Smart401k Blog

In the headlines

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

• Drug maker Roche unveiled an offer to buy the piece of Genentech (NYSE: DNA) that it doesn’t already own
• The rough ride for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) continues
• A tepid forecast from Apple (Nasdaq: AAPL) put pressure on the stock
• Tech equipment maker Brocade (Nasdaq: BRCD) announced a $3 billion offer for Foundry Networks (Nasdaq: FDRY)
• Commodity costs led Costco (Nasdaq: COST) to forecast earnings below what Wall Street had been expecting
• Yahoo! (Nasdaq: YHOO) missed earnings estimates, but investors were encouraged that it wasn’t as bad as feared
• Washington Mutual (NYSE: WM) reported the largest quarterly loss in its history
• Oil prices continued to fall, as did corn
• Minutes from the last Federal Reserve rate setting meeting showed that two of the Fed’s officials voted to hike rates
• Though Amazon.com’s (Nasdaq: AMZN) margins compressed, strong sales growth led to big gains
• The Federal Reserve’s beige book report showed a weakening economy, but held few surprises
• Foreclosures continue to soar, particularly in hotspots like Las Vegas and Miami

Commentary

Though the week ended with the market down just slightly, it finished with some more pessimism in the air than when it began.

The market seemed to carry some of the momentum from the prior week into the beginning of this week, and was up over 1.5% by Wednesday. Additional strength early in the week came from better than expected earnings reports from financial names like Bank of America (NYSE: BAC). Oil, which continued to decline, also helped buoy the market.

The gains in the first half of the week, however, were wiped out and then some on Thursday as the S&P 500 fell 2.3%. Media coverage tied the decline to the disappointing existing home sales report. Despite the coincidence of the report and the market’s dive, it seems more likely that the bulk of the decline was driven simply by investors getting concerned that the financial sector is still not out of the woods. Through Wednesday the Financial Select Sector SPDR (AMEX: XLF) had gained nearly 11% since the beginning of the month, including a big 13% jump the prior Wednesday. That index fell almost 7% on Thursday.

Looking ahead

Between mid-April and the end of May we had a respite from the heavy volatility that held court during the first few months of the year. Since the beginning of June, however, there have been five days with market swings of 2% or greater, suggesting that once again investors are very unclear about what the future holds.

Moving into next week, earnings will largely be the story. Knee deep in second quarter earnings season, investors will be listening closely for updated guidance from companies on what they expect the rest of the year to look like. Expect a lot of major companies to be heading to the earnings podium — on Monday and Tuesday alone Kraft (NYSE: KFT), Verizon (NYSE: VZE), BP (NYSE: BP), Coach (NYSE: COH), Electronic Arts (Nasdaq: ERTS), Northrop Grumman (NYSE: NOC), and United States Steel (NYSE: X), among others, will report.

It’s also going to be a big week on the economic side. Tuesday kicks off with consumer confidence from The Conference Board. The expectation is that the reading will fall slightly from the prior month, however, there is clearly fear out there that the number will be worse and reflect the dour mood among consumers. The employment report follows on Wednesday which will be supplemented with the unemployment rate later in the week.

On Thursday we’ll also get the second quarter reading on GDP, which is sure to attract a lot of attention. The economy notched an anemic 1% annualized growth rate in the first quarter, but the market is expecting a markedly better 1.8% for Q2, and the briefing forecast calls for an even more robust 2.8%.

Be sure to tune back in at the end of the week for a wrap-up of what ends up transpiring. In the meantime, I will — as always — urge that you take the market’s manic moves with a grain of salt and stick to a steady investment program.

In a previous article “The Importance of Rebalancing” our Senior Investment Advisor, Kevin Jaegers, wrote about the importance of keeping your portfolio at the desired risk level by rebalancing.  He mentions that to achieve your desired risk level you will have a portfolio that has a mix of cash, stocks and bonds, or a portfolio that is diversified.  This week, I thought it would be appropriate to focus on diversification and to shed a little light on why this popular investment strategy is so important.

We have all heard the saying “don’t put all your eggs in one basket.”  When it comes to investing diversification is essential, without it, you run the risk of losing a significant portion of your account’s value if a single investment fails.   Your goal is to build a portfolio which will include different types of investments and different types of securities. 

