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Two Ways to Protect Your Retirement Portfolio In a Down Market

taipanjared@gmail.com (Jared Levy, Editor, Smart Investing Daily) — Wed, 01 Sep 2010 15:50:43 +0000

One of the oldest methods of protecting your retirement money is by spreading risk out among different stocks and sectors. While this may be a partially effective way of mitigating the risk of a major drawdown in your account, it does NOT ensure success. In fact, in a broad market sell-off, you may see several sectors moving lower at the same time, similar to what we've experienced over the past couple months.

That begs the question... what to do? The answer is simple...

Sell When Things Are Good or Scale Out of a Position

As a trader, controlling your greed, setting goals and being proactive can not only help preserve your regular capital, but your mental capital as well. Here's what I mean. Let's assume you bought the S&P 500 ETF (SPY:NYSE) at $107 on June 20, 2010; one week later, it is trading at $113 and the charts are looking shaky, not to mention the broad market is not very stable. At that moment, you could take some profits (you just made an annualized return of over 220%) by selling some or all of your shares. You could also sell covered calls against your stock. (Covered calls offer some protection and lower your cost basis.)

In either instance, not only would you have a winning trade that would increase the size of your account, but you would also have a sense of accomplishment and feel more confident when entering your next trade. Not to mention, you would have the capital freed up to do so. This proactive approach to trading is a necessity in today's uncertain financial markets.

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Now let's look at the flip side and assume you don't sell because you had no profit goal established when you initiated the trade and you were feeling a bit greedy. So you decide not to sell but rather hold your long position. Just as above, the charts are shaky and a few days later, bad economic data hits the wires and sends the SPY sharply lower. In addition, the SPY gaps below the 200-day moving average of $111 (as it occurred on Aug. 10). What was support becomes resistance and your trade now becomes a loser.

At that moment you're beating yourself up for not exiting, stressed because your opinion of the stock may have changed and your account is in the red, not to mention you have 20% of your account tied up in the trade, which could have been used to buy a different stock that may have better prospects.

All of a sudden, hoping, wishing and praying are now your strategies of choice. You also may be reluctant to enter another trade for fear of repeating what you just did.

This is obviously an extreme example, but not out of the ordinary. In fact, I have seen this type of situation for years. The point is to have a trade plan, target goal and acceptable loss level in place before making a trade, and stay on top of your accounts and the news! When things are good, do something to protect them – it's NEVER better to sell when a financial market is tumbling and you are under duress.

If I am in a trade and the market or stock climbs higher and higher, I usually like to scale out of my positions, which reduces my investment risk. I also will use proceeds from some of my more risky strategies that I take profits on to finance my less risky bets in a market that has been climbing a wall of worry or is skittish. Be aware of your risk/exposure at all times. No one ever went broke taking profits.

There's another way you can spread out the risks and that's by making use of charts.

(By the way, investing doesn't have to be complicated. Sign up for Smart Investing Daily and let my fellow editor Sara Nunnally and I simplify the stock market for you with our easy-to-understand investment articles.)

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What the Charts Tell Us

Chart patterns can tell you much about a stock. By examining the past history of a stock and its typical behavior, we can get a better idea of its trajectory moving forward. What is most important is that the chart shows us where we might want to place our stop-losses.

Even though there are many ships on the bottom of the sea, many more made it to port unscathed by using charts.

Looking at a candlestick chart of the S&P 500 (which is my favorite broad index, by the way), you'll notice a little dotted line that runs across the chart just above the white arrows. That line is what's called a Fibonacci retracement level (don't get scared, I'll keep it simple). Basically, Fibonacci was a brilliant Italian mathematician who lived in the Middle Ages. There is a sequence of numbers that is named after him and these numbers (or levels in this case) are a popular form of market analysis that many professionals use.

The current support level of 1,040 in the S&P coincides with a Fibonacci level and is considered by many to be major support for the index, which is why for the past week, the lows have been right at 1,040. You have to admit, that's a little more than coincidence. It could be that because many traders use the same indicators to buy and sell with, those levels that are created become self-fulfilling prophecies. It is pretty eerie sometimes how precise they can be.

