Category Archives: Private Equity Securities

Pursuing Both Growth and Value

March 31, 2010
Growth and value stocks have taken their lumps along with the rest of the market, but over the past 20 years these two asset types have experienced similar gains (see chart).

However, the returns from growth and value investments in any given year are not always closely correlated. Maintaining a balance of growth and value investments may help you add a new dimension of diversification to your portfolio. A good first step is to understand the key differences between these investing approaches.

Going for Growth

Growth stocks are associated with companies that tend to have a strong historic growth rate as well as strong growth potential. These companies usually don’t offer dividends because profits are typically reinvested in the company.

A growth company might have an advantage in a rapidly growing new industry or be on the verge of a major breakthrough. Because growth stocks can offer high potential rates of return, they may carry significant risk, which should be considered carefully before investing.

Vetting Value

Value stocks are typically believed to be undervalued by the market. Good candidates are often firmly established companies with solid earnings, but the market has not yet recognized their potential. A value stock investor strives to buy shares of these companies at a bargain price with the expectation that the broader market will eventually realize the companies are a good investment, potentially causing the share price to rise. Value stocks may or may not be a good source of dividends.

The return and the principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investments offering the potential for higher rates of return also involve a higher degree of risk. Diversification does not eliminate the risk of investment losses; it is a method used to help manage investment risk.

Some investors swear by growth or value investing. But by picking the best opportunities from both types of investments, you may be able to broaden your return potential while spreading risk over a more diversified portfolio.

Most Recoveries Are Announced Months After They Begin

Waiting for a Recession to End May Carry Opportunity Cost

Since 1979, when the National Bureau of Economic Research began to formally announce the beginning and ending dates of U.S. economic recessions, the U.S. economy has fallen into recession five times. In each case, the recession was between six months and one year old before the NBER was able to detect it and announce its beginning date. The bureau took an average of 15 months after a recession was over to announce when it had ended.

Recessions take a psychological toll that almost certainly spills over into the early months of a recovery. Because it can take so long for the NBER to determine when a recession began or ended, people who delay financial decisions until they are certain a recession is over are at a disadvantage because they may be operating on old information.

The NBER is a venerable organization whose role as the nation’s official recession timekeeper is widely accepted. Nonetheless, its methods are little known by the investing public. Placing too much faith in the NBER’s recession/recovery announcements without understanding what they mean may result in false assumptions and poor decisions.

Peaks and Troughs

Even though most (but not all) recessions have included two or more quarters of negative growth in gross domestic product — the widely accepted benchmark of a recession — the NBER has a more stringent definition. It prefers to focus on broader measures of economic activity, defining a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

In the NBER’s language, the economy travels through a business cycle that is marked by peaks and troughs. A peak in economic activity represents the end of an expansion and the onset of a recession. A trough represents the end of a recession, when economic activity reaches a low point that is followed by sustained growth.

When You Least Expect It

This means that many recessions occur when they are least expected, when the economy is operating at peak levels. For example, when the recession began in December 2007, the unemployment rate was 4.9% and real gross domestic product was growing at 2.1%.2 This also means that a recovery often begins at the darkest moment, when production, income, and employment are at their lowest levels.

The NBER has garnered widespread respect because it has rarely had to revise a business cycle date. It makes no attempt to announce recessions or recoveries quickly, but waits long enough so that the timing is not in doubt.

The NBER uses an array of tools and measurements to identify peaks and troughs in the business cycle, but perhaps its most important tool is hindsight, something investors don’t have the luxury to consult. Making financial decisions only when you believe the economy is on solid ground could mean missing opportunities in the critical early months of a recovery.

Are You Making These Cash Mistakes?

March 18, 2010
A majority of Americans reported cutting back on their spending in 2009. Fifty-six percent said they were eating in restaurants less often, 59% were spending less on vacations, and 36% postponed an auto purchase. In all, 76% said they had cut back in at least one area.

So it’s not surprising that the personal saving rate has been running higher than normal. It even hit 6% in May 2009, the highest point during this century.

Spending less and saving more is always a good idea, but what should you do with the money you save? Here are some common mistakes to avoid if you have been stockpiling your cash.

Locking It in Too Long

Certificates of deposit are a popular place to park money for the short term, but locking in your cash for years when rates are low means you may not be able to change course if conditions improve. Although inflation has been fairly low, many economists believe it could make a resurgence in the next few years. Inflation is bad news for consumers but good news for fixed-income investors because they can benefit when interest rates rise. If you want to put your cash in CDs, consider those with shorter maturities; they pay lower interest rates but don’t carry a high opportunity cost. FDIC-insured CDs generally provide a fixed rate of return.

Not Paying Off Debt

If you have significant personal debt, it’s usually a good idea to pay it down before you start building a cash reserve. Although you probably shouldn’t send every last penny to your creditors, keep in mind that interest expenses actually slow your ability to save money. The sooner you pay off your debts, the more you can devote to building the cash in your portfolio.

Playing It Too Safe

FDIC-insured savings accounts offer a safer way to preserve your principal, usually in exchange for a low return. In fact, the long-term effects of taxes and inflation could actually reduce your money’s spending power over the long term. A little money in the bank is essential, but it may be a good idea to put larger sums to work.

It may be comforting to have a cash position, but keeping too much in cash alternatives could result in a lower-than-expected nest egg. If you’ve got some cash on the sidelines, consider whether it’s working hard enough to help you pursue your future goals.

Don’t Forget the World

February 10, 2010
If you had to rank domestic large-cap stocks, corporate bonds, 30-day Treasury bills, and global stocks according to their risk levels, which one would you say carries the greatest risks? Given the perilous state of the world economy during the past several months, most people would probably say global stocks.

If you had to rank these same asset classes according to performance, which would you say was the top performer? Over the past 40 years, it was global stocks, despite losing an incredible 43% of their value in 2008 (see graph). Over the long term, global stocks and the S&P 500 have experienced comparable gains, but in any given year they may turn in disparate performances.

If your portfolio doesn’t include some global equities, it might be missing a key dimension. Global investing carries significant risks that are not to be taken lightly, so it is not appropriate for everyone. It’s a good idea to consider whether you are comfortable with the risks before you pursue the potential rewards.

Globalization vs. Political Instability

Developments in technology and trade agreements have opened new markets and opportunities for the world’s economies, whether they are emerging or already industrialized. However, not all nations are able to enforce contract and property rights to the same degree that has made the United States such a great place to invest. A decision to invest in another country must begin with an understanding of the political and economic forces at work in the region.

