Successful Investments Start With These Five Questions...

Successful Investments Start With These Five Questions... By Mike Barrett, analyst, Extreme Value Friday, October 9, 2015

Finding successful investments is hard work. My colleague Dan Ferris and I routinely evaluate dozens of companies before finding a few that are worthy of additional research. Unfortunately, that means we probably spend more time reading about businesses that we don't recommend than reading about those we do. Often, our research begins with a company's annual report. To achieve transparency with investors, public companies are required to file these reports with the U.S. Securities and Exchange Commission (SEC), which refers to them as "10-Ks." Annual reports provide a wealth of valuable data. Better yet, the data are accessible 24/7 on the SEC website. These reports are often 100-150 pages long and contain a mind-boggling array of numbers. Our challenge is to quickly separate what's important from what's not. Or as Arthur Conan Doyle's famous fictional sleuth Sherlock Holmes says… It is of the highest importance in the art of detection to be able to recognize, out of a number of facts, which are incidental and which vital. How do you separate "incidental" from "vital" in a document loaded with thousands of seemingly important facts? You must have a plan. I have read thousands of annual reports in my investing career. Over time, I've developed a system that helps me quickly assess if a company is worthy of further study. My system starts with these five questions…  Are there risks related to the company's revenue stream that aren't readily apparent? Are there other unusual risk factors? Has the company demonstrated that it can grow revenue and earnings? Is there evidence of operating leverage? Is the company generating free cash flow? Let's look at each individually… Question No. 1: Are there risks related to the company's revenue stream that aren't readily apparent?  Typically, an overview of the business and how it generates revenue can be found within the first few pages of an annual report. Spend some time there. I specifically look for two risks…  •   Heavy dependence on just one or a few customers. •   Hidden exposure to commodity prices.   Customer Concentration  Ideally, we're looking for companies that sell to many, many customers. This limits the risk that revenue might suddenly decline from the loss of any one customer. It also limits the leverage any one company can have on the business. Raising prices on a customer that's responsible for 60% of your business will always be a challenge.  Be aware that some industries routinely experience high customer concentration. Food manufacturers like Hain Celestial Group often report Wal-Mart as a major customer (10% or more of sales).  Suppliers of original equipment manufacturer (OEM) auto parts typically have high exposure to one or more of the major car manufacturers. BorgWarner, for instance, reports that 17% of its 2014 sales were made to beleaguered Volkswagen.  Companies in the semiconductor industry also routinely experience high exposure to just a few customers. Cirrus Logic is an extreme example. In 2014, 72% of its sales were made to a single customer, Apple.  Exposure to Commodity Prices  In addition to assessing customer concentration, you also want to determine if there is hidden exposure to cyclical commodities, like oil and gas.  Remember, a company doesn't have to be in the oil and gas business to have significant exposure to its boom and bust cycle. Last November, I addressed this problem in the Stansberry Digest.  Oil prices were starting to fall hard. I warned investors they might be unwittingly exposed if they owned companies that did a significant amount of business with oil and gas producers. Here's what I said at the time…  I've looked closely at hundreds of companies over the past year and I'm continually surprised at the reach of the American oil industry. The manufacturing and global distribution of oil-extraction tools and parts – paired with the transport of crude-oil products – generates billions in revenue for thousands of American companies. If you own some of these companies (or own mutual funds that hold large positions in them), you're more exposed than you think. If oil continues to fall, your portfolio could take an unexpected hit. [One] blue-chip stock that lots of individuals and funds hold is Emerson Electric. Emerson is a global industrial powerhouse operating separate divisions in industrial automation, network power, and climate technologies. Emerson's process management segment has been the primary source of revenue growth over the past few years, thanks to surging demand from oil and gas customers. This division accounts for 35% of Emerson's revenue. A sustained slowdown in domestic oil production (a byproduct of plunging prices) would hurt Emerson's profitability. After I wrote that, the drop in oil prices did resume. And Emerson's stock price has dropped about 29% since then.  Question No. 2: Are there other unusual risk factors?  Toward the middle of a typical annual report, you'll find the Risk Factors section. Here, a company identifies and lists the primary risks for its business.  Many of these risks are generally the same from company to company. For instance, if a recession appears, sales are likely to decline. If another company is acquired, the integration may underperform the expectations management has set.  What I'm looking for are unique risks. Here's an example from the 2014 10-K of Molina Healthcare, which provides health care plans to more than two million members across the U.S. (emphasis added)…  Our profitability depends to a significant degree on our ability to accurately predict and effectively manage our medical care costs. Historically, our medical care cost ratio, meaning our medical care costs as a percentage of our premium revenue net of premium tax, has fluctuated substantially, and has also varied across our state health plans. Because the premium payments we receive are generally fixed in advance and we operate with a narrow profit margin, relatively small changes in our medical care cost ratio can create significant changes in our overall financial results. For example, if our overall medical care ratio for the year ended December 31, 2014 of 89.5% had been one percentage point higher, or 90.5%, our net income from continuing operations for the year ended December 31, 2014 would have been approximately $0.12 per diluted share rather than our actual income from continuing operations of $1.30 per diluted share, a decrease of approximately 91%. This is something you don't see every day – a change of one percentage point in expenses potentially reduces income 91%! No matter how attractive Molina might otherwise be, this vital fact about its business model was a deal-breaker for me.  Question No. 3: Has the company demonstrated that it can grow revenue and earnings?  Near the Risk Factors section, you'll usually find a financial review covering the past five years. This lets you quickly see whether the company has been successful at growing sales and profits.  Growth in these two metrics is vital because it typically means the products and services the company sells are enjoying greater demand over time. Companies that get bigger and better are exactly what we're looking for.  Acxiom is an example of a company that has not been growing revenue or earnings. The provider of enterprise software has been around for more than 40 years, but sales the past two years were actually lower than they were five years ago. Earnings also trended down during this period.  By glancing at Acxiom's five-year financial history just a few minutes into my research, I was able to quickly eliminate it from consideration.  Question No. 4: Is there evidence of operating leverage?  Operating leverage is simply the ability to grow profits faster than revenue.  Superior business models often grow profits faster than revenue, so I consider this a vital fact that helps me quickly determine whether a particular company is worth further evaluation.  Fleetmatics provides fleet management software services to 25,000 enterprise customers with large truck fleets. It's a textbook example of operating leverage. Over the past five years, revenue grew about 37% per year on average. Income grew a much faster 85% per year on average.  Adding lots of new fleet customers didn't require the company to build a new plant. It just needed room for a few new employees and their computers. Capital-light businesses such as Fleetmatics routinely demonstrate operating leverage.  Investors love rapidly growing companies that can grow earnings quickly. They regularly pay dear prices to own them. That's why these kinds of companies are rarely found in the Extreme Value model portfolio. Ideally, we look to buy these kinds of businesses during major market downturns when everything goes on sale.  Question No. 5: Is the company generating free cash flow?  The last thing I look for when starting the evaluation of a new company is its ability to generate free cash flow.  This can be easily determined by going to the Statement of Cash Flows, which normally follows the Balance Sheet and Income Statement about two-thirds of the way into a typical annual report.  Free cash flow is not a line item on the cash-flow statement. Instead, it has to be calculated by deducting expenditures for property and equipment (i.e. capital expenditures, or "CapEx") from net cash from operations (or operating cash flow).  As Dan likes to say, free cash flow is what gives equity its value. This is the surplus capital management has at its disposal to grow the business, reduce debt, and give back to shareholders via dividends and share repurchases.  The cash-flow statement in an annual report normally covers the last three years. Ideally, what I'm looking for is growing free-cash-flow generation over that period. If a company was unable to generate even a moderate amount of free cash flow over the last three years, I usually lose interest in it as a potential investment idea.  There are almost 7,000 companies listed on the three major U.S. stock exchanges: NYSE, Nasdaq, and Amex. Finding the handful of businesses that will translate into successful investments is hard work.  Having a plan like the one outlined above helps us eliminate many subpar businesses from consideration quickly… and focuses our attention on those that are worthy of your investment capital.  As you conduct your own research, I highly recommend you follow this guide.  Good investing,  Mike Barrett Source: Daily Wealth Follow us on Twitter: @blacklioncm

