Smart401k Blog

In the headlines

A look at some of the market movers over the past week:

• BHP Billiton (NYSE: BHP) announced a strong quarter on the back of rising commodity prices
• Home prices are continuing their slide
• Profit at Home Depot (NYSE: HD) continued its slide in the second quarter, but beat estimates
• Shareholders green-lighted the acquisition of NYMEX (NYSE: NMX) by CME Group (NYSE: CME)
• Lehman Brothers (NYSE: LEH) may be getting ready to sell its asset management business — that’s if it can avoid being the target of a hostile takeover
• Hewlett-Packard (NYSE: HPQ) managed to top Wall Street’s expectations
• The producer price index for July was well above what was anticipated
• Crude oil continued to be volatile and finished the week up slightly
• Yet more investment banks reached agreements regarding auction rate securities
• Gap (NYSE: GPS) managed to post better-than-expected earnings

Commentary

An upswing in the second half of the week couldn’t make up for a rough start and the S&P 500 fell 0.5% on the week.

There’s really not a whole lot to say about the past week, as it progressed largely as expected. Though earnings were still coming out, the market has already largely looked past them and on to next quarter and second half earnings, along with the broader economic picture. So the market moved largely on speculation about where the economic downturn is in relation to the bottom, as well as how much further financial companies will have to write-off. As has been the case in recent weeks, Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) were at blame for a lot of the negative headlines during the week.

Meanwhile, oil continued to play a big part in investor sentiment. Global political concerns, specifically regarding Russia, sent oil up, though not by much. The size of the increase of producer price index did raise eyebrows, though inflation concerns continue to be damped at least to some extent by the moderating commodity prices.

Looking ahead

Expect the unexpected next week — again. There will be a few important economic reports out next week including a report on second quarter GDP, the minutes from the most recent Federal Reserve meeting, consumer confidence, consumer sentiment, and personal income. Any one of these releases has the ability to move the markets if the actual results are out of line with expectations. Keep in mind that there will be a lot of talk about the fact that GDP in the second quarter — which is expected to have grown at a 2.7% annual pace — got a big boost from the government’s tax rebate program.

The coming week is the last big week of earnings before reports start settling down again in anticipation of the end of the third quarter. The market will likely overlook most of the earnings reports next week as it continues to focus on the bigger picture issues.

Once again, look out for speculative reports about Fannie, Freddie, Lehman, and their ilk to be the primary factors in the market next week along with continued debate about the condition of the economy. If the market repeats its pattern of the past couple of weeks, pessimism will rule the roost early in the week before the outlook softens at midweek and finishes just slightly up or down.

While there are plenty of very smart people out there — economists, stock analysts, and the like — that are analyzing the economy and the markets, trying to base an investing strategy on them is likely to prove frustrating at the least and disastrous at the worst. The reason is that most of the time for every bright, accomplished analyst who holds a certain opinion, you will be able to find a similarly bright and similarly accomplished analyst who has an equally convincing and diametrically opposed viewpoint. At the same time, the speed at which markets move and the extent to which they try to anticipate turns means that by the time great numbers of smart folks start to agree, it’s already too late to act on those opinions.

So what’s the solution? You got it — stay out of the guessing game completely and maintain a well crafted, steady investment plan that you continue to contribute to through thick and thin.

It’s almost that time of year again – the time where you begin to trade your Sundays on the lake for some time in front of your TV, eagerly hoping that your favorite football team finally has a successful season.  Being a Chiefs fan for as long as I can remember, I’m not expecting good things anytime soon.  Luckily though, I am also involved in our work-sponsored fantasy football league, ensuring that my Sundays will almost certainly be unproductive for the next few months.   

For those who have not played before, the basic setup is you first draft your team and then each week you compete against one person in your league.  Scores are calculated based on the real performance of those players you select, and the person with the highest score earns a win for that week. 

In preparation for our draft last night, I realized that the process I took to decide which players I would pick was very similar to that of the investment selection process:

·       Do your research.  In fantasy football, you look at each player’s track record of success, whether they are working with the same coach, health status and their outlook for the season based on any other factors you know.  You should also research your investment options as extensively as you can, by looking at the fund type, past return history, manager tenure, performance outlook, etc.