Diversification vs. Currency Fluctuations

The dollar has a record of stability that is hard to match, but its recent weakness is a reminder that dollar-denominated investments can be risky, too. Investing abroad offers the opportunity to help manage these risks by spreading them across multiple economies and currencies.

However, currency fluctuations also pose risks. If an investor’s domestic currency is strong against a foreign currency, the investor may be able to gain purchasing power when exchanging to the weaker currency. But if the foreign currency continues to weaken, any investment gains and the principal may lose value when exchanged back into the domestic currency. Staying abreast of the forces that influence a particular currency’s value is essential to successful global investing.

Stellar Potential vs. Financial Reporting

The greatest return potential is frequently associated with the greatest risks. This is true whether you are talking about a start-up company or a fledgling economy. Because the U.S. economy is mature, its accounting standards are among the most rigorous in the world. Growing economies are often marked by lax accounting standards, which can make it more complicated to perform the due diligence that is essential to finding sound investment opportunities.

The risks of global investing are numerous, but so are the potential opportunities. A decision to pursue foreign investment opportunities should begin with a thorough examination of your risk tolerance.

Beware the Better-Than-Average Effect

We’re always hearing about the “average” person. You know, the one who is 36.7 years old, graduated from high school but probably not from college, earns between $33,000 and $62,500 per year in a white-collar job, owns a three-bedroom home worth about $167,000, has 1.86 children, eats 160 pounds of sugar every year, and will live to be 78.1 years old.

That doesn’t sound like you, does it? And if it seems to you that it wouldn’t take too much effort to distinguish yourself from the average American, well, then, you are average, too.

Economists have found that, on average, people tend to believe that their own lives are improving at a faster rate than most everyone else’s. This phenomenon, dubbed the better-than-average effect, shows up in studies in which individuals are asked to rate their own personal well-being and the well-being of the country.

Research suggests that this belief may cause investors to become overconfident, leading them to underestimate risk, trade in riskier securities, overreact to private information, underreact to public information, and trade more aggressively in periods after they observe market gains.

Basing your financial strategy on inflated expectations could be a costly mistake. Imagine planning for a 12% return from a portfolio that actually yields only 6%. This type of overconfidence may cause you to save too little or spend too much. Adopting a more conservative outlook may encourage more disciplined saving. If your portfolio outperforms your expectations, you may reach your goals sooner than expected.

Hot Topic: The Year of the Roth IRA Conversion?

February 1, 2010
The number of Google searches for information about Roth IRA conversions has increased dramatically recently. In fact, search data reveals that the number of people searching for the phrase “Roth IRA conversions” more than tripled between January and November 2009.

This surge in interest about Roth IRA conversions is hardly surprising considering that starting in 2010, all taxpayers, regardless of income, are eligible to convert tax-deferred retirement assets to a Roth IRA. Prior to the change, the law prevented taxpayers with household incomes above $100,000 from converting assets to a Roth IRA.

If you are among the nearly 50% of Americans who believe their own taxes are going to increase, you may be interested in the possibility of a tax-free income that a Roth IRA conversion can bring.

A Roth IRA is a retirement savings vehicle that differs from tax-deferred retirement accounts such as traditional IRAs and most employer-sponsored retirement plans. With a Roth IRA, you make contributions with after-tax dollars, but qualified withdrawals after age 59½ are tax-free. Furthermore, a Roth IRA does not require minimum annual withdrawals after age 70½. It should be noted that there are still annual income limits in place for determining eligibility to contribute to a Roth IRA. The income limitation was eliminated only for conversions.

To qualify for the tax-free and penalty-free withdrawal of earnings and amounts converted to a Roth IRA, the account must be in place for at least five tax years and the distribution must take place after age 59½ or as a result of death, disability, or a first-time home purchase ($10,000 lifetime maximum).

Taxing Choices

When you convert tax-deferred assets from a traditional IRA and/or a former employer’s 401(k), 403(b), or 457 plan, the amount you convert in a given year needs to be declared as income on your tax return. If you are younger than age 59½ and pay the taxes from money that is not in the tax-deferred account (the recommended option), you can avoid a 10% federal income tax penalty.

Fortunately, you have options when it comes to paying the taxes on a Roth IRA conversion. In 2010 only, you can convert eligible retirement assets to a Roth IRA without having to claim the amount as income on your 2010 tax return. If you elect to do this, you must declare half of the converted amount as income in 2011 and the other half as income in 2012. In this way, you wouldn’t have to start paying taxes on a 2010 Roth IRA conversion until April 15, 2012.

However, by deferring the taxes on a 2010 conversion, the converted amount will be taxed at the income tax rates in effect in 2011 and 2012. As it stands, tax rates are scheduled to increase in 2011. Unless Congress acts to avert the tax rate increase, the taxes on Roth IRA conversions will be higher after 2010.

Also consider whether converting a sizable amount to a Roth IRA could move you into a higher tax bracket. If so, you may decide to convert smaller amounts over a period of several years.

If you have IRAs into which you have made both deductible and nondeductible contributions, the tax implications of a Roth IRA conversion can become complicated. It may be prudent to consult a tax professional.

You Can Change Your Mind Later

If you change your mind after utilizing a Roth IRA conversion, you can elect a “do over,” called a recharacterization. The assets would be converted back to tax-deferred status and you can file an amended tax return seeking a refund of the income taxes you paid on the conversion. In order to qualify, you must recharacterize the funds before October 15 of the year following the year in which you converted.

Roth IRA conversions offer the potential for tax-free income in retirement for taxpayers at all income levels. If you want more information about converting to a Roth IRA, call today. It’s critical to review your individual situation before making a decision about moving important assets.

Getting the Right Mix

Almost one-third of investors say that none of their retirement savings is going into stocks, according to a recent online poll. Some of the respondents cited the current economic climate as a reason for the dearth of equities.

It can be difficult to avoid emotional reactions to changes in the market, but a carefully considered long-term asset allocation strategy may help your retirement portfolio better endure volatility. After all, research suggests that over 90% of a portfolio’s performance is a direct result of how its assets are allocated.

Asset allocation is the process of dividing your investment dollars among asset classes that often behave differently in different market cycles. An asset allocation strategy may help reduce your exposure to risk and possibly enhance your portfolio’s performance over the long term.

