Smart401k Blog

By Matt Koppenheffer for Smart401k

When terms are thrown around as often and as liberally as “emerging markets,” it can sometimes be pretty easy to take the idea for granted and never step back and say, “What exactly does that mean?” So what are we talking about when we say emerging markets?

One way to start might be to look at the antithesis of an emerging market — what we might call an “emerged market.” An obvious example of such a market is the US, where we have a mature, industrialized economy, robust capital markets, and highly developed regulatory bodies. We could also take that mold and apply it to a bunch of other economies globally such as the UK, Japan, Canada, Australia, and the Netherlands — to name a few.

Now on the flip side, we could also look at the countries that are known as LDCs, or less developed countries. These are the countries that still have a lot of work to do before they become major players in the global economy. Often, political conflict or civil war has prevented these countries from making a real push towards industrialization. This group includes countries like Sudan, Cambodia, the Democratic Republic of the Congo, Afghanistan, and Haiti.

So where does this leave us? You may have noticed that some of the most exciting, high growth economies have not been mentioned yet — countries like China, India, Brazil, and Russia. Well guess what? These are actually part of the group that are defined as emerging market countries. This group of countries is well into the process of industrializing and creating robust and dynamic marketplaces for both goods and capital.

But we have to be careful not to pigeonhole the four countries mentioned above as the only emerging market countries. Those four have become the most well known of the emerging markets countries partly because of their size and fast growth, but also thanks to the handy mnemonic “BRIC” (Brazil, Russia, India, China) that was introduced by a 2003 research report from investment bank Goldman Sachs. However, the category also includes a variety of really exciting, though sometimes overlooked, countries such as Israel, the Philippines, Mexico, South Africa, Saudi Arabia, Turkey, South Korea, and Indonesia.

Now that we have a better sense of what we mean by emerging markets, the next logical question might be why we’d want to invest in them. In the enduring words of Bill Clinton: “it’s the economy stupid!” Or rather the growth in the collective economies of these countries. It’s hard to read anything in the realm of international business without hearing about the astounding growth in countries like India and China. And for investors, great economic growth typically goes hand in hand with bullish stock markets.

So the bottom line is that having some exposure in your portfolio to these high-growth countries can be like throwing some espresso in with your coffee — it can give your portfolio a little extra boost.

Well then, if that’s the case, we might logically wonder why it wouldn’t be best to just abandon the slow, plodding growth of the US and Western Europe for the excitement and high returns of the emerging economies. To carry forward the coffee metaphor a bit further, imagine if you abandoned your regular morning cup of coffee for an entire mug full of espresso. There might be some undesired consequences from such a move.

Though the emerging markets are quite attractive from an investor’s perspective when it comes to potential returns, they also carry quite a bit more risk than their already-emerged counterparts. In other words, these are economies that are still very wet behind the ears. It may be easy to forget when considering the size of China and its growing international clout, but the regulations and the governance in that country do not have a particularly long track record and there’s no guarantee that it will continue to keep the economy as open as it is or endorse the kind of pro-shareholder policies that, say, Americans are used to. Of course, China is only one example — the political and economic climate in China may even seem tame when compared to other emerging economies such as Russia, Colombia, the Philippines, Pakistan, and Jordan.

Just a decade ago, a financial crisis in Southeast Asia showed exactly why it pays to have selected exposure to these economies. A bubble in asset values in Southeast Asia led some countries — particularly Thailand — to prop up their currencies. When it became clear that this wasn’t going to be a long term solution and the countries began floating the currencies again, the bottom fell out and the region was plunged into economic crisis.

That type of outcome is a relatively unlikely one when it comes to investing in emerging markets. However, the fact that the risk is a real one is the reason that, while having some exposure to emerging markets is a good idea, it should augment a portfolio that’s grounded in stable holdings in developed markets.

You might say that your emerging markets holdings should be the delicious slice of cheesecake after dinner, but never your steak entre.

By Scott Revare CEO, Smart401k.com

 What a ride we had this past quarter. Here are a few notable highlights:

• The US Stock Market (as measured by the S&P 500) hit a record historic high on July 19^th.
• From July 19^th to August 15^th 19 market days - the market dropped 9.4% - almost an official market correction.
• 36 market days later, on October 5^th the market recovers the 9.4% drop and hits a new historic high.
• USA Today noted that since 1950, the Standard & Poor’s 500-stock index has posted a daily loss of more than 2% on an average of four days a year. Yet in just the past nine months, the S&P 500 has posted daily losses of more than 2% six times.
• USA Today also noted that the Dow Jones industrial average gained or lost more than 1% on 24 days in the third quarter the same number of times it did for all of 2006.

In a few short weeks the market showed us both its resilience and its newfound increased volatility. So as retirement plan investors with a long-term viewpoint - what lessons can we learn from this wild ride of a third quarter?

1. Hanging on for the ride can pay off.

It really came back, didn’t it? It seems like human nature leads us to want to do something to defend ourselves when confronted with bad events. We also seem to think that when the market drops, it will just keep going down. Whenever the markets drop significantly in one day, or over a few days, our customer call and email volume increases over 30% at Smart401k. People inevitably ask our advisors what they should do they seem to expect us to tell them to quickly sell - bail out before it’s too late! But the best prescription for long term investors is to do nothing - just hang on for the ride. Historically, the markets have always gone up over time. As long as you are properly invested (i.e. diversified) and have the luxury of 5 or more years to wait, history says time is on your side.