The bottom line is if the S&P breaks below that level, we could sell off further, which is why you might want to consider setting a stop-loss just BELOW the 1,040 level (if you were invested in the S&P).

View Larger Chart

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How to Protect Your Portfolio From Black Swans

snunnally@email.com (Sara Nunnally, Editor, Smart Investing Daily) — Mon, 30 Aug 2010 16:51:13 +0000

A Scout's motto is "Be prepared." But how can you be prepared for something completely unexpected? Today's investment markets are riddled with uncertainty, seesawing in poor economic headwinds, and pockmarked with burst bubbles.

We think we've seen the worst, but are we sure about that?

Late last week, the financial market's buzzword was "Black Swan." A black swan is an unforeseen event, random and extremely difficult to predict. Most often, the term refers to something bad.

An article from The Wall Street Journal on Friday was titled, "How to Profit from Black Swans" Here's an excerpt:

A growing number of money managers and financial firms are rolling out investment products designed to exploit big declines known as "black swan" events. Most of the products are geared toward institutional investors such as pension funds, endowments and high-net-worth families – but black-swan strategies are trickling down to Main Street as well.

The point behind this strategy is to take advantage of unexpected stock market moves, but because of the risk and uncertainty of black swans, Nassim Nicholas Taleb – the man who coined the term in his 2007 book The Black Swan: The Impact of the Highly Improbable – says the strategy is designed to be used with only 10% of your financial portfolio, while keeping the other 90% in ultra-safe investments.

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Are Ultra-Safe Investments Really What You Want to Buy?

Today's ultra-safe investments might include T-bonds, which are jumping in price, but dropping in yield... Not the best way to make money.

These new black swan investment products – though timely and with a catchy name – count on being right, and black swans by their very nature are unpredictable. It's a speculator's dream, but the realization of said dream may never come to be.

And with 90% of your money sitting in ultra-safe investments, yielding next to nothing, you might just end up losing money.

Of course, I could be wrong... But in my opinion, you should be making that 90% of your financial portfolio work for you, not sit in some half-baked mattress strategy.

The smart thing to do would be to protect your financial portfolio from these random black swans, rather than try to chase the trend as it screams down the tracks. That does mean putting a chunk of your portfolio in ultra-safe investments, but not the vast majority.

Black Swan-Proof Your Financial Portfolio

Consider the Permanent Portfolio, conceived by Harry Browne in his book Fail-Safe Investing: Lifelong Financial Security in 30 Minutes.

The Permanent Portfolio consisted of four types of investments, each weighted equally: stocks, long-term bonds, cash and gold. The strategy assumes that in prosperous times, stocks would climb. In contracting times, bonds would balance deflation. With rising interest rates, gold hedges against inflation. And cash (or a money market fund) would give you a fair amount of safety.

This gives you a strong base to build a lasting financial portfolio strategy, but it only tells you what types to buy.

You also might want to consider "how" to buy them... And there's one method that can help protect against black swans across these portfolio types.

It's called dollar-cost averaging. Say you wanted to invest in eBay, Inc. (EBAY:NASDAQ) in May when you thought the stock had put in a bottom. You bought $300 worth of eBay at $23.91. As of midday on Friday, eBay traded for $22.66 a share, and you're sitting with a slight loss of 5.2% – if you'd decided to hold on to eBay as it fell through the $20 mark in July.

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Turning Losses Into Gains as Share Prices Fall

Had you put a very conservative 15% stop-loss on this investment, you would've been stopped out in late June.

But using the dollar-cost averaging method, you'd be sitting with a gain of 5.4%!

Here's how it works. Instead of shelling out $300 on May 1 at $23.91 a share, this method suggests spreading that cash out over multiple investments as eBay's price is falling: $100 on May 1 at $23.91; $100 on June 1 at $20.96; and $100 on July 1 at $19.64.