Consider the Factors

The appropriate percentage of equities, debt instruments, and cash equivalents in your portfolio will depend on some key factors:

  • Financial goals. Are you saving for retirement? Your children’s education? A second home?
  • Time horizon. When will you need the money: 10, 20, 30 years? How old are your children? When do you want to retire?
  • Risk tolerance. How comfortable are you with exposure to risk? Do market fluctuations make you nervous? Are you young enough to recover from losses?

These three variables make the appropriate allocation potentially different for everyone. A 55-year-old nearing retirement will have different needs than a 40-year-old with two children preparing for college.

Moreover, investments can be diversified within each asset class to further reduce a portfolio’s exposure to risk. For example, the stock portion of a portfolio can be divided into small/large cap, value/growth, and other categories.

Asset allocation and diversification do not guarantee against investment loss; they are methods used to help manage investment risk. The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

After developing an appropriate asset allocation strategy, it is important to periodically revisit and revise your strategy. Over time, outperforming assets may grow and skew your percentages. You may need to rebalance your portfolio in order to maintain your percentages. Also, you may need to make changes to your allocation as you near retirement or as your investing goals change. Be aware, however, that rebalancing may result in taxes owed.

Although current market conditions may warrant re-examining your asset allocation, be careful not to abandon a carefully considered strategy in favor of an emotional reaction.

New Year: Check and (Re)balance

January 12, 2010
These days, people are a bit cynical about making new year’s resolutions. And who could blame them? Although most adults (68%) admit to having made resolutions, only 17% usually keep them.

Even if you have gotten a bit jaded about making new year’s resolutions, don’t let it stop you from doing what you need to achieve your financial goals. In one recent survey, respondents cited financial obstacles as the number-one limitation standing between them and their dreams.

Maybe the poor success rate enjoyed by resolution makers has something to do with the fact that the most popular resolutions — losing weight and paying off debt — tend to be the most difficult. Here are three simple tasks you can do in the next year that could boost your progress toward your goals and dreams. They’re easy to accomplish, and you don’t have to wait until January 1 to get started.

Check your asset allocation. Over time, the proportion of assets in your portfolio can be expected to shift as they earn differing rates of return. For example, if your bond investments have done better than anything else in your portfolio, you may be at risk of having more bond assets than might be considered suitable for someone with your risk tolerance, time horizon, and long-term goals. Rebalancing your portfolio doesn’t take much effort, and it’s a good way to eliminate unnecessary risk and help ensure that your portfolio is in a good position to take advantage of opportunities.

Check your beneficiaries. Most of the assets in accounts that require you to designate a beneficiary, usually life insurance policies and retirement accounts, will convey directly to your heirs outside the probate process. Courts tend to treat these types of beneficiary designations as sacred, even if the family is able to provide evidence that the outcome would not be what the deceased would have wanted. Birth, divorce, and death are all potential causes of outdated beneficiary designations.

Check your credit report. It’s always been wise counsel to check your credit report, but it may be even more important now. Lenders have tightened lending standards in the wake of the credit crisis; credit is still available at good rates, but mainly to people with high credit scores. Go to to order your credit report online or by mail.

Ready or Not, You’re Retired!

It has become commonplace for people to retire at a younger age than they originally planned. In 2009, a whopping 47% of retirees left the workforce earlier than they expected.

It would be great if most of these people were retiring early because they had plenty of money and no longer needed to work, but this simply isn’t the case. Ninety percent gave negative reasons for retiring early, citing such causes as health problems, company downsizing and/or closure, outdated skills, and the need to care for a family member.

The news here is not that planning to retire at a particular age is a waste of time, but that it may be a good idea to prepare for the possibility that you may be forced into retirement as early as five years before your ideal retirement age.

Hallmark of Uncertainty

Did you know that only 10% of current retirees were still working after age 65, even though 31% of workers expect to stay with it past 65? If you keep telling yourself that you can make up for a potential shortfall by working longer, it could be an indication of how you view your financial situation. In general, people who lack confidence in their retirement security expect to retire later than people who are more confident.

Retiring in a Recession or a Bear Market

One good reason to be prepared early is the possibility that you may be forced into retirement during (or because of) a recession or a bear market. If you are trying to make up for lost time by working longer, you may also be tempted to take investment risks that can cause havoc for your finances if a downturn occurs when you are close to retirement.

Many of the recommended steps to take during the final years before retirement are designed to help protect you from dramatic swings in the market or the economy, in order to help insulate your long-term outlook from short-term developments. These steps usually include a gradual migration away from riskier assets seeking capital appreciation and toward more conservative, income-producing investments.

Finding Out Too Late

Another risk of planning to work longer is the possibility that you could overestimate the benefits of doing so and, as a result, fail to evaluate exactly how far behind you are and what steps are necessary to reach your goals. Any options that you have to make up for a shortfall could be limited by a shortened time horizon.

Obviously, there may be no way to see a forced retirement coming. But by recognizing the risk now, you may be able to take steps to help ensure that your retirement is everything you dreamed it would be.

Investors Flock to Bond Funds, But What Happens When Rates Rise?

January 6, 2010
The amount of money flowing into bond mutual funds hit a dizzying pace this year. If the trend continues, bond funds will attract more than twice as much new money as they did in 2008 and a stunning 11 times more than investors are putting into stock funds this year.

Although bond funds don’t ordinarily enjoy greater inflows than stock funds, this sometimes occurs during periods of stock price volatility. This development is not surprising, but it is alarming nonetheless. Here’s why.

Interest rates are low and the Federal Reserve is likely to keep them low for the foreseeable future. As long as joblessness remains a problem, the Federal Reserve will be reluctant to raise interest rate targets and, in fact, may have little reason to do so. It has been the Fed’s habit to raise rates when the economy is growing too fast and is at risk of high inflation. But an economy with high unemployment is not likely to suffer from too-rapid growth. Plus, job creation would probably suffer from higher interest rates.

But interest rates will inevitably go up, and when interest rates rise, the value of existing bonds typically falls, which can adversely affect a bond fund’s performance. Of course, the pain will not be evenly spread because bond funds will react differently depending on their objectives, but the effect on the bond market could be pronounced.

Many investors may have piled into bond funds thinking they were a “safe” alternative to stock funds. The S&P 500 lost 37% of its value in 2008, and investment-grade corporate bonds gained 7%. Investors who were smarting from their losses may have soured on stocks and decided the conservative return potential in the debt markets might be more appealing than the chance of suffering further losses in the equity markets. In the financial world, these investors are “chasing performance,” but they could be setting themselves up for yet another round of losses.

