Beware of Gotchas in Growth & Guaranteed Annuities

June 7, 2010 — Sam H. Fawaz

I’ve had several prospects ask about growth and guaranteed annuities being promoted by many in the brokerage and insurance industry.  If there’s one thing you can count on in the financial industry, it’s that the industry will always come up with products that capitalize on fear amongst investors or the frenzy in a particular market segment.  Today, many investors and pre-retirees are discouraged by increased market volatility and low or negative rates of return of late.  The financial and insurance companies respond with products to try and address these concerns and they certainly do sound attractive.

I’ve analyzed and read more annuity prospectuses in my career than I care to admit, and I have yet to find one that delivers on its promise without numerous “gotchas.”  As with any financial product, there is never a free lunch. From hidden and high fees, low guaranteed returns, vague and complicated guarantees and draconian penalty and surrender provisions, the majority of annuities, variable and otherwise, simply don’t make much financial sense.  Annuity and life insurance salesmen, brokers and “financial advisors” always tout the great benefits their products have, but rarely delve into the details of the contract or the downsides.

Remember, when you sign up for any insurance or annuity product that has a penalty or surrender charge, after the right of rescission period has passed (usually three days after signing), the penalty or surrender charge you sign up for is 100% payable whether you keep the product for the requisite term (via higher expenses over 7-17 years) or pay it outright and get out of the contract early.  So waiting until the penalty or surrender period ends does not save you from paying the penalty or surrender charges.  In fact, you’ll lose more by waiting since most contracts have sub-par investment choices with higher annual expenses.

If you’re considering an annuity, keep the following points in mind:

  1. Ask yourself what you intend to use the annuity payout for and when you think you’ll need it.  It is rare that you can’t find an investment that more effectively meets your needs. If you want secure or risk-free retirement income, look at the annuity distribution options and income stream.  In most cases, you would be better off putting your money in bank certificates of deposit and simply liquidate principal as needed.  This way, your heirs get the remaining principal at death rather than the insurance company.
  2. Many people are swayed by the guaranteed current rates on deferred annuities until they realize that the guaranteed rate changes annually, is usually lower than market rates and that the annuity has a 7-17 year unavoidable surrender charge or penalties.
  3. If the guarantee is really important to you, keep in mind that the guarantor is an insurance company much like AIG. How thoroughly have you researched the financial health of the underwriter?
  4. If you are intent on buying an annuity, focus on a fixed and immediate annuity.  Find the best one with the lowest internal expenses, shortest surrender term, and best guarantees.  A fee-only planner can help you choose the best one that has no commissions or hidden compensation to sway his recommendation.
  5. Focus on how relevant the annuity is to your financial goals and whether it is the best solution to the issue you are trying to address.  This helps you move the focus from the product and toward a focus on your personal financial goals, which is what it’s all about.
  6. Remember that an annuity is not an all or nothing decision. You can commit just a portion (10-50%) of your portfolio to an annuity to hedge and diversify your holdings.

I hope this update helps you understand a little more of what goes on with growth and guaranteed income annuities.   My thanks to fellow NAPFA member Bedda D’Angelo for her tips on keeping annuities in perspective.  If you have any questions or comments, please don’t hesitate to post them here.  If you or someone in your family or circle of friends is considering hiring a financial planner, please visit our website or consider a complimentary financial roadmap.

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Market Update for May 20 2010

May 20, 2010 — Sam H. Fawaz

Today marked the 9th day out of the last twelve where the market sold off in a clear message that world governments need to get their acts together and control their fiscal, spending and regulatory policies.  With the Euro currency at historic lows, demonstrations in Greece, an environmental offshore oil catastrophe, German bans on naked short selling, higher than expected weekly job claims, and financial regulatory reform debates going on, we’ve had the perfect storm to extend this market correction.  Stock markets don’t like uncertainty and wishy-washy policy making, so they express their dismay by selling off risky assets.  As of today, the major indices have given back all their 2010 year-to-date gains and then some.  Nonetheless, the long term stock market uptrend remains intact, though as I’ve indicated before (May 6), we’re in for some bumpy times in the market for the summer.

I wish I could say that my crystal ball knew when this short-term pain to the downside would be over.  However, all technical indications is that this move downward is a bit overdone, though admittedly the move to the upside was also overdone in the short-term.  I believe that we’ll see a short or intermediate-term bounce in the next couple of days as value investors and bargain hunters swarm the markets.   We will do the same as the waters calm down.

Indications from Washington are that we may get a vote on the financial reform bill (being debated) tonight and perhaps remove some of the uncertainty in the markets.  I’m not sure what the Obama Administration will tackle next (immigration reform, tax reform, ban on sovereign bailouts, take your pick), but you can bet that it will also rattle the markets when it gets underway.  The European Union appears to be working on a few measures to further restore confidence to the markets and those measures may come to light over the weekend or early next week.  Longer term, we will have to contend with overseas currency and economic weakness, further sovereign debt issues, huge budget deficits, and a stubbornly high unemployment rate.  For the time being though, we have an improving fundamental economic picture, ultra low interest rates, excellent corporate earnings, and plenty of unspent stimulus to keep the market uptrend going for awhile.