This gives you an average price per share of $21.51. Using Friday's midday price of $22.66 a share, that's a gain of 5.4%.

This strategy can help you mitigate losses, too, thereby protecting you from black swans. With an average cost of $21.51 a share, in early July at eBay's bottom price of $19.06, you'd see a loss of 11.4%, while the lump investment at $23.91 has a loss of 20.3%.

That's a big difference that saves you money – even during black swan events – and can keep you invested in the market and ready for any upswing.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

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Don’t Get Trapped by Market Micro-Bubbles, the Silent Wealth Killers

snunnally@email.com (Jared Levy, Editor, Smart Investing Daily) — Fri, 27 Aug 2010 14:57:33 +0000

Today's article is about market bubbles. Right now, you're probably wondering why I am talking about market bubbles when the S&P 500 is trading down 6.5% since the first trading day of January this year, and down 33% from the 2007 highs. On top of that, home prices have fallen 30% (on average) to 2002-2003 levels, and unemployment is nearly 10%. Frankly, most of the globe is struggling to pay its bills. So doesn't all of this mean any kind of market bubble has burst? Well, the answer is, not all of them.

Even in tough economic times, when everything seems (and maybe should be) cheap, investors will always find investments to pile into, even if they are short-term bursts, which can easily cause micro-bubbles. I call them micro-bubbles because these market bubbles probably won't be on the front page of every newspaper or the focus of your nightly newscasts, and they may not even last that long, but they are out there and can hurt you if you buy near the top. What is most interesting is that these micro-bubbles are formed by investors who are sometimes looking for "safe-haven" investments, because they are fearful of corrections in the major markets like the S&P 500 and housing. Even safe havens can be a dangerous place to lurk sometimes.

I'm going to offer you a couple examples of possible micro-bubbles and how to spot them, so you can maybe save yourself some money if they do indeed correct. Also keep in mind that just because a bubble or micro-bubble is forming, it doesn't mean it can't get bigger, or it may not even be a market bubble at all. Every market is determined by supply and demand and bubbles can occur if these two factors get way out of balance.

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Micro-Bubble #1: Cotton & Wheat

Most of you probably are not hoarding your cotton undergarments and boxes of cereal for fear of inflation, although with cotton and wheat both being U.S. dollar-denominated commodities they do tend to have a contra-dollar relationship, meaning that when the dollar is weakening (inflationary), that would put upward pressure on prices, but that is not what has driven these daily life necessities to micro-bubble status this time.

Daily Cotton Chart

Cotton's price jump can be attributed to last year's reduced U.S. production of 12.2 million bales, which was the smallest crop in 20 years. If you compound this with the ever-increasing populations (increased demand) of countries like China and India along with a shift in crop selection to more food and less cotton, you get a recipe for higher prices. Analysts believe that the 50% jump in cotton prices over the past year will be impetus enough for farmers to ramp up production, hopefully driving prices down. Not to mention cotton, like many other commodities, is also driven by global demand. When we humans are happy and making money, we are probably going to feed and clothe ourselves well; right now the world still has some tough times to overcome. Some experts in cotton are calling for a price correction in the coming months.

So What About Wheat?

Wheat might be an example of a micro-bubble that has already partially burst. If you look at the extreme price run-up in wheat from early June to August, it's pretty easy to see. Now, of course there was at least some reasoning for the 65% monthly run-up in wheat prices, namely the Russian ban on wheat exports. According to LiveMint.com, this phenomenon called "agflation" was essentially created out of thin air and completely overdone. The analysts there believe that the run-up in prices wouldn't stick and they were right; wheat has come sharply off its highs and some expectations are for further correction as well into early next year.

Wheat was up slightly yesterday on news that global wheat production will be 1.1% smaller than was previously forecast a month ago. Also keep in mind that these high prices helped many American wheat farmers, who were able to sell futures to lock in those multiyear highs.