The purpose of diversification is to reduce your risk by allocating your account across several different market segments and position your account for long-term success.  This does not mean that you simply select your mutual funds by random and call yourself “diversified.”  Rather its means that you will establish your core choices (Large Cap, Small Cap, International, Bonds, etc.) and then allocate the appropriate amount to each investment for your risk level and your timeframe.  In a properly diversified portfolio, the performance of all of your assets will vary and you will have some assets that go down and some that will go up or remain steady, but overall your portfolio has reduced volatility and risk.

 An investor’s timeframe can be the most influential factor when diversifying your portfolio.   Your timeframe is determined by how long you have until you retire and/or start taking withdrawals from your account.  An appropriate portfolio for the investors with a short-term time horizon would have a greater percentage toward cash and bonds to lessen the volatility on the account; this need for a conservative portfolio is because when the time comes to take a withdrawal your account is positioned where market fluctuations will have a smaller impact on the value of your account and your ability to make adequate withdrawals.   Longer timeframes provide an opportunity to invest a majority of the portfolio into stock funds because you are able to look beyond short-term market movements and the years of high returns balance out periods of low returns.  With a longer time horizon periodic (short-term) market fluctuations become less important.  A well diversified portfolio will likely have less volatility and steadier returns over the long-term than an undiversified portfolio.

When it comes to investing, everyone’s situation is different and is influenced by many factors. It is important to determine your situation before making any investment decisions.  You will first need to decide what type of investor you are and what type of portfolio will be appropriate for you.  If you find yourself struggling with this step, it is important that you get some help (feel free to contact us with any questions or comments or you can get started and register with Smart401k).  Always remember that the market will go up and the market will go down, but if you keep your portfolio properly diversified you can give yourself an opportunity to benefit from long -term growth in the market while also reducing the overall volatility and risk in your portfolio.

Jessica Slaters, Investment Advisor

In the headlines

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

• The US government announced plans to backstop Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) if necessary
• InBev succeeded in its takeover of Anheuser-Busch (NYSE: BUD)
• Investors and deposit holders alike started the week squeamish after the FDIC’s seizure of IndyMac
• The SEC got serious about cracking down on the spread of false rumors, then set its sights on short selling
• Following the US tax scandal with Swiss bank UBS (NYSE: UBS), the IRS closed certain tax loopholes
• Driven by food and energy, the producer price index jumped 1.8% in June
• Despite the government rebate checks retail sales posted a lower than expected gain
• Merrill Lynch (NYSE: MER) reported yet another big loss and announced the sale of its stake in Bloomberg
• The consumer price index also jumped in June, likewise at the hands of food and energy
• Earnings from Wells Fargo (NYSE: WFC) helped spark a major rally in the shares of banking stocks
• Citigroup (NYSE: C) posted another major loss, but beat analysts’ expectations
• Oil prices fell hard during the week and closed under $130 per barrel
• Both Google (Nasdaq: GOOG) and Microsoft (Nasdaq: MSFT) posted disappointing earnings that pulled down the Nasdaq market on Friday

Commentary

I thought last week was wacky, but it doesn’t hold a candle to this week. Worries over Fannie and Freddie along with the flop of IndyMac started the week off on a dour note and then the release of the producer price index jump made things worse on Tuesday. By the end of the day on Tuesday the S&P 500 was down 2% . But that’s when the real excitement started.

Bank earnings, SEC actions, and oil prices all came together to provide serious spark for certain areas of the market. Earnings announcements from financial institutions seemed to convince many investors that the banking industry may not be in as bad of shape as assumed. This, combined with the SEC crack down on shorting practices, had bank shares soaring — Wells Fargo finished the week up 21%, while Bank of America (NYSE: BAC) was up 27%, and Citigroup jumped 20%.

Meanwhile, oil prices finished the week just under $129 per barrel, well below their high of $147 from the prior week. The 12% dive not only helped fuel the market rally, but also stoked talk of a bursting bubble in oil prices.

Sobering the market’s run in the second half of the week were the disappointing earnings reports from Google and Microsoft. Many had expected that tech would be a safe haven from much of the economic malaise and though Intel (Nasdaq: INTC) reported positive earnings earlier in the week, the Microsoft and Google reports served to weaken that assumption.

Looking ahead

It is anyone’s guess at this point how this crazy market will start the next week. The most likely scenario is that investors will be riding the positive note of the strong performance in the financial sector, but it’s also likely that they shrug off those gains and focus on the weak Google and Microsoft earnings and the cries that any rally would just be a bear market rally.