Because I felt that it was more likely than not that the majority of the short-term move downward was over today, I decided to lift about 50% of the contra-position hedge that I held on client accounts.  This will allow portfolios to more fully benefit when the uptrend resumes. Leaving 50% of the position “on” allows me to be at least half-right in case there is more downside to come.  This is just prudent hedging.  Should the markets show signs of continuing their downward trend, then it’s just as easy to put the position back on and perhaps add to it.  As of this moment, I see no negative longer term indicators in the markets that tell me that I should be liquidating equity positions and moving to a higher cash position.

Please check out my January-February 2010 Money Magazine Portfolio Makeover-Can I retire Early? http://bit.ly/5aGwIO

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Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.

My no-nonsense no-spam policy: If you’d prefer not to receive future updates, just reply and let me know by typing “unsubscribe” in the subject (please don’t hit the spam button-it just puts me on a universal spammer’s list which is tough to get off of.)I’ll take you off my list immediately and permanently.  I will never sell, share, rent or give away your e-mail address to anyone.  Period.

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Market Update-Week Ended March 27, 2010

March 28, 2010 — Sam H. Fawaz

The stock markets have been enjoying several weeks of continued gains after a market correction that ended around mid-February.  Corporate earnings have been stellar, mostly on a net income basis, but many have also enjoyed sales growth as well, albeit from a low (2009) base.

We’ve had stock market indices that have run up to 18 month highs and we came within 100 points of 11,000 on the Dow Jones Industrial Average this week.  Down days in the market have been only very mildly down as investors enjoy more confidence that the economy is slowly improving and that the possibility of a double-dip recession this year is nil.  This has all happened despite bad news from Europe relating to Greece’s possible default on their sovereign debt, Fitch’s downgrade of Portugal’s sovereign debt, passage of “Obama Care”, poor sales of U.S. Treasury bills, record federal deficits, and still dismal (though improving) unemployment figures.  The news that a South Korean Navy ship experienced an explosion yesterday barely made the markets blink.  High inflation is currently nowhere in sight, though it’s a certainty that it will be here before we know it.

With any long string of stock market gains (with only minor down days) comes the inevitable correction in the market. During the latter part of this week, days that were up for the most part suffered downside reversals and profit-taking towards the end of the day.  This could be a sign of another correction coming (perhaps in the range of 5-10%), portfolio managers adjusting their quarter-end books, or just traders preparing for a week or so off for the Easter holiday.  Dwindling stock market volume certainly would indicate that many are planning some time off.  A correction would be healthy for the market, and would give those still sitting on the sidelines or mostly invested in bonds an opportunity to jump back into the stock market at a lower price.  Stories are abound about $3 trillion still on the sidelines in money market accounts earning less than 1-2% interest or invested in low-risk short-term bond funds.  I personally still believe that we will enjoy returns this year in the low to mid-teens while gross domestic product (GDP) growth will be in the 3-4% range, which is historically low.

Next Friday April 2nd, while the stock markets are closed (the bond markets are open), unemployment figures for March 2010 will be reported and they’re expected to show actual job growth for the first time since early to mid-2008.  The boost will be partially attributable to the hiring of census workers, though employers, who are enjoying record productivity levels, have been increasingly hiring temporary workers and will have no choice but to make permanent hires soon, as the existing workforce grows exhausted from one person doing the work previously done by two people.  Even General Motors announced this week that it is recalling 700 workers to its plant in Ontario Canada and plans to hire 60-70 new workers.  The employment trend is definitely in the up direction, but the speed is still at a snail’s pace.  For the unemployed, the pace is understandably far too slow.

For those taking some time off for spring break and the Easter holiday week (post or pre), I hope you enjoy your time off and have good weather wherever you go.   To all who have to work, enjoy a great holiday nonetheless.

I welcome your comments and feedback. If you have any questions, please feel free to get in touch with me and be sure to share this post with your friends and colleagues.  And please be sure to let them know about me if you think that they might benefit from my services.  As a CFP® and NAPFA registered investment advisor, we have a fiduciary responsibility to always put your interest ahead of ours and avoid conflicts of interest.  Most brokers and advisors cannot say this nor do they adhere to this very high standard of care.

A summary of the week’s market results :

Market Update For Week Ending 3/26/2010

Index Close Net Change % Change YTD YTD %
DJIA 10,850.36 +108.38 1.01 +422.31 4.05
NASDAQ 2,395.13 +20.72 0.87 +125.98 5.55
S&P500 1,166.59 +6.69 0.58 +51.49 4.62
Russell 2000 678.97 +5.08 0.75 +53.58 8.57
International 1,572.26 +0.17 0.01 -8.53 -0.54
10-year bond 3.86% +0.17% +0.05%
30-year T-bond 4.75% +0.17% +0.06%

International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.