Daily Wheat Chart

The lesson here is that, as with cotton, higher prices beget more planting, and more supply may lead to lower prices. In the near term, there are still issues with drought and the ongoing ban on exports in Russia and the Ukraine. Experts believe that the drought will have minimal impact on the 2011 crop, which is planted in September.

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Micro-Bubble #2: U.S. Treasury Bonds

The 10-year note is a known safe haven and as much as I believe this country has a serious debt-to-income problem, the debt is still deemed by many experts as manageable at 40% of our gross domestic product. I am concerned with the fact that even with the slew of supply (our government has issued 3.3 trillion dollars in debt over the past two years), bond prices have continued to rise, which pushes the yields on those bonds lower.

And yields have gone lower -- 10-year T-note yields fell to a 19-month closing low of 2.49% on Tuesday, then moved slightly higher to end at 2.54% on Wednesday.

There are analysts out there calling a top in bond prices (which would be a bottom in yields). The question is how quickly economies can improve, at which point the waterfall of safe-haven investors will stop piling into already crowded U.S. Treasury bonds. I personally wouldn't be a buyer of Treasuries at these levels.

Daily 10-Year Note Yield

(If you move the decimal one place to the left, this gives you the 2.53% yield)

Lesson Learned

If you look at a chart and see some amazing price action or you hear about a security that is making big moves, do your homework before jumping in! Of course there are plenty of trades that may look like a bubble but continue to run. Make sure that your reasoning for putting a trade on is viable and sustainable.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

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Why These Four Propane Gas Stocks Are Set to Climb in the Next Few Months

snunnally@email.com (Sara Nunnally, Editor, Smart Investing Daily) — Wed, 25 Aug 2010 15:39:33 +0000

After I read Jared's article on Monday, I realized we're in a similar boat, but heading in very different directions...

I've spent my first year here in Milwaukee renting a nice two-story house across from a county park just south of the city. It's very convenient: five minutes from downtown, 10 from Lake Michigan, and 10 from General Mitchell International Airport. (That helps out a bit when I fly into Baltimore for Taipan's think-tank meetings.)

Now I'm looking for a house, and I'm in the perfect position to buy. I don't have to sell a house in order to buy, and banks are really hurting to lend to qualified buyers. In fact, I put in an online application to Wells Fargo (WFC:NYSE) one late afternoon and got a phone call from a broker that evening, way after business hours!

But unlike Jared, I'm not looking for a penthouse in the heart of downtown.

Rather, I'm looking at old farmhouses with a decent amount of acreage for our four horses, handful of dogs, and my un-catlike cat who's even scared of the little lovebird on our kitchen table.

As soon as you get away from city services, like water, sewer and power, you're making a different kind of investment.

In fact, of all the homes I've looked at over the past couple of weeks, most were heated by oil or propane gas. With the evenings already starting to get pleasantly cool here in Wisconsin, I've got winter heating bills to look forward to.

That means I've got to start paying more attention to heating oil prices, and propane gas supplies.

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What Heating Oil and Propane Gas Inventories Mean for This Winter

According to the Energy Information Administration, propane inventories jumped by 2.4 million barrels last week, as prices for propane gas fell 7.2 cents per gallon last week.

Heating oil prices fell 15.5 cents per gallon with inventory supplies for all distillate fuels climbing 1.1 million barrels to 174.2 million barrels.

And yet, these figures compare poorly (for the homeowner) to last year's statistics. Prices for propane gas were 13.5 cents lower this time last year, and prices for heating oil were 14.3 cents lower per gallon.

That said, heating oil inventories are much, much higher than they were a year ago, which might do the Northeast good this winter... So let's look at propane gas.

Propane gas inventories are well within their five-year average, however, so you can expect supplies to drop significantly between December and March. And as stocks are nearly 10 million barrels below last year's inventory, we might see a sizable pop in propane gas prices.

For the homeowner (or soon-to-be homeowner, like me), this isn't a good scenario.

