Tag Archives: stock market

They’re Down, They’re Up. Who can handle the volatility?

Posted by on May 13, 2010 No comments
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Scary stuff, isn’t it?

The Dow Jones drops 1000 points in a matter of minutes, and you can feel the panic from investors.

To be honest, I actually didn’t see it.  The market appeared to be having a really bad day without mistakes, so I went to the gym to blow off some of the volatility.  I came back to emails and videos of mass hysteria.  Technology certainly does nothing to calm the nerves as it relates to the markets.

What ended up happening is the markets logged their worst week in a long time (the excuse was Greece, but I’ve already been over that enough).  Just looked like the markets were in the mood for a pullback.  Still, the large increase on Monday and then the swing upwards yesterday could also exasperate investors.

This is where long-term investors tell you that it is important to stay invested.  And they are right.  The average investor loses out for precisely one reason:  They sell in a panic, rather than with a disciplined approach.  If you are a long-term investor who has no discipline, the best thing you can do is never, and I mean NEVER turn on CNBC, or Fox Business, or CNNMoney.  These programs will give you a coronary, whether you are prone to them or not.  Further, don’t check your account balances daily.  The feeling of euphoria on “up” days, is half as strong as the feeling of despair on “down” days.

Seriously, stay away from looking at it.  Even if you do it yourself.  It’s not going to help you.  If you have a plan, stick to it.  If you don’t, get a plan.  Because it is a sure bet you’ll fail if you have no plan.  Once you have a plan, and don’t look at things on a microscopic level, you will be the one who can handle the volatility.

How Do Annuities Make Guarantees?

Posted by on May 5, 2010 No comments
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I recently had someone ask me how insurance companies are able to make the guarantees on the annuities they sell to people.

Because of the recession, continuing economic downturn and the volatility of the stock market, droves of people have been putting their money in guaranteed instruments (CDs, Annuities, Treasuries).  The obvious question is, what do they guarantee?

It depends.  Some guarantee a return of principal (your original investment).  Some guarantee lifetime income.  And still others guarantee a certain rate of return.

The answer to the question about how they make those guarantees is a little more complicated.  The first answer is fees.  A variable annuity, “all-in” for expenses can cost nearly 4% of your money per year.  Not all are like that, but there are several layers of fees.  If it is a variable annuity, they are charging M & E (Mortality and Expense) which is a fancy way of saying that they are protecting the insurance company from you living too long or if they have to pay out.  There is also the mutual fund fees (what gives the annuity “growth).  And any riders (guaranteed income rider, etc.).

Fixed annuities don’t work like that.  Basically, the insurance company invests the money you give them and gives you the fixed interest rate, keeping the difference for themselves.

Another answer is that insurance companies are required to keep enough capital so that they can pay out all of their claims should they have to.  That can be quite a bit of money, but they usually manage to do that.  In the event that they cannot pay all of their claims, often another insurance company will buy the contract.

Then there are fixed indexed annuities (or FIAs).  These were formerly called Equity-Indexed Annuities (EIA’s).  Basically, these annuities guarantee a fixed rate of return (2% or something to that affect).  The insurance company takes the money you give them and invests it in bonds (or some other fixed income security).  They utilize the income off of the bonds and a portion of the principal to buy call options.  Some of the income off of the bonds is used as your “guarantee”.  The call options are usually bought on a specific index (example the S & P).  If the S&P 500 goes down, the options expire after a set time period worthless, and the client receives the guaranteed amount.  If the S&P 500 does nothing, then the options expire worthless, and the client receives the guaranteed amount.  If the S&P 500 goes up enough so that the options have increased in value, then the insurance company exercises the option, “calling” the stock to them at a lower price, then selling it at the premium price immediately.

Using a specific crediting formula, the insurance company gives a portion of that gain to the annuity holder.  In good times, this can result in a pretty decent return on your annuity.  In bad times, it protects your investment.  But how is the insurance company making money?  They take a portion of the gain, which may or may not be significant, depending on the contract and insurance company.  With so many people fleeing to annuities, they have reached economies of scale so that they can offer better terms.

It is possible to have the benefits of an annuity without actually paying an insurance company.  There have been reports of unscrupulous annuity salesmen.  These people are in the minority.  There are good annuity salespeople out there that want to do the right thing for their clients.  That said, be careful what you sign.  Just because someone guarantees you something, doesn’t mean there isn’t a catch.  Have a third party advisor or insurance expert look at the contract before you sign it.

Why You Shouldn’t Get Your Stock Picks From Your Fitness Trainer

Posted by on February 22, 2010 No comments
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This was supposed to be a presentation that I was going to give at Ignite Raleigh.  Unfortunately, stock picks didn’t seem to be the interest of most people.  Social media was the primary focus.  Everybody wanted to know how to use Twitter, Facebook, et al for marketing and advertising purposes.  Those are great, but I feel I would be doing you all a great disservice if I didn’t at least write about it.