Posted in General, investing, markets. Tags: , , . Leave a Comment »

Portfolio Makeover: Can I Retire Early?

January 17, 2010 — Sam H. Fawaz

Money Magazine recently approached me to perform an investment portfolio makeover for a couple in the Metro Detroit area, Kevin and Janice Ford.  The article, written by Money Magazine Senior Writer Donna Rosato, was published in the January-February 2010 double-issue.  The Roasato’s met with me recently and we put together a financial plan and asset allocation.  Here’s an intro to the article and a link to the full one:

(Money Magazine) — Kevin Ford has worked as an engineer in the Detroit auto industry for more than three decades – currently for the car company that best suits his name. His wife, Janice, is also a veteran of the field, a fellow engineer who even ran her own dealership for a few years before leaving the industry in 2005 to do part-time business development consulting.

Kevin hoped to follow her into retirement at age 55, and two years ago that seemed doable. The family had nearly $1 million saved, plus a hefty pension; they had no debt besides a $300,000 mortgage; their son, Darrell, was out of college and daughter, Kimberly, would be done in 2011.

To continue reading, please click here http://bit.ly/5aGwIO.

Posted in General, investing, markets, retirement, Taxes. Tags: , , , , . 3 Comments »

Should College Freshman Start A Roth IRA?

September 3, 2009 — Sam H. Fawaz

At no time since the Great Depression have college students worried more about money.  Tuition continues to rise, financing sources continue to contract.  So why should a student worry about finding money for, of all things, retirement?

Because even a few dollars a week put toward a Roth IRA can reap enormous benefits over the 40-50 years of a career lifetime that today’s average college student will complete after graduation.  Take the example of an 18-year-old who contributes $5,000 each year of school until she graduates.  Assume that $20,000 grows at 7.5 percent a year until age 65.  That would mean more than a half-million dollars from that initial four-year investment without adding another dime.

Consider what would happen if she added more.

There are a few considerations before a student starts to accumulate funds for the IRA.  First, students should try and avoid or extinguish as much debt – particularly high-rate credit card debt – as possible.  Then, it’s time to establish an emergency fund of 3-6 months of living expenses to make sure that a student can continue to afford the basics at school if an unexpected problem occurs.

To contribute to an IRA, you must have earned income; that is, income earned from a job or self-employment.  Even working in the family business is allowable if you get a form W-2 or 1099 for your earnings.  Contributions from savings, investment income or other sources is not allowed.

Certainly $5,000 a year sounds like an enormous amount of outside money for today’s student to gather, but it’s not impossible.  Here’s some information about Roth IRAs and ideas for students to find the money to fund them.

The basics of Roth IRAs: I’ll start by describing the difference between a traditional IRA and a Roth IRA and why a Roth might be a better choice for the average student.   Traditional IRAs allow investors to save money tax-deferred with deductible contributions until they’re ready to begin withdrawals anytime between age 59 ½ and 70 ½.  After age 70 1/2, minimum withdrawals become mandatory.

Roth IRAs don’t allow a current tax-deductible contribution; instead they allow tax-free withdrawal of funds with no mandatory distribution age and allow these assets to pass to heirs tax-free as well.   If someone leaves their savings in the Roth for at least five years and waits until they’re 59 1/2 to take withdrawals, they’ll never pay taxes on the gains. That’s a good thing in light of expected increases in future tax rates.  For someone in their late teens and early 20s, that offers the potential for significant earnings over decades with great tax consequences later.  Also, after five years and before you turn age 59 1/2, you may withdraw your original contributions (not any accumulated earnings) without penalty.

Getting started is easy: Some banks, brokerages and mutual fund companies will let an investor open a Roth IRA for as little as $50 and $25 a month afterward. It’s a good idea to check around for the lowest minimum amounts that can get a student in the game so they can plan to increase those contributions as their income goes up over time.  Also, some institutions offer cash bonuses for starting an account.  Go with the best deal and start by putting that bonus right into the account.  Watch the fine print for annual fees or commissions and avoid them if possible.

It’s wise to get advice first: Every student’s financial situation is different. One of the best gifts a student can get is an early visit – accompanied by their parents – to a financial advisor such as a Certified Financial Planner™ professional.   A planner trained in working with students can certainly talk about this IRA idea, but also provide a broader viewpoint on a student’s overall goals and challenges.  While starting an early IRA is a great idea for everyone, students may also need to know how to find scholarships, grants and other smart ideas for borrowing to stay in school.  A good planner is a one-stop source of advice for all those issues unique to the student’s situation.

