At least a significant portion of them are jumping into the stock market, which, given historical patterns about returns following market dips, is probably a good idea.”

I guess the caveat here is that the survey consisted of Gen Yers who are currently investors. As opposed to a random sampling of Generation Y in general. I think if you were to sample a number of random 20-somethings you would definitely find a more cautious stance towards investing.

Nevertheless, it’s great to see that a portion of individuals our age have taken matters into their own hands and started investing for themselves. It’s always been my opinion that people are better off taking the time to learn about investing in order to handle their own financial affairs, rather than handing the matter off to a financial advisor. I’ve said it before, but no one cares as much about your money than you. By starting early, young investors can learn from their mistakes and overcome them so they don’t hamper future financial goals such as retirement.

Do you think of investing as an enjoyable activity? If so, why?

Is Gen Y’s Financial Situation Really That Bad?

Stephen Kline — Thu, 15 Oct 2009 00:49:22 +0000

SmartMoney published an article today about Gen Y’s financial condition: For young adults, a decade lost?

“A new survey conducted for the AFL-CIO suggests many American workers under 35 can’t manage the basic financial building blocks of an adult life. The union calls the past 10 years a “lost decade” for these young people, during which many fell short on getting their own places, finding stable jobs and saving money for emergencies.”

The article paints a particularly bleak picture of the current financial status of our generation, highlighting a lack of high paying jobs and an inability to save money for the future.

“About 31% of survey respondents said they made enough money to pay their bills and set some money aside, but 70% said they did not have enough money saved to cover two months’ worth of living expenses. Parents of these young workers know how far they are from making it on their own; one-third are living with their folks.”

The question is… do we really have it that bad financially? I realize it’s quite tough out there right now because of the recession, but I’d like to think that things aren’t as bad as the author makes it out to be. Perhaps our perception of how we’re really doing is a bit skewed?

We grew up in one of the most prosperous times in history, and we’re use to a lifestyle that entails consuming new and exciting products. We view our own situations and compare them to those of our parents and the people we see on television. Unfortunately, these aren’t realistic comparisons for the average 20-something to be making. The financial positions of our parents have been battled for and earned over their decades in the workforce; while, the lifestyles of those on television are largely fictional and exaggerated. We’re doing ourselves a disservice to expect similar lifestyles.

Instead, tune out the fiction you see on TV., and ask your parents about how they lived when they were in their 20’s. After hearing their tales of small, roach infested apartments and struggling to pay bills, maybe we’ll see that our situation isn’t so unique after all. In fact, even with the headwinds we face, many of us do have the power to save and invest for our future. You may have to start off small, but getting the ball moving in your favor at such a young age is worth a bit of sacrifice. As the column illustrates…

“A person who’s able to save, say, $2,000 a year from age 22 to 30 will retire with more money than a person who saves the same amount over a longer period from age 30 to 60, says Thomas Holland, a partner at wealth advisory firm Global Vision Advisors.”

Is This The Biggest Sucker Rally?

Stephen Kline — Thu, 17 Sep 2009 11:36:54 +0000

Here’s some intriguing conversation on whether the recent stock gains are a suckers rally…