·       The future is uncertain.  Because you do not actually know whether your picks will be good or not, you manage your risk as much as possible by making informed decisions.  Remember that past performance does not guarantee future results in either situation; you shouldn’t pick a player based completely on last year’s performance and you shouldn’t just select a fund based only on recent returns.

·       Monitoring your selections is important.  Just as you need to make sure your players are healthy and performing in fantasy football, you need to also periodically evaluate how your investments are doing.  We recommend doing this once every quarter.

·       You will inevitably make mistakes and there will be some surprises.  What seemed like a fool-proof pick early in the season may turn disastrous later (e.g. your star player gets hurt); or maybe a relatively unknown player has a career year and unexpectedly gives one owner a huge boost.  Maybe you mistakingly drafted your quarterback too soon, which left you with lower quality picks later.  The same is true with picking investments; some things could have been prevented, and others are completely beyond your control. 

What looked like a solid investment when you picked it may suddenly take a big downturn, or an unproven investment takes off and becomes your portfolio’s biggest star.  Perhaps you became overly aggressive when the markets were doing well, and have now experienced huge losses during the downturn.  The important thing is that you learn from previous experiences and make changes that are appropriate for your situation.

And I could go on… but remember that this is an ongoing process.  Proper investing requires some attention periodically to make sure you stay on course with your current goals and objectives. 

The last connection I want to make is one major diffence between the two.  From past experiences, and all the message boards I’ve read leading up to our draft, my conclusion is that people make more informed decisions and are more prepared for fantasy football than they are about investing.  Of course, I don’t know this for sure, but people are certainly more enthusiastic about it anyway.   There are also more accessible resources for draft-day strategies; you can print off a cheat sheet five minutes before your draft and still be pretty well-prepared to make some decent decisions (cheat sheets are prepared by fantasy football ‘experts’).  The same is not true for investment strategies. 

Even though you may know that investment selection is probably more important than something like fantasy football (or any hobby for that matter), it’s easy to understand that it’s not terribly exciting.  For those that are interested in making better investment choices, many do not know where to turn or how to even begin getting the guidance they need. 

A couple of basic sites that I suggest to get started are:

http://morningstar.com/

http://finance.yahoo.com/

These sites will allow you to research any publicly-traded funds that you have available in your retirement plan.  Look for funds with good track records, and be sure that the managers have been with the fund long enough to take credit for the past performance.  Also, pay attention to the types of funds you are looking at; you shouldn’t have too much exposure in any one single asset category.  There is no set amount of time you should spend researching your options, but the goal is to at least have a gameplan set in place before you start picking your investment options.

For those that are getting stuck at this point, or just don’t have the time necessary for this process, do not give up – the quality of your retirement may depend on it. 

If you find yourself looking at the list of funds in your work-sponsored retirement plan, and wondering how to begin building your team of investments, please consider allowing us to assist you.  We will put together a strategy that makes sense for you so your investment ‘draft’ goes as successful as possible.

 Kevin Jaegers, Senior Investment Advisor

In the headlines

A look at some of the market movers over the past week:

• Apollo Management (Nasdaq: AINV), GSO Capital, and TPG are buying some $8 billion of leveraged loans from Royal Bank of Scotland
• The extra measures to prevent naked short selling expired on Tuesday
• NBC, a GE (NYSE: GE) subsidiary, is capitalizing on its Olympic coverage
• Swiss bank UBS (NYSE: UBS) posted another big quarterly loss and announced that it will split its wealth management and investment banking divisions
• Wachovia (NYSE: WB) joined JPMorgan (NYSE: JPM) and others in settling with investors over auction rate securities
• Apple’s (Nasdaq: AAPL) much hyped new revision to the iPhone seems to be selling even better than had been expected
• Goldman Sachs‘ (NYSE: GS) stock took a hit as rival investment banks downgraded the stock due to Goldman’s high amount of exposure to global equity markets
• CVS (NYSE: CVS) announced the acquisition of Longs Drug Stores (NYSE: LDG)
• H&R Block (NYSE: HRB) announced the sale of its financial advisory business to Ameriprise Financial (NYSE: AMP)
• Wal-Mart (NYSE: WMT) posted solid profit growth and raised its full year outlook
• General Motors‘ (NYSE: GM) shares suffered after Moody’s (NYSE: MCO) cut their debt rating
• Retail sales fell, largely thanks to lower auto purchases
• Inflation readings continued their upward march
• Famed hedge fund manager George Soros made a big bet on Brazil’s Petrobras (NYSE: PBR)
• Existing home sales are still not showing a bottom