There will be less to examine on the economic front next week — existing and new home sales will likely be the most notable points. The earnings schedule, on the other hand, is packed. We’ll continue to hear more from the financial industry in the form of earnings reports from Bank of America, SunTrust (NYSE: STI), and Wachovia (NYSE: WB), among others. But we’ll also have some heavyweight earnings calls from a host of companies in other industries including Yahoo! (Nasdaq: YHOO), Halliburton (NYSE: HAL), Amazon.com (Nasdaq: AMZN), and McDonalds (NYSE: MCD). Expect that the movement of the market next week will be a combination of the actual earnings results reported and the way in which investors read the news.

In closing, after a strong week, just as after a tough week, it’s important to remember that retirement savings is a long term endeavor and no one week or one month or even one quarter should swing your savings routing in a particular direction. We continue to recommend that the best way to sleep well and build your retirement nest egg is to stick to a consistent savings plan.

As more and more people are signing up to have the blog delivered by email we noticed that many of you aren’t fully completing the registration process. So, I thought it would be helpful if I walked you through the process:

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I am a fairly new parent, with a 2-year old son.  For anyone that is or has been in this situation, you know that there are many challenges that come along with raising a family, money being a major one.  It seems like your finances are being pulled in all directions, from normal living expenses (which seem to be constantly rising), to childcare and other kid-related expenses, and at the same time still trying to come up with enough extra to put away each month.  One of the biggest adjustments I’ve had to make with the transition into parenthood was how to best utilize our discretionary income (amount left-over after taxes and normal expenses).  There are two things I know must be planned for, retirement and college.  Tackling one of these is tough, let alone both at the same time.

Without a doubt, there are some families that will have the resources to do both without much of a problem; however, I would guess that they are in the minority.  For the rest of us, there will be difficulties in sufficiently planning for both events.

I did a quick calculation based on my situation to estimate what the total costs would be to send my son to an in-state, 4-year public college.  There are many sites with calculators, the one I chose was:

http://apps.collegeboard.com/fincalc/college_cost.jsp

The national average in today’s dollars is $12,841 annually.  This amount covers tuition and fees, books and supplies, room and board, etc.  Using a 5% inflation rate, with 16 years until college, I’m looking at a total cost of $120,814.  This is assuming he finishes school in four years (if he’s like me, it will take longer) and assumes I will have no other children (unlikely).  The reality is that most families will qualify for some financial aid, but even so, the amount needed to fund a child’s higher education is daunting.

So, the question is:  If you can really only afford to put money away for one or the other, which one do you choose? 

I, like a lot of parents, want to do everything I can to make sure my child has the best opportunity to succeed in life.  Plus, college expenses will come before I need any retirement money, so it would seem that my focus should be on college first, then retirement.  The answer that makes sense to me though is the opposite.  Here’s why I think your retirement should come first:

1. There are many ways to fund a child’s education; such as: scholarships, financial aid, student loans, etc. My son may even have to work before and during college; I did. You won’t have this kind of flexibility with retirement.

2. It takes a significant nest egg to fund the type of retirement that most couples desire. This means you have to save and save now. You can’t get a loan for retirement.

3. You may be in a better financial position to help out when the time comes. Typically, the beginning years of raising a family will be the most financially challenging (at least I hope so). Families may choose to have only one parent working, and those that are will probably be at the beginning of their careers. This is also the time that many families move into their first home.

In my situation, we are taking a combination approach.  We are funding our retirements with regular contributions to our 401(k) plans and using unexpected money that we have left-over from tax refunds, bonuses, etc. to start stashing into college savings accounts.  We are also fortunate to have parents that contribute a little each year for my son’s education.  So while this plan may be inadequate for the total cost of college, at least there is some money going to work now.  More importantly, we have a solid plan to meet our retirement goals.

There is also the possibility that he will choose another path altogether.  He may have the ability to start a successful business, join the military or just decide to work for a couple of years after high school.  I know people that saved for a couple of years, went to a community college, and then transferred to a 4-year school with very little help from their parents.  My brother went to work for an employer that offered some tuition assistance, so he just worked full time and took a little longer to finish school.  He and I both agreed that our accomplishments meant more when we were paying for it. 

Of course, being like many dads, there is that hope that he will excel at a sport and go on to become a highly-paid athlete.  You can bet I’m working on that one…his golf swing is already better than mine. 

Kevin Jaegers, Senior Investment Advisor