Plan to invest a set percentage from the student’s vacation, part-time or work/study paychecks: People who save in excess of 10 percent of their earnings are much better positioned for retirement than anyone else. Remarkably few people set that goal.  One of the benefits of the IRA idea is it gets students committing early to the 10 percent figure every time they deposit a paycheck. It’s a habit that will help them build a good life.  Better yet, set up an automatic withdrawal from your savings or checking account for the IRA contribution.

Get relatives to contribute: If a student regularly gets gifts of money from relatives, it might not be a bad idea to mention the IRA idea to those relatives.  Adults like to help kids who are smart with money, and if the student can commit to this savings plan rather than spending it at the mall, they might feel considerably better about the money they give away.  At a minimum, the student should earmark a set amount of “found” money like birthday and holiday gift money toward a Roth IRA in excess of the 10 percent figure.  Again, the IRA contributions cannot exceed the student’s earned income for the year.

Sam H. Fawaz is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families. This column was co-authored by Sam H. Fawaz CPA, CFP and the Financial Planning Association, the membership organization for the financial planning community, and is provided by YDream Financial Services, Inc., a local member of FPA.

Posted in investing, retirement. Tags: , , , , , , . 2 Comments »

Evaluating Equity Mutual Fund Recommendations

August 14, 2009 — Sam H. Fawaz

I’m a charter subscriber to the Consumer Reports Money Advisor (CRMA) newsletter and I just received the August 2009 issue.  The CRMA is a very informative newsletter that I always read cover to cover and I highly recommend it to anyone who wants the straight talk on personal finance (I have no affiliation with CRMA).

In their monthly “Money Lab” article entitled “Time to Move Back into Stocks?”, CRMA discusses how it may be time for folks who were severely hurt by the recent market downturn (and perhaps left the markets) to pick themselves up, dust off, and start looking at the stock market again.  Waiting for someone to sound the all-clear sign is not going to happen, and if you wait until everything “feels” good, you’re going to miss out on some of the most important gains of the economic recovery, which usually come in the first 12-18 months.

The article goes on to list five large capitalization funds (large caps) and five small capitalization funds (small caps) as standouts.   Now I normally don’t like to promote or recommend anyone rely on a magazine or a newsletter’s choices for investments, but I trust the CRMA more than other consumer publications.  For most people, the funds that are right for you can only be determined with a careful assessment of your goals, risk tolerance and investment time-frame.  Once these items are known, a proper asset allocation can be constructed.

But I was curious to see how CRMA’s choices stacked up with a methodology that I use to screen funds for my own clients.  So I popped the names of the funds into my research tool, ran an research report on them and I present my observations here.

First, the screen criteria listed for the CRMA choices were:

  1. The funds consistently outperformed their peers (but no period or specific criteria were listed).
  2. Funds had managers that had run them for at least 4 years.
  3. The funds have an expense ratio of no more than 1.4% for small caps (the average expense ratio for small caps is 1.54%) and no more than 1.27% for large caps (1.27% is the average for large caps).

Their choices and a few observations:

Small Caps

Name Ticker Morningstar
Category
Buffalo Small Cap BUFSX Small Growth
Neuberger Berman Genesis Inv NBGNX Small Blend
Queens Road Small Cap Value QRSVX Small Value
Royce Special Equity Invmt RYSEX Small Value
TCW Small Cap Growth I TGSCX Small Growth

From this list, the Royce Special Equity Invmt (RYSEX) and Neuberger Berman Genesis Inv (NBGNX) were on my preferred list of small cap funds.  The rest were not, so I was only batting 0.400.  Naturally, I wanted to know why the rest didn’t make my list.

Queens Road Small Cap Value (QRSVX) did not make my list because it does not have a 10 year history, has only $22M in total assets and a somewhat higher (though still below average) 1.35% expense ratio.  I generally like to see a fund with a 10 year history, at least $50M in total assets and a low expense ratio that matches its best performing peers.

Although TCW Small Cap Growth I (TGSCX) ranked highly for performance compared with its peers for 1, 3 and 5 years, it was ranked in the bottom 15% of funds in its class for the 10 year period ending June 30, 2009.  Though 10 years is a long time, there are funds in this category that make the grade for all periods.  In addition, although TGSCX had a high return rating, it also came with a high risk ranking, and I generally avoid high risk funds, especially when there are funds that generate high returns with lower risk factors.

At first glance, the Buffalo Small Cap fund (BUFSX) revealed that it was outstanding in most respects, so I was puzzled why it wasn’t on my preferred list.  Looking at all the criteria, the fund risk was a bit higher than others but not the highest in the group.  This fund makes big sector bets which can go awry and cause short-term performance problems.  The fund has a 2% redemption fee if you cash out in 180 days or less.  Nonetheless, in the small cap growth space, this is a fine choice.

Large Caps

Name Ticker Morningstar
Category
Yacktman YACKX Large Value
Parnassus Equity Income – Inv PRBLX Large Blend
Fairholme FAIRX Large Blend
Aston/Montag & Caldwell Growth N MCGFX Large Growth
CGM Mutual LOMMX Large Growth

From the above list, only Parnassus Equity Income – Inv (PRBLX) is on my preferred funds list for large cap funds.   The rest were not, so I’m batting 0.200 in this category.