Commentary

Amidst a slew of earnings and economic data, the market stayed basically flat this week. The 1.2% drop on Tuesday was the largest move of the week and was balanced out by moderate up days on Monday, Thursday, and Friday.

Uncertainty is still the buzzword in the market. Financial companies are having a major pull on the indexes and investor sentiment in general, as it’s yet unclear whether they have already recognized the worst of their losses. At the same time, investors still aren’t sure what to make of the broader economy. Currently it is teetering on verge of recession, but there isn’t a consensus on which direction it is headed.

Meanwhile inflation continues to climb ever higher on screaming food and energy prices. The 5.6% year-over-year increase reported this week is far above the reported “comfort zone” of the Federal Reserve. Investors, however, have been feeling more sanguine about inflation lately due to the heavy drop in oil and other commodity prices.

Looking ahead

After such a busy week this week, next week will be somewhat lighter — at least when it comes to economic and earnings reports.

We still have a couple weeks of relatively heavy earnings reports left, but the atmosphere seems to be winding down as compared to the beginning of the reporting season. Next week will bring some big names like Home Depot (NYSE: HD) and Gap (NYSE: GPS), but we can probably count on the financial companies continuing to steal most of the spotlight.

On the economic front, reports will be much lighter and what we will see next week will be of lower consequence than what we’ve been getting the past couple weeks. Because of the moderating energy prices, investors will likely overlook the producer price index unless it is far above expectations or core PPI makes a big jump. The weekly initial claims and crude inventory reports could prove to be the highlights of the week.

My expectation is that media attention and market sentiment next week will more likely be set by one-off reports from Wall Street and media analysts. These will be of similar content to the reports we’ve been getting for the past year — someone either saying that financial stocks have bottomed or they haven’t or else saying that the US is either in a recession or it’s not. Trying to keep up with the myriad opinions out there on these topics is probably not worth your time since by the time you finish reading one opinion somebody else publishes another opinion that contradicts it in whole.

The best plan for your retirement money right now is to keep it invested according to a diversified allocation, and continue adding to it on a regular basis. The best plan for your psyche is to take the market’s crazy gyrations with a grain of salt — or else stop looking altogether.

One of the goals I have for my blog articles is to help educate you on the basics of investing and managing your portfolio. In my opinion, education is the most effective way to gain the knowledge necessary to appropriately and successfully prepare for retirement.

Recently, we have been hearing the term inflation and I thought I would explain why inflation is so significant, and how it relates to your retirement portfolio.  

Inflation, simply put, is the rise in prices of goods and services and the loss of purchasing power of your money over time.  This means that your savings in today’s dollars will not be able to purchase as much tomorrow as you are able to purchase today.  For example $20 in 2008 has the same buying power as $7.53 in 1980 and $20 in 1915 has the same purchasing power as $433.30 in today’s dollars!  History shows that inflation has averaged approximately 3-4%a year.  For example, prices rose an average of 2.4% in the 1960’s, 6.7% in the 1970’s, and 5% in the 1980’s. (www.bls.gov)

Inflation represents the minimum return you must generate with your investments to maintain the “value” of a dollar you have today for when you spend it in the future.  Let’s say inflation is 3% a year.  In order to purchase what you can today next year (disregarding non-inflation related price increases) you need to generate a minimum of 3%.  Taking it a step farther and you’ll find that inflation also affects the “real” return generated by your investments.   If you have a mutual fund that generated 8% in a year with 3% inflation your real return is 5%.