Bonds vs. Bond Funds

It’s important to note the distinction between bonds and bond funds. An investor who buys individual bonds is typically interested in generating income and preserving principal. This is considered a fairly conservative strategy, and it could help insulate bond investors from fluctuations in interest rates until their bonds mature. Investors who are careful to stagger the maturity dates in their bond portfolios may be able to further reduce the risk of having to reinvest a large percentage of their principal when rates are low.

Bond funds, on the other hand, may employ a less conservative strategy by trading bonds before they mature in order to pursue gains by taking advantage of fluctuating interest rates. This may allow them to offer greater return potential, but usually with higher risk. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with the underlying bonds in the funds.

Bond funds can play an important role in an investment portfolio, but they shouldn’t be thought of as a safe harbor to park money until the stock market settles down. Any decision to purchase a bond fund should be made based on your personal circumstances, such as your time horizon, risk tolerance, and personal goals.

Home Equanimity

The collapse of the housing market has provided a painful lesson for those who were counting on their homes as a source of retirement income. Falling home prices illustrate the potential difficulties of relying on the sale of a home to pay for retirement.

Since 1987, U.S. housing prices have risen 4.1% annually. During that same period, the Consumer Price Index rose 3% annually. Thus, when you subtract inflation, home prices produced a real return of only 1.1%. Additionally, you need to factor in property taxes, maintenance, and insurance, which can all serve to erode the long-term growth of a home’s value.

Movin’ on Out

The prospect of cashing in your home’s equity to pay for retirement may be enticing when home prices are rising. However, when prices are falling, it’s much easier to see why this is an unreliable strategy.

First, home values are subject to cyclical trends, so there’s no guarantee that your home will be worth what you were planning on when you are ready to retire. There is also the possibility that, depending on market conditions, you may have trouble selling it.

Next, you’ll still need somewhere to live. If you buy a smaller place, you will need to pay transaction and relocation costs, which could consume money you thought would help pay for retirement.

Throw It in Reverse

One way for older homeowners to capitalize on the equity in their homes is a reverse mortgage. But despite their recent surge in popularity (the government insured 11,660 reverse mortgages in April 2009, the highest monthly total since the program began in 1990), reverse mortgages may not be an appropriate strategy for some people.

Homeowners aged 62 and older can use a reverse mortgage to borrow against the value of their homes, and there’s no need to pay back the loan as long as they continue to live there. The loan is paid off by the sale of the home after they move out or after both spouses pass away. The amount a homeowner might be able to receive from a reverse mortgage will depend on the loan’s interest rate, the owner’s age, and the home’s equity value. Reverse mortgage loan fees are typically high and can reach up to 10% of a home’s value over the life of the loan.

The collapse of the housing market has caused many people to take a second look at the way they view their homes.

Confident in Consumer Confidence?

December 22, 2009

In September 2008, the subprime mortgage crisis reached a crescendo. Several banks asked for government bailouts and loans or filed for bankruptcy. Mortgage guarantors Fannie Mae and Freddie Mac were placed in conservatorship. The Federal Reserve and central banks around the world scrambled to pump liquidity into the credit markets. To top it all off, the world’s stock markets drifted lower as the crisis unfolded.

At the time, it seemed as though the sky was falling. No surprise then that the consumer confidence index (CCI) fell to what was then the lowest point recorded to that point. The October reading was 38.8 points, more than two times lower than it was a year earlier.

You are no doubt familiar with the CCI because the news media faithfully reports it every month. But how useful is this economic indicator to individual investors?

Lag of Confidence

The CCI measures the public’s confidence in the health of the U.S. economy, which can be useful in anticipating future spending patterns. To calculate the CCI, The Conference Board polls 5,000 households who rate current and expected business conditions for their regions. Their answers are used to create a numeric score, which rises when consumers are confident and falls when they are not confident.

One study of the CCI dating back to 1977 found that the index has some correlation to stock market performance, but it’s not what you might expect. In general, large jumps in consumer confidence were followed, on average, by sub-par returns. Conversely, large drops usually preceded above-average returns.2

Another study found that consumer confidence erodes when stock prices decline, but low CCI readings are more likely to be followed by high stock returns than low returns.

The lesson here is that a low CCI is not always bad news, and a high CCI is not always good. The consumer confidence index can be a useful tool, but it should play only a minor role in your overall outlook.

Playing Catch-Up with Contributions

Most Americans are no longer convinced that they are financially prepared for retirement. In the 2009 Retirement Confidence Survey, only 13% of workers indicated they were “very confident” that they will have enough money for a comfortable retirement, the lowest level since the annual survey began in 1993.

Are you worried that you might have to choose between working longer or living with less than you had planned? Fortunately, if you are age 50 or older, you may have an opportunity to catch up to your retirement savings goals.

Make Up for Lost Time

The costs associated with raising a family and sending children to college can make it difficult to save for retirement. Congress recognized this when it carved out exceptions to the limits on contributions to employer-sponsored retirement plans and IRAs for people who are approaching retirement age.

In 2009, workers 50 and older can contribute an extra $5,500 to a 401(k) plan or a similar employer-sponsored retirement plan, on top of the $16,500 workers of all ages are allowed to contribute. The catch-up limit for IRAs is $1,000, on top of the standard $5,000 annual contribution limit.

Contributions to employer plans and traditional IRAs are generally not included in taxable income. So in addition to socking away more money for retirement, workers 50 and older who are taking advantage of the catch-up limits might help reduce their current tax burdens. (However, there are limits on the deductibility of IRA contributions for active participants in employer-sponsored plans, so be sure you understand the rules.)

Distributions from traditional IRAs and employer-sponsored retirement plans are taxed as ordinary income and may be subject to an additional 10% federal income tax penalty if taken prior to reaching age 59½.

Funding a comfortable retirement requires a comprehensive approach and extensive preparation. However, something as simple as increasing your contributions to tax-advantaged retirement programs can go a long way toward helping you pursue your long-term financial goals.

Measuring the Jobs Situation

December 18, 2009

Headline Unemployment Rate Is a Tiny Facet of Overall Picture

Most people understand that a rising jobless rate is one of the hallmarks of a shrinking economy. But the national unemployment rate does not always reveal a complete picture of the jobs outlook. For example, when the downturn began in December 2007, the unemployment rate was a mere 4.9% — hardly the stuff of recessions.