Yacktman (YACKX) is ranked #1 in its category for all period rankings (1, 3, 5 and 10 years), but it does not make my preferred list due to above average risk for the past five years.  It also has a 2% redemption fee if you cash out in 30 days or less.  The managers run a concentrated portfolio (currently 31 stock holdings), which can add to volatility and performance swings over time.  The fund’s propensity to hold cash (20% last year) can hamper the fund when the market is roaring, though it helps in down markets.  In most respects, this is a good fund.

Fairholme (FAIRX) is not on my list because it doesn’t have a 10 year history (currently stands at 9.5 years) and fund’s five year risk is high.  It also has a 2% redemption fee if you cash out in 60 days or less. This fund concentrates its picks in individual sectors and is a highly concentrated portfolio (currently 21 stocks), with top positions representing as much as 15% of assets. Otherwise, it’s ranked #1 in its category for all periods.

Aston/Montag & Caldwell Growth N (MCGFX) is in the top 35% of funds for the 10 yr category ranking.  The managers run a concentrated portfolio (currently 31 stock holdings), which can add to volatility and performance swings over time.  This is the only fund in the recommended group that charges a 0.25% 12b-1 (marketing) fee.  It is a fine fund, but with such a wide universe of large growth funds, you can do better.

CGM Mutual (LOMMX) has excellent 3, 5, and 10 year rankings, but its 12 month category ranking was in the bottom 16% of large cap growth funds.  The 5 year fund risk is above average, so it doesn’t make my list of preferred large cap growth funds.  Year to date, it’s in the bottom 2% of similar funds and is the only fund in the recommended group that has a negative return (-1.27%).  While long term performance is what matters most, I can’t overlook the short term under-performance.  The fund also has concentrated holdings (only 15 stocks and 7 bonds).  Although it’s classified as a large cap growth fund, the prospectus objective is a balanced fund (stocks and some bonds).

Please keep in mind a couple of things when using the forgoing information: 1. This is not an endorsement or recommendation for any particular fund; 2. Fund performance, managers, expenses, operations, etc. change on a daily basis, so a fund that looks great today, may not look so good next week or next month.  With this in mind, if you are managing your own investments, you should be sure to review your choices at least once a year, preferably when you are re-balancing your investments, to ensure that they still meet the objectives you had when you bought them.

Overall, my objective here was not to criticize or praise the choices of the CRMA.  While these funds are good choices in general, knowing more about them can help you decide whether they are appropriate for your portfolio.

Posted in General, investing. 3 Comments »

Market Update and A Caution For The Week Ending 5/29/2009

May 29, 2009 — Sam H. Fawaz

The markets ended up for the third month in a row with a late day rally on Friday, capping one of the best (albeit volatile) months in two years. With the exception of the Dow Jones Industrial Average (of 30 stocks), all indices are positive for the year.  GM traded below $1 a share today as bankruptcy is likely to occur on Monday.

Opinions about the markets’ direction run the gamut from “drunken bulls” to “raging bears”, with everyone taking each up or down day to prove their point.  But the solid fact is that the market is in a confirmed uptrend, and no opinion can argue with that.  But that’s all they are: opinions.

Economists predict that the recession will end by the 3rd quarter of this year, but the recovery will be slow.  For states like Michigan and California, recovery will likely begin in the 1st or 2nd quarter of 2010.  In the meantime, we still have to deal with waning consumer demand and higher unemployment.  Nonetheless, consumer confidence rankings jumped nicely in April, a bullish sign for the markets and the economy.  Remember, the stock market usually leads an economic recovery by 6-9 months.

Our investment approach remains a cautious, defensive one as we closely monitor the markets for signs of sell-offs.  Over the past few months, I’ve slowly increased clients’ allocations to equities and bonds to take advantage of the markets’ rallies.  However, I continue to maintain a healthy allocation to cash as a defensive move should the markets begin to move against us.  Any move this high, this fast, is a good reason to be cautious.  Fortunately, technical indicators confirm that the bullish sentiment is higher than bearish negativity and therefore give reason to be optimistic.  As billions of dollars of economic stimulus hits the streets, it can’t help but “lift all boats.”

Many prognosticators and so called experts predict that the low on March 9 was not the bottom, and that we’re merely experiencing a bear market rally.  Some even predict that we may have a severe 35-40% drop from here before the economic recovery and the “real bull market” kicks in later this year.  That drop could begin next week, next month, or next quarter—no one really knows.  I would be remiss if I didn’t warn you about this possibility. I don’t know if they’re right or not, but everyone should nonetheless be prepared for that possibility.