We cannot predict what inflation is going to be in the future but when you choose your investments, you will always need to consider the long-term effects that inflation will have on your returns.   The impact of inflation on your portfolio depends on the type of securities you hold. Everyone, no matter if you hold all cash or all stocks, is affected by inflation.  Individuals living off a fixed income are typically the most affected by inflation (they receive the same amount per month which in turn purchases less and less as time goes by) while individuals with exposure to the stock market theoretically are the most likely to have investments that exceed the rate of inflation and as a result have the ability to purchase more with their invested dollars.

Inflationary risk is just one of the many risks associated with investing and unfortunately, it is often overlooked when assembling a retirement goal or plan.  I’ll try to continue to cover the areas I feel are important for individuals to be aware of, but if you guys have any that you’d like to know more about please let me know by posting a comment to this post of by sending an email to info@smart401k.com.  And as always, please feel free to contact us by phone or email if you have any questions that you’d like to address on a one-to-one basis with myself or another one of our advisors. 

Jessica Slaters, Investment Advisor

As many of you probably do, I read the Wall Street Journal as often as possible.  Last week, I read an article detailing how West Virginia had recently switched back to a pension plan from a 401(k).  I initially focused on the article because “401(k)” was in the title, but became more interested as I read about the issues that brought about the change of heart.  Upon finishing the article I was both concerned for those adversely affected and reinforced in my belief of the importance of impartial, unbiased advice for participants.

Let’s start with a quick recap.  The state of West Virginia switched to a 401(k) because like many employers they were facing continually increasing costs from their defined benefit (”db”) plan.  When they decided to switch to a 401(k) they instituted a generous employer contribution of 7.5% vs. the most common private sector match of 50% on the dollar up to 6% of an individual’s salary.  The plan offered stock and bond mutual funds, a money market fund, and an annuity.  Seems like a pretty good set-up… right? Well, besides the fixed annuity part, but that’s a personal opinion.

So what went wrong and forced the state to switch back to a defined benefit plan?

First, the state actually lowered the amount employees were required to contribute to the plan (6% in the db plan and only 4.5% in the dc, or defined contribution, plan).  A large employer match is great and certainly helps individuals prepare for retirement, but lowering the required contribution each individual had to make seems a bit odd to me.

Second, the plan had a fixed annuity option.  I imagine there are situations where a fixed annuity makes sense for an individual. However, I struggle to think of a reason why almost 2/3 of plan assets should be invested in one, which according to the article was reached at one point during the plans existence. (If you want to learn more about annuities, check out our Primer on Annuities) 

Now while I don’t understand why you would invest in a fixed annuity in a dc plan, I do understand how it happened.  The story mentions that Valic (the company that offered the fixed annuity) sent in salespeople to talk about the annuity.  In fact many of these salespeople were former educators and school employees.  While I’m all for knowledgeable advisors working with participants to build appropriate investment plans, I have a problem with individuals who are “not authorized or directed to give investment advice” but who are “… only authorized to sell a fixed-annuity contract.”  Inherently, this relationship is going to be rife with potential conflicts.  First, a salesperson is incented to sell a product.  Second, if you are a knowledge resource shouldn’t you be able to talk about other investments or the pension plan as a whole… especially in something as important as retirement investing?

So what does this mean?

I urge everyone who reads this post, no matter if you are a participant or employer, to do the research necessary to select appropriate investments.  Or if you aren’t interested (or don’t think you have the knowledge) please consider using an advice provider.  I’d love for it to be Smart401k, but would find it gratifying simply to know that you are taking control of your investments.

If you are an individual and want more information on Smart401k click here or contact one of our advisors who are authorized to provide advice.  If you’re an employer and want to know more about how we can strengthen your plan and educate your employees click here to request more information.

If you have any questions or comments, feel free to post of comment to this article or call us at 1-877-627-8401.

Till next time…

Scott H

Full Disclosure: My knowledge about the situation is entirely contained with the WSJ article “When 401(k) Investing Goes Bad” that was published on Monday, August 4, 2008.