Employment tends to be a lagging indicator because most employers will cut back on other expenses in order to avoid layoffs for as long as possible. Moreover, when conditions begin to improve, employers may avoid or delay hiring until they are confident that the recovery is sufficient to justify additional labor costs.

In order to gain a true understanding of current employment conditions, it’s necessary to look beyond the headline unemployment rate to consider other indicators that reflect the nation’s jobs situation.

Households and Establishments

The Department of Labor works with the Bureau of Labor Statistics (BLS) and the Census Bureau to survey representative samples of households and employers to come up with the Current Population Survey and the Current Employment Statistics survey. The results of these surveys are combined in the Employment Situation, a monthly report published by the BLS.

The Current Population Survey, also called the “household survey,” sends trained interviewers to 60,000 sample households to collect information about who is employed, unemployed, or not in the workforce. Although this survey is used to calculate the unemployment rate, it also tracks the size of the civilian workforce, the number of people who are employed, the number of involuntary part-time workers (people who want full-time work but can’t find it), and people who are marginally attached to the workforce (meaning they looked for work sometime during the past 12 months but not during the previous four weeks).

The Current Employment Statistics survey, also called the “establishment survey,” gathers information from the payroll records of about 160,000 businesses and government agencies. It counts persons employed in nonfarm-related businesses such as factories, offices, stores, and government offices. This survey is the main source of information about the number of jobs created or lost in a given month in a range of industries. It also tracks the average number of weekly hours worked by production and nonsupervisory workers and their average hourly wage.

Jobless Claims

Every week, the BLS assesses the number of people who file claims for unemployment insurance benefits. The data is reported weekly, although many experts follow a four-week average to smooth out weekly fluctuations. Jobless claims do not reflect the total rate of unemployment because not everyone who is unemployed applies for or is eligible for unemployment benefits. But jobless claims can give a more immediate indication of employment trends because they are reported weekly, and most people file soon after becoming unemployed.

Tracking the many employment indicators can help provide a better perspective on the broader employment picture. The clues from these reports may reveal clues about the direction of the economy and the financial markets.

Let us hear your thoughts below:

Moving Forward from the Credit Crisis

On Monday, September 15, 2008, the country awoke to news that three of the nation’s largest financial institutions were unable to survive without help. Merrill Lynch found a buyout partner in Bank of America. AIG was able to secure funding from federal sources. Lehman Brothers, however, was unable to secure a lifeline and the firm filed for bankruptcy, the largest in history and a major spark that set off the global financial crisis.

In a matter of days, the nation’s financial structure had changed.

By now, this story is painfully familiar to most investors, who watched portfolios and retirement account balances shrink in the ensuing months. Now, more than a year after that fateful September day, the economy shows signs of stability. Yet many investors still wonder what has been done to correct the mistakes uncovered during the credit crisis and, more importantly, whether this situation could happen again.

Several proposals have come from the new administration, and the financial institutions have worked to “clean up” their balance sheets. However, it is still unclear exactly what form, if any, reform will take.

Reform Still to Come?

In March, Treasury Secretary Tim Geithner sought legislation that would empower the government to take over failing institutions like Lehman Brothers in order to prevent domino-like collateral damage from taking down other firms. This “resolution authority” would let the government step in, as it did with Fannie Mae and Freddie Mac just prior to Lehman’s collapse, to help firms avoid bankruptcy, which can freeze credit markets and lock up assets. Proponents say that the resolution authority, if executed properly, could be more efficient than ad hoc bailouts and could help avoid “too big to fail” dilemmas. However, the measure seems to be in legislative limbo and may not move forward.

A Presidential Proposal

In June, President Obama released an 88-page plan that detailed his proposal to overhaul the financial regulation system. In general, his plan would give the government greater power over Wall Street. It aims to increase government oversight and close regulatory gaps. The president’s proposal also seeks to create a new agency that would oversee consumer products, including mortgages and credit cards. The administration maintains that regulatory reform is a top priority, although no official legislation has yet been proposed.

Some observers question whether the proposed regulations will amount to safer and more efficient markets or lead to less efficiency and expensive bureaucratic overreach. Either way, the plan will likely see revision before anything is enacted.

In a bid to win support for his planned overhaul of the financial system, President Obama gave a speech to bankers on Wall Street on September 14, 2009, warning against the reckless behavior that led to the financial crisis. The president urged the big banks to put senior executive bonuses up for shareholder votes and to create pay structures that reward employees for long-term performance instead of short-term gains.

President Obama has also stressed the importance of bringing change to Fannie Mae and Freddie Mac. The administration’s proposal, however, is not expected until early 2010.

For their part, banks have been working to improve their balance sheets. The stress test that the 19 largest banks went through earlier in 2009 helped to diagnose the health of the institutions, revealing that while many of the firms needed to raise additional capital, the amount needed was lower than many people had predicted. Moreover, the largest banks have all made great strides to improve their capital ratios, considerably reducing leverage.

With the economy out of intensive care, the focus shifts from setting the break to preventing further injury. Although some steps have already been taken, additional government and private-sector action may be needed to reduce the risk of future problems.

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Fixed Annuities May Offer Stability

November 6, 2009

In the wake of steep stock market declines in 2008, American workers have begun to doubt whether their tax-deferred retirement plans will be able to generate the income they will need during their retirement years. In fact, only 42% of participants in a 2009 survey still expect their 401(k), IRA, and other retirement savings plans to be a major source of retirement income — the lowest measure since the annual survey began.

If you are concerned about having a stable source of retirement income, a fixed annuity may just fit the bill.

Income Now or Later

A fixed annuity is a contract with an insurance company that guarantees a fixed rate of return during the life of the contract. Payouts can be structured to provide a guaranteed income that will last for a specific period or for life. There are two basic types of fixed annuities from which to choose.

An immediate fixed annuity is typically funded with a lump-sum premium, and income payments start immediately thereafter. This type of annuity is most often purchased at the end of a career and the beginning of retirement.

A deferred fixed annuity can be funded with either a lump sum or a series of payments. The contract will begin making income payments at a specific future date, and the future value of the contract is based on the rate of return specified in the contract. A deferred annuity allows contract owners to accumulate retirement assets over time on a tax-deferred basis.