For my clients, I will continue to take advantage of the upside of the markets as long as it lasts and will not simply wait on the sidelines for the bears to arrive.  If or when the bears return, I am prepared to make the necessary tactical adjustments to minimize the effects on client portfolios and lock in as much of the recent gains as possible.  If the bears decide to stay for awhile, then we’ll take advantage of those conditions and attempt to profit from such bearish conditions.

In any case, future annualized returns on equities and bonds are likely to be in the single digits for some time.  Nonetheless, there’s no substitute for regular saving and continuous financial planning.  That combination can help overcome any lower expected returns.  Remember, it’s never too late to start.

I welcome your comments and feedback and invite you to read the below articles.  If you have any questions, please feel free to get it touch with me and share this with your friends and colleagues.

http://www.ydfs.com

Market Update For Week Ending 5/29/2009
Index

Close

Net Change

% Change

YTD

YTD %
DJIA

8,500.33

+223.01

2.69

-276.06

-3.15
NASDAQ

1,774.33

+82.32

4.87

+197.30

12.51
S&P500

919.14

+32.14

3.62

+15.89

1.76
Russell 2000

501.58

+23.96

5.02

+2.13

0.43
International

1,317.31

+27.10

2.10

+79.89

6.46
10-year bond

3.47%

+0.02%

+1.22%
30-year T-bond

4.34%

-0.05%

+1.65%

International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.

Market Wrap
A volatile post-holiday week ended with the bulls back in control of Wall Street and most major equity indices in positive territory for both the week and the year to date. The Dow industrials continued to lag, held back by developments at component General Motors in particular, but other benchmarks gained 3% to 5%. Foreign shares also ended in the black, while bond markets were mixed. For more on recent trading activity, please read:
http://finance.yahoo.com/news/Stock-market-fluctuates-after-apf-15385078.html

Consumer Confidence Revives
The American public’s battered sense of the economy’s health revived somewhat in April. Analysts warn that while the light at the end of the recessionary tunnel may finally be in sight, it will take some time for a true recovery to begin. In fact, while the business environment seems to be improving in many parts of the country, conditions in the Midwest in particular appear to be getting worse as the auto industry lurches from crisis to crisis. For more on the latest economic indicators and what they mean for the economy, please read:
http://bloomberg.com/apps/news?pid=20601087&sid=aYRGnAW70og8

Is The Recession Nearing An End?
Some economists now say the longest and most savage economic contraction in six decades may finally be winding down. But while consumers are in relatively high spirits, both labor markets and home prices remain fragile at best as layoffs and foreclosures continue. Where are the “green shoots” that some see heralding a new cycle of economic growth? And where are the storm clouds ahead? For more, please read:
http://www.msnbc.msn.com/id/30979615/

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions. Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions.

Posted in investing, markets. Tags: , , , , , , . 2 Comments »

Five Tips to Avoid Potential Investment Fraud

April 13, 2009 — Sam H. Fawaz

I recently wrote about avoiding investment fraud (How to Avoid Being Madoff’ed) but the subject keeps coming up.  In the most recent news from Wall Street, securities fraud has affected individual investors, pensions and charitable organizations.  At the risk of being a bit repetitive, here are five key safety tips that may help you prevent this from happening to you:

1. Know your advisor.

Most advisors (like me) are registered with government organizations. You can research registrations and review any past complaints with the Securities and Exchange Commission (www.sec.gov), or with the respective state regulatory agency.  If a firm is a Broker-Dealer, you can research it with the Financial Industry Regulatory Authority (www.finra.org).  You should also be aware of what you have authorized your advisor to do.  For example, if you have granted your advisor discretion over your investments, then you have given her permission to buy and sell investments to meet your stated objectives without your approval for each individual trade.  The authority you have granted your advisor should be stated in your client services agreement (you do have one, right?)

2. Know your investments.

Consider stocks, bonds, exchange traded funds (ETFs), and mutual funds that are publicly traded and listed on major exchanges like the New York Stock Exchange.   They are valued independently at least daily, if not minute by minute, when the exchange is open.  You can check their reported returns against your own portfolio.  If you can’t look up the prices and performance of what you own in the newspaper or on the Internet-that’s a red flag, so ask more questions.  If you choose to invest in complex securities like private placements, then you have much more additional homework to do.

3. Use an independent custodian.

By utilizing an independent custodian, there is objective, unbiased pricing of underlying securities.  Investment performance can look better if the prices reported to clients are manipulated, showing winning performance year after year despite the ups and downs of the market.  For example, our custodian, TD Ameritrade, receives security prices through well-known third-party pricing vendors or directly from issuers.  In many cases, prices are provided on a real-time basis for most securities.  We have no input on asset pricing or valuation.  Clients get statements directly from TD Ameritrade.  In addition, your advisor’s independent custodian should have a business continuity plan and a privacy policy to provide access to your investments in the event of a disaster and to protect your personal information.