The premise isn’t so much fitness trainers, just that fitness trainers gave me the idea.  I have known personal trainers who give out stock tips to their clients as if they are serving double duty.  Which I guess I shouldn’t complain, when people ask me about workout tips, I usually provide them.  With the caveat that I really don’t know what I’m talking about and anything I tell you is third hand.  Kinesiology and nutrition and some other terms that I’ve never studied are complex.  A lot like investments.  So I am the first to say I am no expert.  After all, I work out six times a week, figure I eat healthy, and can’t drop a pound to save my life.

My reason for writing this is not so much the lack of expertise among the fitness trainers (they could be well studied in capital markets and understand securities more than the average person and maybe even more than some investment advisors), so much as the lack of understanding about the particular investor.  Which is what gets me going about financial opinion writers/pundits/tv critics.

Unable to tear my eyes from the television, I watch these shows and marvel at the dearth (10 dollar word) of bad advice being given out.  Not because the advice is bad, just that those providing it have no idea whether or not they are giving the right advice.  A good example would be recommending to someone who is obese that they need some more fat in their diet.  We don’t know if the advice fits.

So it is fascinating to me to see these people on television.  Let’s start with Cramer.  Booyah, anybody?  Jim Cramer is a former hedge fund manager who used to work at Goldman Sachs.  Jim Cramer is a smart guy and he is also a very animated guy.  He is also wrong quite a bit.  Oh, not about the stocks that he picks (although Barron’s did an article a few years ago pointing out that the stocks he picked went down rather quickly), but the fact that he has no idea what else everybody has in their portfolios.  Do his picks make sense for everybody out there?  Unlikely.  In fact, they are probably a small minority of people that they do make sense for.

What about Suze Orman?  What about those teeth?  Those teeth are nice and bright, and can be a little scary… but what about her advice?  Suze makes an effort to gather some information.  However, that information gathering is cursory and there is no verification.  Plus, others who may be in similar situations may apply her advice to theirs, but may be off because of other circumstances.  Suze is also smart and has done quite well for herself.  But here she is wrong.  Not because she isn’t good at what she does, but because she is providing advice out of context.

And everybody’s favorite, Dave Ramsey.  Dave Ramsey has made quite a name for himself.  Poor guy has had to file bankruptcy before and advocates zero debt.  Forget credit scores and the like.  Pretty much the opposite of Suze Orman.  Well, Dave does what they all do.  Provide blanket advice for problems that the advice may not fix.  Or even address.  I know I am getting pretty close to blasphemy here, but really it is getting quite out of control.

But what about you Mike?  You write things on this blog all of the time and you don’t know about my situation.  That’s true, I don’t.  But the advice I provide generally talks about being careful about making those decisions and often involve asking you to consult a professional (me or someone I think you should talk to).  Also, I never give specific recommendations, as that would be irresponsible and really should be illegal.  Why?  Because I don’t know your situation.  In order to properly give advice, a professional needs to know the situation.  Physicians read your charts, attorneys use discovery and financial advisors ask you questions and look at your financial statements.

So why shouldn’t you get your stock picks from your fitness trainer?  Because he doesn’t know your specific situation.

Correction? Did someone misspeak?

Posted by on February 15, 2010 No comments
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What is a correction? Well, the web definition is “that which is substituted in the place of that which is wrong” or “rectification, the act of offering an improvement on a mistake; setting right”. Of course, since this is a financial blog, we are talking about a market correction. Mostly because any time you turn on a financial show, they are talking about how “the correction is coming!” Ahhhhh, run for the hills!

I’ve been wanting to write this blog post for a while, but I figured I’d wait until we were already close to a correction so that it would be a little more relevant. That way, hopefully there won’t be a huge level of panic when we actually reach the correction mark.

A market correction is defined as a reverse movement, usually downward, in the price of an individual stock, bond, commodity or index. The percentage change required in order for it to be considered a correction is 10% or more. If the prices do not recover fairly quickly, then most analysts think that there will be a bear market. For those who think that: News Flash! We have been in a bear market for quite some time.

What most are talking about however, is a correction to the recent rally from last March. Some feel that prices rose too quickly and thus a correction will occur. In and of itself, and in the grand scheme of investing (especially if you have a long time horizon), corrections aren’t bad. They are simply an adjustment to the market when securities have become what is known as “overbought”, which just means what it says.

So, did the market rise too far too fast? Well, some people certainly think so. The interesting thing is that everybody has an opinion on this (including me), but that opinions are not what moves the markets, investors are. But if investors are scared that a correction might occur, what will happen? The market will become “oversold” which creates a buying opportunity.

But wait Mike, you say. The markets are efficient, everyone says so. Well, if the market can be oversold and overbought, I submit that in fact the market is NOT efficient. In fact, in volatile times like this, I’m would compare the stock market to a Hummer that gets 6 miles per gallon. Terribly inefficient.

What is the point of all of this? Don’t fear a correction. When the market corrects, it’s a little like when you first started driving. You always over-corrected when you changed lanes or turned or recovered from a turn. You usually will get where you are going, you just might get out of whack on the way there. Bottom line, use downward price movements to add to your portfolio in a tactical manner (read: Don’t just buy some random stuff).