The amount of income paid by an annuity depends on a range of variables: the amount paid in premiums, the contract’s rate of return, the age and gender of the contract holder, and the number of years over which income payments will be received. Most annuity contracts offer options that provide income payments for the rest of the contract holder’s life or for the lives of two people.

Annuities have contract limitations, fees, and expenses. Any guarantees are contingent on the claims-paying ability of the issuing insurance company. Most annuities have surrender charges that are assessed during the early years of the contract if the contract owner surrenders the annuity. The earnings portion of annuity withdrawals is subject to ordinary income tax. Withdrawals prior to age 59½ may be subject to a 10% federal income tax penalty.

A source of guaranteed income may help remove some of the uncertainty associated with retiring when the financial markets are fluctuating. Annuitizing a portion of your savings may allow you to enjoy your retirement years free of the fear that you might outlive your money.

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A New Way to Diversify

With nearly $450 billion in assets and growing, exchange-traded funds may be ready for their turn in the spotlight. The number of ETFs has grown from 80 at the end of 2000 to 737 at the start of 2009. Although these investment vehicles have entered the mainstream, some investors may feel that ETFs are shrouded in mystery.

Yet once you demystify them and understand how they work, you will be in a better position to determine whether exchange-traded funds may be appropriate for your portfolio.

What Is an ETF?

Exchange-traded funds are unique investments that resemble mutual funds in some ways and behave like stock in other ways. ETFs are baskets of securities put together by investment companies. They are usually assembled to track an index, sector, or other group of stocks.

Individual shares of ETFs are similar to individual shares of stock in that they can be traded, causing prices of those shares to fluctuate throughout each trading day. The prices of ETF shares tend to track the value of the underlying securities, although supply and demand for the shares themselves can affect share prices relative to the underlying securities. The principal value of exchange-traded funds will fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

What Benefits Do ETFs Offer?

Because a single share of an ETF represents an entire portfolio of investments, ETFs offer a way to diversify that could be cost-prohibitive for investors to achieve by directly purchasing the underlying investments. Investors can use ETFs to target specific indexes, sectors, or types of securities to match their financial goals. Diversification does not eliminate the risk of investment losses; it is a method used to help manage investment risk.

Typically, ETFs are passively managed and, as a result, may offer lower expense ratios and greater tax efficiency than mutual funds. Also, there are no sales loads or minimum investment amounts associated with ETFs; however, investors usually need a broker to buy ETF shares and typically have to pay a commission.

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A Long Look at the National Debt

October 23, 2009

Short-Term Deficits Pale in Comparison to Unfunded Liabilities on the Horizon

Dwindling U.S. economic activity and accelerating government spending resulted in a record $455 billion federal budget deficit for fiscal year 2008. During the same trying period, the total national debt increased to about $10 trillion, and the forecast for 2009 was for an even larger deficit and more government borrowing.

As the numbers continue to escalate, how can we put the magnitude of the current national debt in perspective? Are there risks involved when government pushes the payment of its obligations into the future? And could it be that government action to reform entitlements such as Social Security and Medicare is all but imminent?

It’s All Relative

To better comprehend the size and scope of the national debt, it helps to measure it against the size of the overall economy. At $10 trillion in 2008, the national debt represented 69.5% of gross domestic product, which is only slightly higher than the previous high point in 1996, when it reached 67.3% of GDP. Yet consider how U.S. government debt compares to that of other nations. Italy’s debt-to-GDP ratio was nearly 120% in 2007, and Japan’s was over 170%.2

What’s the Risk?

Economists have long debated whether short-term deficits increase competition for loanable funds and put upward pressure on interest rates, and a significant amount of research has tested this theory. Among 66 studies on how budget deficits affect interest rates, half found they do have significant effects and half found mixed or insignificant effects.

The primary and less debatable risk is that long-run structural deficits and the accompanying debt levels could one day lead to a crisis of confidence among both foreign and domestic U.S. creditors.

Paying for Promises

As our society ages, demographic changes will begin to drain Social Security trust funds beginning in 2016, and health-care costs for older Americans are expected to grow significantly. Over the next 75 years, the government estimates that the present value of future expenditures on Social Security in excess of future revenue is more than $6.5 trillion, while that of Medicare is $36 trillion. This amounts to more than $42 trillion in unfunded liabilities for these two programs alone.

Under current law, the federal debt held by the public would reach 170% of GDP by 2040 and far surpass the post–World War II historic high of 109% of GDP. By 2080, the total government cost would be more than three times its annual revenue.

As future budgets are proposed, it’s not likely that government leaders can continue to ignore the unfunded liabilities that threaten to increase the debt burden to unsustainable levels over the coming decades. It’s likely that younger and higher-income Americans will eventually pay the price for program reforms by way of higher taxes and/or a reduction in future benefits.

Municipal Haste

The administration has stated that it intends to raise tax rates on people with incomes in the highest tax brackets in order to finance programs such as health-care reform.

The current top federal income tax rate of 35% is low by historical standards but is scheduled to revert to its original 39.6% rate after 2010. Meanwhile, the national debt is $11 trillion and growing, and the federal government is facing more than $40 trillion in unfunded entitlement obligations for Medicare and Social Security.

When you consider these staggering figures plus the hundreds of billions of dollars that the government is borrowing this year to help stimulate the economy, it becomes difficult to imagine a future in which tax rates will not be significantly higher.

Fortunately, municipal bonds offer an opportunity to earn an income that may be free of federal income tax.

Breaking the Bonds of Taxes

Municipal bonds are sold by state and local governments. Some munis are designed to raise immediate capital to cover expenses and are backed by the taxing power of the issuing government. Revenue bonds are issued to help fund infrastructure projects and are supported by the income the projects generate. Municipal bonds tend to have low default rates.

Muni bonds offer a potential source of tax-free income that tends to be more valuable to those in higher tax brackets. The interest on municipal bonds is typically free of federal income tax. As a result, munis tend to pay lower interest rates than taxable bonds. Thus, the tax benefits from a municipal bond are partially determined by your income level.

The principal value of bonds will fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Bond interest paid by a municipality outside the state in which you reside could be subject to state and local income taxes. If you sell a municipal bond at a profit, you could incur capital gains taxes. In some cases, municipal bond interest could be subject to the federal alternative minimum tax.

Although no one is sure when changes to the tax code may be made in the future, higher taxes may be inevitable. Call today to discuss strategies that may help lower your tax burden with municipal bonds.