4. Check on protection.

Your advisor’s custodian MUST be a member of the Securities Investor Protection Corporation (SIPC); if not, find one that is.  If it is, the securities in your account are protected up to $500,000, of which $100,000 may be applied to cash.  For additional information, please visit www.sipc.org and see the Account Protection Sheet.  Our custodian, TD Ameritrade, also provides additional coverage through London insurers of up to $149.5 million per customer of which $900,000 may be applied to cash (and an aggregate of $250 million for all customers).  Please see the Evidence of Excess SIPC Coverage for additional details.  SIPC protection and Excess SIPC insurance protect against losses from brokerage failure, not from market value decline.

For additional information, please see TD Ameritrade’s FAQ for Investors on Protection against Market Fraud.

5. If it Sounds Too Good…

One final thought: If it sounds too good to be true, it probably is.  Beware of consistent annual returns that are out of line with established benchmarks.  Remember, there is no return without risk, so never believe anyone who says that they can get you a high return with little or no risk.  There’s always a “gotcha” hiding somewhere (e.g., excessive fees, commissions, early termination penalties) when they tell you this, so you should be very suspicious.

If you or someone you know has been affected  by investment fraud, or if you have any questions, please comment below.

Posted in General, investing. Tags: , , , , , , , , , . 2 Comments »

Are Mutual Funds Becoming Obsolete?

April 1, 2009 — Sam H. Fawaz

The markets that we’ve seen during the past several months are unlike any others I’ve seen in my lifetime.  In fact, they’re probably unlike the markets most of us have ever seen.   This market upheaval has caused me to re-examine everything that I thought was “sacred” about investing and the markets. This in turn has led me to begin questioning many basic premises about how financial planners think about investing, proper diversification, and trading.  Specifically in this article, I’m looking at the future of saving and investing in mutual funds.

I’m by no means an expert in this area.  But I have taken to reading and researching as much as I can about what works and what doesn’t work while saving and investing for the long and short term.  Between listening to tons of podcasts, attending numerous webinars and conferences, reading books, newsletters, magazines and newspapers, I’ve become intimately familiar with the arguments advanced by “buy and hold” crowd and their counterparts, the “market timers.”  I’ve learned that both approaches have their merits, and each has its time and place in the right types of markets.  This article is not about those merits or which method is superior.

While re-examining and researching mutual funds in client and prospect portfolios, and seeing how much some of them suffered in this awful bear market, I keep asking myself if there is a better way to invest their money.  Even though most mutual funds were down 35-50% over the past twelve months, I shook my head in disbelief that many of the same funds, even as late as January 2009, were still ranked as four and five star funds by the investment rating firm Morningstar.  Really?  Four and five stars were given to funds ranked in the bottom 35% of their category?  Funds that had double-digit negative annualized returns for 1, 3, and 5 years still earned three or four stars?

Just to be clear, as an advisor, I don’t rely on Morningstar “Star” rankings to rate and choose funds for my clients and prospects.  I dig much deeper into the details and third party information for comparison, research and evaluation purposes.  But I know that many consumers do rely on star rankings.  And I have to wonder how much of a favor Morningstar is doing for consumers when managers who are paid handsomely to manage mutual funds missed the whole financial crisis and didn’t steer their funds away from the financial or the big oil stocks in the second half of 2008.

In a secular bear market like the one we’ve been in, buying and holding mutual funds (or any investment for that matter) can be a money losing proposition.  But mutual funds have a few characteristics that make them even riskier, if not downright inappropriate for certain market conditions.

One characteristic that makes mutual funds riskier is the once-a-day, end-of-day pricing; you can’t get intra-day pricing on a mutual fund like you can on a stock.  If the market is trending down, there’s no way to cut your losses when the writing’s on the wall and the market’s headed for a big daily loss.  Wouldn’t it have been nice, on an 8% down day, to cut your losses in half?  Well, sorry, you can’t; you have to ride it all the way down.  Of course, on an up day, you may benefit from the extra upside.  Exchange traded funds (ETFs), which trade just like stocks, don’t suffer from this disadvantage and can be bought and sold at intra-day prices.

Another risky characteristic of mutual funds in bear markets, closely related to the above characteristic, is the inability to put a stop-loss order on a mutual fund.  If the market is crashing, and you’re unable to monitor your investments every minute that the markets are open, you could lose big or give up a good chunk of your gains.  Stocks and ETFs don’t have this disadvantage; you can have a standing stop-loss order on them with your broker for up to 6 months.  As soon as the stock or ETF drops to the sell-stop price, a sell is triggered and voila, you’re in cash, protected from further downside.  This gives you time to assess market conditions and decide on your next investment.

The inability of most mutual funds to deviate from their stated investment objectives prevented many mutual funds from cashing out on money losing stocks (almost all of them in 2008) and being able to sit on the sidelines with significant amounts of cash.  Funds with more flexibility in their cash positions, and those with the ability to take inverse (e.g., short) positions fared better than most in this bear market.  To be fair, many ETFs are index-based and have the same problem.