2. Prepare yourself for market volatility.

There are two important things to keep in mind during times of market volatility.  First, be mentally prepared. The worst thing you can do is let emotions take over and start making decisions that are not consistent with your long term investment approach. Take a deep breath and make sure you are approaching any investing decisions with a long-term perspective. Second, if market volatility keeps you from sleeping at night, consider changing your long-term investing strategy. By increasing your fixed income (e.g. bond) holdings, and decreasing your equity holdings (stock mutual funds), your overall investments will experience less ups and downs. This most likely means your investment returns will be less over time, but your health and well being is more important.

3. Keep investing.

The funny thing about market drops is that they usually are accompanied by large-scale pullbacks from investors. Many investors sell what they have, and even more stop their contributions to their retirement accounts. Investors withdrew $12.3 Billion dollars from stock funds in August. Yes, that’s the month that the S&P hit its quarterly low. In the months since, the market hit a new high. When you know you are going to be investing in the market over many years, isn’t it better to be investing when the market is lower?

4. Stay properly diversified.

It’s easy for market movements to put your investment allocations out of whack. Different types of investments grow at different rates over time. For example, international funds have grown faster than most US based funds this year. By getting your investments back to your target allocation percentages, you are in effect selling investments that are relatively higher priced, and putting your money in investments that are relatively lower priced, since they haven’t grown as fast. This seems counter-intuitive, as you would naturally think you should keep investing in something that has been going up. But this approach ensures that you are moving money out of investments that have already experienced higher than market-average growth before those investments inevitably experience a drop back to market averages. You are in effect œselling high and buying low.

If you stick to your long-term investing strategy and ride out any market gyrations, you put time on your side working to your advantage. Historically speaking, that’s a good thing.

Value funds have not had nearly the year so far that growth funds have, though with a gain of 7% large cap growth has been able to outpace both small and mid-cap value funds. Since many of the traditional defensive stocks fall in the large cap value category, the market volatility and the threat of recession has helped buoy this group.

With continued high oil prices, it’s not surprising that the oil majors in the group such as ExxonMobil, Chevron, and ConocoPhillips have bolstered the year-to-date performance of the large cap value funds. These stocks are up 23%, 30%, and 24%, respectively. Companies related to oil production such as Halliburton have also had a strong year so far.

Though technology names typically make less of a showing in value funds than growth funds, large cap value has seen some spillover from the strength in technology this year. Year to date IBM and AT&T are both up 22%, while Texas Instruments has gained 28%.

On the downside, large cap value funds do have significant exposure to the weakness that has hit the financial sector due to the housing and credit market problems. American International Group, JPMorgan, and Bank of America are all down single digits for the year, and Citigroup has lost 13%.

By: Matt Koppenheffer for Smart401k.com

Benjamin Graham was a finance professor at Columbia University and is known to this day as “The Father of Value Investing.” He taught some of the most renowned investors including Warren Buffett, Bill Ruane, and Walter Schloss. He also wrote one of the most influential investing books, The Intelligent Investor.

In The Intelligent Investor Graham tells a story about a man he calls Mr. Market. In the story, Mr. Market is a business partner of yours. Every day Mr. Market comes to your door and offers to either buy you out of the partnership or sell you his stake in it.

But here’s the catch: Mr. Market is a bit manic depressive. Because of this, on some days he’ll come to the door feeling jubilant and will offer you a high price for your share of the business and demand a similarly high price if you want to buy his. On other days, Mr. Market will be inconsolably depressed and will be willing to sell you his stake for a very low price, but will also only give you the same lowball offer if you want to sell your stake.

On any given day you can obviously buy from or sell to Mr. Market, but you also have the option of completely ignoring him. If you do ignore him, he never holds it against you and always comes back the following day.

Now Mr. Market the man isn’t real, but the stock market behaves a lot like the fictional character. Every day we can pull up quotes for various stocks or for the entire market as a whole. If we think the prices are low in relation to value, we can buy; if we think prices are high in relation to value, we can sell; and if prices fall somewhere in the grey area in between, we’re never forced to do either. And every day (every weekday at least) the market does its thing all over again no matter what we did or didn’t do the day before.

The catch here is that though Mr. Market offers some great deals from time to time, investors have to be alert and ready when those offers come up. Investors have two options when it comes to this. The first is to do the analysis themselves and take up Mr. Market on his offers directly. While many individual investors are very successful with this, it requires a lot of knowledge, time, and, most of all, interest.

Fortunately, for those that don’t have the time to or aren’t interested in tracking the markets there are mutual fund managers that are ready and willing to roll up their sleeves and do the work for them. When taking this route, though, the investing dynamic changes. Instead of focusing on patience and diligent analysis, the focus should be on steady, consistent investing.

The reason for this is that it is very tough for investors that aren’t doing their own analysis and closely following the market to accurately gauge where the market is headed. Many investors try to do this anyway, and the unfortunate result is that they tend to invest more when Mr. Market is in one of his overexcited moods, and stop investing altogether when Mr. Market is depressed and offering the best deals. When investing with a fund manager, making regular contributions over an extended period of time allows an investor to build an ever growing retirement portfolio while leaving the specifics of where and when to invest to the fund manager.

Of course, picking the fund manager(s) is a topic in and of itself!