The Long Road Ahead

October 6, 2009

Investing in stocks has never been for the faint of heart, but lately the road has been especially rocky. The recent downhill ride has left many investors wondering whether they should swear off equities altogether.

However, investors who react emotionally to current events could find themselves missing out on potential long-term opportunities. Consider the historical record. In the past, the markets have usually rewarded those who invested for the long term. Using a buy-and-hold strategy is one way to help manage risk and possibly overcome the effects of short-term volatility.

In the 50 one-year holding periods since 1958, the S&P 500 Composite (total return) experienced 12 periods with negative returns. However, over the 41 10-year holding periods since 1958, only one 10-year period showed a negative return.

Of course, this doesn’t mean you should never sell your holdings at any given point. Always consider your risk tolerance, time horizon, and overall financial goals when buying or selling investments.

The stock market has had its share of roller-coaster thrills lately, but don’t be tempted to react emotionally. Call today to review the long-term implications of your investment strategy.

Looking for a Recovery in Odd Places

The business world loves a good economic indicator. Chief executives, budget planners, small-business owners, and others who must make assumptions about the health and direction of the economy take a keen interest in popular indicators such as consumer confidence, gross domestic product, housing starts, stock prices, employment data, and even the price of gold.

Economic indicators may take on extra significance when the nation is in a recession and anxious for signs of a recovery because the national psyche plays a key role in business cycles. People who are not experiencing any personal financial problems may nonetheless rein in their spending or alter the timing of major purchases when the news is telling them that the national economy is in difficult straits.

Right on the Kisser

When investors and economists anticipate that the economy is approaching a turning point, they may look in some unusual places for early indications of a shift in consumer behavior. After all, someone who can identify a recovery or a downturn before everyone else may gain a competitive advantage. Over the years, this has given rise to a number of odd economic indicators, although some are more valuable as entertainment than as a basis for financial decision making.

Keeneland thoroughbred sales: The epicenter of the world thoroughbred horse market is Keeneland, a horse auctioneer near Lexington, Kentucky. Business columnist Daniel Gross suggested that the prices of thoroughbred race horses at Keeneland might be a good indicator of how the ultra-rich feel about the global economy. Race horses are highly speculative investments. When the rich are feeling their oats, they bid up pony prices. When their appetite for risk declines, so does their willingness to spend big. For example, from 1993 to 2000, a time when the economy was flourishing, Keeneland’s sales rose for eight straight years. But Keeneland’s sales dropped sharply in 2001 and 2002 as the global economy went into recession and the stock market plummeted. Gross receipts for Keeneland’s January 2009 Horses of All Ages Sale were $32.8 million, down from a year earlier.

Lipstick sales: Leonard Lauder (the son of Estee Lauder and chairman of Estee Lauder Companies) found that his lipstick sales increased during tough economic times. He reportedly coined the term “lipstick index” during the 2001 recession, but the idea that cosmetics sales flourish during a tough economy goes back at least to the Great Depression, when cosmetic sales increased by 25%. One theory is that women are more likely to give up expensive luxuries such as designer shoes and handbags before they would consider cutting back on cosmetics (which they consider more essential), and that they may reward their own frugality with less expensive luxuries such as lipstick. In autumn of 2001, during the aftermath of the terrorist attacks on September 11, 2001, lipstick sales increased by 11%. Therefore, according to this theory, when lipstick sales are up, it may be a sign that consumers are feeling negative about the economy, although lipstick sales have increased during prosperous times as well.

Scrap metal sales: This was a favorite of former Federal Reserve Chairman Alan Greenspan. Scrap metal is a significant source of raw material for industrial production. Greenspan believed the market for scrap metal was a leading indicator and that rising prices were an early signal of an economic recovery. Scrap metal prices are down so far in 2009 but remain relatively high compared with historical numbers.

Skirt length theory: According to this one, skirt lengths reflect stock market direction: short skirts reflect an up market; long skirts reflect a down market. The explanation is that short skirts tend to be in vogue during bull markets because consumers are more optimistic and may spend freely, adding to corporate earnings. When confidence wanes and the outlook for stocks is gloomy, the theory goes, hemlines head downward.

Men’s underwear sales: Greenspan once said that he also paid close attention to the sales of men’s underwear. His theory was that when men are feeling truly pinched by a tightening economy, underwear is one of the first purchases they will postpone because almost no one sees a man’s underwear. Therefore, because sales of men’s underwear tend to be fairly level, Greenspan took an interest when sales dipped. Conversely, pent-up demand can cause men’s underwear sales to be among the first signals of an economic recovery, indicating men are confident enough to replace their worn-out underwear.

Cardboard box sales: This indicator is used by some investors to gauge industrial production. An estimated 75% to 80% of all nondurable goods are shipped in cardboard packaging.g When cardboard sales go up, it could be a sign that companies are shipping their goods in greater volume.

It’s important to remember that even though these offbeat indicators may be an interesting diversion, they shouldn’t supplant financial fundamentals and your long-term investment goals. When it comes to your investments, you should rely on a carefully considered strategy, not on whether consumers are wearing old jockey shorts or purchasing more lipstick.

Higher Education Pays, But So Will You

October 2, 2009

Even as the economy stumbles, the price of a college education keeps on climbing. Average tuition and fees at public four-year colleges and universities rose 6.4% in the 2008–09 academic year, while costs at private four-year institutions rose 5.9%.

Higher college costs and trying economic conditions have interrupted the education plans of many aspiring students. In a recent survey, 57% of high-school seniors lamented that they were considering less prestigious and less expensive college options, and 16% were putting their searches on hold because they didn’t think their families could afford to foot the bill.

It’s likely that admission to the nation’s top colleges and universities will remain competitive, but adequate college savings can help ensure that a student’s opportunity to attend his or her school of choice is not compromised by the lack of resources. Fortunately, Section 529 plans are designed to help families save for future higher-education costs.

Study This Strategy

With a 529 savings plan, investment earnings accumulate on a tax-deferred basis. Contributions and earnings can be withdrawn tax-free if they are spent on qualified higher-education expenses such as tuition, fees, room and board, books, and other school supplies.

Family members can contribute up to $13,000 ($26,000 for married couples) to a 529 plan each year per student without triggering gift taxes, and there are no donor income limits. Contributions up to $65,000 ($130,000 for married couples) are also allowed in a single year as long as no other gifts are given to the student by the same contributor(s) for five years.