Mutual funds also suffer from a lack of timely disclosure of their investment holdings.  While they all publish their stock and bond holdings, most holding lists are usually at least three months old.  Mutual fund managers don’t like to publish their holdings more frequently so they don’t have to tip their hand to the competition.  It’s important to know what investments your funds are holding so you don’t duplicate or overlap your holdings with funds carrying the same stocks or bonds.  And if your fund was still holding, say Washington Mutual when it was sold for pennies on the dollar to JP Morgan Chase, maybe you would have known better to avoid the fund.  ETFs are much more transparent and publish their holdings on a daily basis.

Many will argue that ETFs have commissions that must be paid to buy and sell them, thereby making them a more costly option than mutual funds. To that I say three things: 1) commissions at most big brokers are about $19.95 or less; 2) the potential higher-gain or lower-loss on an ETF may pay for the commission in multiples; and 3) many desirable mutual funds have transaction fees much higher than ETF commissions at many brokers.

So will the mutual fund industry eventually die? I don’t think so.  Mutual funds are so ingrained in institutional settings and retirement plans that they likely have a long future ahead of them.  But I have a feeling that the mutual fund industry is already trying to reinvent itself.  Many of the big mutual fund companies have gotten into the ETF business because of the net (negative) out-flows from mutual funds and the net (positive) in-flows to ETFs.  Perhaps mutual funds will get some of the nice advantages that ETFs have like intra-day pricing, sell-stops and timelier holdings disclosures.

What I also hope for is that more 401(k) and self-directed retirement plans embrace ETFs and give employees the option to invest in them.  That way, they’re not sitting ducks when the markets come crashing down.

Do you think that mutual funds are headed for extinction? Do you think that employees should have more choices (e.g., ETFs) when it comes to their 401(k) investment choices? Please let me know what you think.

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Rally Week Market Update For Week Ending 3/27/2009

March 28, 2009 — Sam H. Fawaz

We had a pretty good streak going in the markets this week until Friday’s profit taking spoiler. The technology laden NASDAQ index was even in the black year-to-date, if only for one day.  Despite the 20% plus gains over the last few weeks, all indexes remain in negative territory year-to-date and we remain in a treacherous bear market despite this rally.  Continued caution remains the advice on investing.

Are we at a bottom yet? Read on for one theory.

The severity of this bear market is a crisis in confidence more than anything else. What started out as a crisis in subprime mortgage loans quickly spread to leveraged instruments including credit default swaps and subsequently evolved into a more generalized crisis in confidence.

Over the past few months, recession pressures and a gloomy consumer mood have propelled financial markets lower. That’s why consumer expectations, usually considered an indicator of future spending, is an important gauge to watch.  The consumer outlook for the future, as measured by the University of Michigan/Reuters sentiment survey, fell in February before improving in early March.  The Conference Board also releases a monthly consumer survey; in February, expectations fell to a 40-year low.

With massive government stimulus now in place, the consumer mood could brighten in the months ahead.  New data for the University of Michigan/Reuters survey of consumer sentiment released Friday came in at 57.3 for March; that’s up slightly from February’s 56.3.  It was also slightly better than expected, but still near the worst reading in 30 years.

The Conference Board results will follow next Tuesday. If a market bottom is truly in place, we may see an upturn in this measure as well, according to analysts.

I remain skeptical of government estimates of personal spending and income, home sales increases, and unemployment.  First, they are estimates that ultimately get revised unfavorably when the real data becomes available.  Second, the pundits as well as the administration are content to “spin” any good news to suit their current agenda and to take credit for any positive news.  Finally, contrary to CNBC “entertainer” Jim Cramer’s assertions, the fundamentals of the economy still don’t support a solid upturn yet.  First and second quarter 2009 earnings reports will likely bear this out, so I’m pretty sure that we’re not out of the woods just yet; and not for awhile anyway.  Hopefully I’m wrong and this bull market will continue, but I continue to urge caution when investing.

Do you agree or disagree? I’d love to hear what you think.

Market Update For Week Ending 3/27/2009

Index

Close

Net Change

% Change

YTD

YTD %
DJIA

7,776.18

+497.80

6.84

-1,000.21

-11.40
NASDAQ

1,545.20

+87.93

6.03

-31.83

-2.02
S&P500

815.94

+47.40

6.17

-87.31

-9.67
Russell 2000

429.00

+28.89

7.22

-70.45

-14.11
International

1,083.64

+29.04

2.75

-153.78

-12.43
10-year bond

2.76%

+0.14%

+0.52%
30-year T-bond

3.62%

-0.04%

+0.93%

International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.

Sam H. Fawaz CFP®, CPA is president of Y.D. Financial Services, Inc., a registered investment advisor. All material presented herein is believed to be reliable, but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions. Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions. No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions.
Posted in investing, markets. 2 Comments »
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