For the investor, it's an opportunity:

View Larger Chart

This is a one-year chart of Suburban Propane Partners LP (SPH:NYSE), AmeriGas Partners LP (APU:NYSE), Energy Transfer Partners LP (ETP:NYSE), and FerrellGas Parners LP (FGP:NYSE) in blue, red, green and gold respectively.

Note the steady rise in the last quarter of 2009 into the winter season of 2010.

These four propane gas stocks might be preparing for another such steady climb as we head into winter. You'll see that at least three of the four have had a significant pullback, which could indicate readiness for another climb.

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What and When to Play Propane Gas

Of the four stocks I've mentioned, APU performed the best last winter, narrowly edging out SPH with a gain of 16.95% versus 16.27%. That's a slim gain, and in comparing the fundamentals, these two trade pros and cons. SPH has higher quarterly revenue growth for its most recent quarter, but APU has higher gross margins. Both of these stocks have lower-than-industry-average P/E ratios, and ETP's and FGP's P/E ratios are well above 30 and 40 respectively.

SPH has the edge in liquidity, though, and has a lower debt ratio. Also APU has a large percentage of its stock held by insiders. That's a bit of a red flag...

Now you have an idea of what to play, let's look at when to play it.

As I said before, we've seen a significant pullback in both, and as we're heading into the cooler months, your starting point could be anytime between now and October, though it would be prudent to wait and see an end to the pullback before jumping in.

For SPH, that might look like a bump back above $48.54.

Getting out, though, is what we really want to talk about. Even though winter – and falling propane gas supplies – continues into March, consider taking any gains off the table in mid to late January, or early February, depending on the chart and the weather.

For the past five years running, SPH has shown significant drops during these months. In fact, if we go back to our gains comparison for last winter, we see a rise of 20.63% had the exit point been in January as opposed to the end of March.

With propane gas prices climbing more than 43% in the last quarter of 2009 and into 2010, propane companies could pack some punch for your investment portfolio this winter... Or help mitigate those heating costs if you've got a quaint century-old farmhouse on 20 acres in the Heartland.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

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How to Earn 18% Without Buying a Single Stock

taipanjared@gmail.com (Jared Levy, Editor, Smart Investing Daily) — Mon, 23 Aug 2010 17:11:25 +0000

I recently put one of my townhomes on the housing market to sell. It has been completely remodeled and is in a great location at a price that is the lowest in the area and by far the cheapest when compared to similar units in square footage, location and finish out. (No, I'm not trying to sell you my home.)

I have marketed my home on every real estate website out there and even lowered the price of my unit to the cheapest in my building. The home is located in one of the densest and most desirable areas of Dallas, Texas. Even after all that and 40 days on the market, I have had one showing. I'm not looking for pity at all; in fact, taking this frustration in stride I realized there are some real deals to be had out there.

You see, I am also looking to buy another property and boy, do I have a selection, including penthouse condos in the nicest part of town that were once selling for $300,000 and up are now priced below $120,000 in some cases. The plethora of inventory and the current weak state of the American consumer and would-be homebuyer have created an enormous opportunity for those who have a little faith, knowledge, patience and willingness to look for value in the housing market.

The real value may not be from the sellers like me who are looking to unload their homes and move on, but mostly from struggling homeowners and the banks, lenders and Fannie Mae, who currently have a glut of properties on their books that they need to unload (known as real estate owned or REO). You see, banks and even Fannie Mae are not in the business of buying and selling homes. Their job is simply to lend money or insure those notes for the borrowers who have now jumped ship and offered their deeds in exchange for the monies owed.

Many of the banks we know have already taken enormous write-downs on these bad loans and the next step is to move them off the books and get whatever cash they can. This means exceptional deals for you, and what's even better is that you can buy these homes not only at a relatively cheap price, but you get to leverage your money at a very low cost (interest rates are at a 40-year low) and collect dividends through rent, which can actually pay for your ownership while you wait for values to rise. If values don't rise, remember that you can still reduce your cost every month through rent and take legal tax deductions on the money borrowed as well as any repairs you need to do.