As with other investments, there are generally fees and expenses associated with participation in a 529 savings plan. There is also a risk that the plan investments may lose money or not perform well enough to cover college costs as anticipated.

The tax implications of a 529 plan should be discussed with your legal and tax advisors because the plans can vary significantly from state to state. Also note that most states offer their own 529 plans, which may provide advantages and benefits exclusively for their residents and taxpayers.

Before investing in a 529 savings plan, please consider the investment objectives, risks, charges, and expenses carefully. The official disclosure statements and applicable prospectuses, which contain this and other information about the investment options and underlying investments, can be obtained by contacting your financial professional. You should read this material carefully before investing.

The average debt for college graduates who borrowed money for college has reached $22,700, with many owing much more. For parents who worry about the financial future of their children, it can be worth the investment to support worthy students in their pursuit of a higher education.

Stalking the Mighty Consumer

What group can claim credit for being the driving force behind the world’s largest economy? Hint: You are probably a member of this group.

The answer is U.S. consumers, whose spending is responsible for more than 70% of U.S. gross domestic product (GDP). As we’ve seen in recent years, when consumer conditions are bad, the effects can be widespread. If consumer spending falters, it affects business income and tax revenues. If revenues fall far enough, the effects can include increased unemployment, which in turn exaggerates the problem because the unemployed have reduced incomes and tend to make fewer purchases.

Economists, traders, investors, and policymakers all take great interest in the financial health of consumers and what they may do next. Here are some popular indicators of consumer behavior.

The Monthly Retail Trade Survey is conducted by the U.S. Census Bureau, which mails questionnaires to about 12,500 businesses. The Census Bureau uses the data to estimate the dollar value of total national retail sales, the value of month-end retail inventories, and the ratio of retail inventories to sales.

The Monthly Retail Trade Survey results are used by the Bureau of Economic Analysis to help calculate GDP and by the Bureau of Labor Statistics to calculate the consumer price index and productivity measurements. The White House uses them to analyze current economic activity. The Federal Reserve uses them to detect trends in consumer behavior. And the private sector uses them to measure economic trends.

The Bureau of Labor Statistics Consumer Expenditure Survey comprises two separate surveys that collect information from about 7,000 households. The weekly Diary Survey asks participants to document their expenditures for food and beverages, nonprescription drugs, tobacco, and other personal care products. The quarterly Interview Survey asks about larger monthly expenditures such as housing, clothing, transportation, entertainment, and health care.

The Consumer Expenditure Survey is noteworthy for the ways in which it links the data collected with the respondents’ household characteristics. Characteristics measured include the amount and number of incomes in the household; how long they have lived in their homes; as well as their age, gender, education, race, and other details that might illuminate consumer behavior.

Perhaps the best-known consumer survey is the Consumer Confidence Index, which measures consumer attitudes rather than behavior. Each month, The Conference Board polls 5,000 households about their assessment of business conditions and the outlook for their regions. The rub is that the CCI does not appear to predict consumer behavior. Consumer spending has increased every year, regardless of the direction of consumer confidence. Dips may occur from one month to the next, but spending has increased on an annual basis as far back as available records go.

Consumer behavior can be a good source of clues about the direction of the economy and the financial markets. Keeping a close eye may help with decisions about your portfolio.

Estate of Emergency?

July 10, 2009

Most people wouldn’t think about traveling somewhere new without a map. Yet 50% of Americans don’t have a will, which can leave their heirs without the proper directions to divide their possessions.

To help ensure that your estate is distributed according to your wishes, it’s important to have certain legal documents in place. A solid estate conservation strategy begins with these basic documents.

Where There’s a Will…

A good starting place is a will. This legal document will guide the probate court as it oversees the distribution of your titled property after your death. A will is also the appropriate place to name a guardian to care for your minor children and any assets they may inherit from your estate until they reach legal age.

Powers That Be

The next step is to consider whether you need to name financial and medical powers of attorney. A financial power of attorney designates someone to act on your behalf in financial matters should you become mentally incapacitated. A medical power of attorney empowers a designated person to make nonfinancial medical decisions in the event you are unable to make them yourself. Powers of attorney are valid only during your lifetime.

Fill in the Blanks

Life insurance benefits and most retirement plan assets are not subject to probate but rather convey directly to the beneficiaries named on the beneficiary account forms, regardless of what your will might say. This means it is critical to name the appropriate people. It’s also a good idea to review your beneficiary designations periodically to ensure that they still reflect your wishes.

Trusting Your Heirs

You may also want to consider whether you might benefit from a trust. Trusts are separate legal entities that hold your assets and administer them according to your wishes. Assets placed in certain types of trusts are not considered part of your taxable estate.

The use of trusts can involve a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.

These basic estate documents can provide a useful roadmap that matches up your heirs with their share of your legacy. For help getting from point A (assets) to point B (beneficiaries), call today.

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The Positives of Negative Correlation

All individuals, organizations, industries, and even national economies are subject to routine setbacks, ranging from minor inconveniences to major catastrophes. The recent performance of the U.S. economy, the largest economy in world history, is a good reminder that even something that may sometimes seem miraculous and invincible is subject to downtrends, cyclical or otherwise.

An investment portfolio is likewise not immune to setbacks. In fact, setbacks are so likely to occur that the best defense may be to expect some losses but to employ a method to help reduce any damage.

Up vs. Down

Different types of investments are subject to different types of risk. For example, on days when you hear that stock prices fell, it would not be unusual to hear about a rally in the bond market. This tends to occur when investors decide to shift away from stocks because the risks facing debt instruments might be more palatable.

However, a strategy of identifying investments that face offsetting risks is much more complex than simply spreading your money among stocks and bonds. Such a strategy would involve first identifying correlations between different investments.

In the financial world, correlation is a measurement of how two securities perform in relation to each other. Securities that are negatively correlated will have prices that tend to move in opposite directions. Securities that are positively correlated will have prices that move in the same direction.

By examining the historical relationship between the performance of two different investments, it’s possible to compute a correlation coefficient, which measures the degree of correlation. A correlation of +1 means the investments have a perfectly positive correlation and will perform identically. A correlation of –1 means they have a perfectly negative correlation and will always move in the opposite directions. A correlation of zero means that the two investments are not correlated; the relationship between them is random.

Assets that have relationships that can be correlated might be found in different industries, sectors, or asset classes. Few asset groups are perfectly negatively correlated, but your portfolio may still be able to benefit from the correlation principle.

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