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REOs, Foreclosures and Short-Sales

While some realtors may steer you away from these types of sales because of the extra work sometimes needed to execute a contract, as well as the possibility of reduced commissions, you shouldn't ignore the values they offer. REOs and foreclosures are generally the most attractive because the banks have either already taken full control of the property or they are in the process of doing so and want to get that asset off their books. A short-sale is when the owner of the property is negotiating with the bank to sell the home and will satisfy the note for an amount lower than what they owe. Those are sometimes a bit tougher to complete, but may also offer great profit opportunities.

Lower Volatility

The equity markets can be quite volatile and have the ability to fluctuate plus or minus 2-3% daily. That can create a ton of headaches, not to mention spook you into exiting a position because you don't want to see your investment lose more value. The real estate market is much less volatile than the Dow Jones Industrial Average. That doesn't mean we didn't have a bubble in the real estate market, the likes of which had not been seen in decades. However, bubbles tend to occur less frequently in the overall real estate market and this recent bubble has corrected itself.

Case-Shiller 10-City Price Index 1987-Today

View Larger Chart

Dow Jones Industrial Average 2000-Today

View Larger Chart.

How Do You Go About It?

Just because real estate is cheap doesn't mean you need spend $300,000 on a fancy new condo! Think small -- remember that the more affordable it is to you, the more affordable it will be to the masses. I suggest keeping your investments under $150k (preferably $100k) and in dense, desirable areas where you can find renters and lots of potential buyers.

In the major cities across the U.S., renters are in vogue and if you can pick yourself up a clean unit or fixer-upper in a nice neighborhood, you may discover a gem. Fannie Mae properties also offer financing called Homepath loans, which are flexible in terms, cheaper to complete and have lower rates even for people with less-than-perfect credit. They even offer repair financing if you want to incorporate that into your loan. Check out homes and programs here: http://www.homepath.com/.

If you can live in the home, then of course you can spend a bit more, but look to save on what you are currently spending if at all possible and either pay down the principal on the new mortgage or buy some other investments with your extra cash.

But let's assume you are looking for a pure investment property -- don't forget to check with the township or realtor to find out what the home has sold for in the past to ensure you're getting a good deal.

How to Legally Trick a Mutual Fund Into Paying for Your Retirement

It’s simple and easy. By using this little-known “siphoning” method, you could collect thousands of dollars every month without paying a cent to the mutual fund industry.

Folks around the country are starting to break free from the high fees and low performance of the mutual fund industry. Like Dave DeRossi, who used “siphoning” to get a check for $74,480 on January 27.

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So Here Is What Your Investment Might Look Like:

Let's say you find a home for $100,000.

You put 10% down, which is a $10,000 investment, similar to what many of us may put into the stock market. (You can put more or less down, if you are doing conventional financing through the FHA. With Homepath, you can put as little as 3% down, although you may be required to pay PMI if you put down less than 20%.)

That means you are financing $90,000. Let's assume you finance it at a 4.5% rate (current 30-year rate). This will cost you $456 per month.

Taxes will vary; in Dallas, for example, you can expect to pay around $200 per month.

You may or may not have to pay a condo fee, but let's assume it's $100 per month.

Your total monthly cost in this property would be around $756.

Of course you should do this math beforehand when figuring out if this is a good deal, and whether you can rent the property for $900 per month. Remember, you can also deduct mortgage interest and some repairs, upgrades and depreciation, but check with your accountant on those!

In this case you are making about $1,800 per year on your $10,000 investment. That's 18% annually you could receive to pay down your debt on an asset that you now own, which should begin to appreciate in value moving forward.

Of course, there are no guarantees and you have repairs to make, but if you keep a renter in the home, eventually you will own the home free and clear and whatever you sell the home for would be pure profit!

That 18% is more than you could make in the stock market. In fact, if you bought the Dow Jones in August 2000, you'd have lost 9%, not to mention the money you spent on Maalox. This is one reason why diversifying your portfolio makes perfect sense.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

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