The Future of the International Monetary System

The Future of the International Monetary System

By Jim Rickards

Triffin’s dilemma arose from the Bretton Woods system established in 1944. Under that system, the dollar was pegged to gold at $35.00 per ounce. Other major currencies were pegged to the dollar at fixed exchange rates. The architects of the system knew that these other exchange rates might have to be devalued from time to time, mostly because of trade deficits, but the devaluation process was designed to be slow and cumbersome.

A country that wanted to devalue (for example, the U.K. in 1967) first had to consult with the International Monetary Fund, IMF. The IMF would typically recommend structural changes, to fiscal policy, tax policy and other areas designed to cure the trade deficit.

The IMF also stood ready to offer bridge loans of hard currency to help the deficit-hit country withstand temporary stresses while the structural changes were implemented. Only if the structural changes failed and the trade deficits were persistent would the IMF allow devaluation.

That was the process for countries other than the U.S. As far as the U.S. was concerned, the link between gold and the dollar was fixed for all time and could never be changed. The dollar/gold link was the anchor of the entire system.

This fixed link between the dollar and gold made the dollar the most prized reserve currency in the world. That was the hidden agenda of Bretton Woods. With the dollar as the main reserve currency, U.K. pounds sterling, a competing reserve currency, would eventually fall by the wayside.

The U.K. relied on Imperial Preference among its trading partners in the British Commonwealth to gain trade surpluses, and also relied on the willingness of those Commonwealth partners to hold sterling in their reserves. The Bank of England assumed Commonwealth members would not ask to convert the sterling to gold. Imperial Preference came under attack by the General Agreement on Tariffs and Trade, the GATT, which was also part of Bretton Woods. (Today, GATT is known as the World Trade Organization, WTO.)

Bretton Woods was a one-two combination punch designed by the U.S. to destroy the British empire. GATT undermined Imperial Preference. The dollar-gold link undermined sterling. It worked. The U.K.’s trade deficits persisted, and the Commonwealth partners demanded their gold. Eventually, the pound sterling was devalued, and the empire dissolved. It was replaced by a new age of U.S. empire and King Dollar.

There was only one problem, and Robert Triffin pointed this out. If the dollar was the lead reserve currency, then the entire world needed dollars to finance world trade. In order to supply these dollars, the U.S. had to run trade deficits.

The U.S. sold a lot of goods abroad, but Americans quickly developed an appetite for Japanese electronics, German cars, French vacations and other foreign goods and services. Today, China has replaced Japan as the main source of exports to the U.S.; still, Americans have not lost their appetite for imports financed by printing dollars.

So the U.S. ran trade deficits, the world got dollars and global trade flourished. But if you run deficits long enough, you go broke. That was Triffin’s dilemma. Any system based on dollars would eventually cause the dollar to collapse because there would either be too many dollars or not enough gold at fixed prices to keep the game going. This paradox between dollar deficits and dollar confidence was unsustainable.

This system did break down in the 1970s. The solution then was to abolish the dollar-gold peg in 1971, and demonetize gold in 1974. But there was a third leg of the stool invented in 1969 -- the IMF’s Special Drawing Right, SDR.

The SDR was a new kind of world money printed by the IMF. The idea was that it could be used as a reserve currency side by side with the dollar. This meant that if the U.S. cured its trade deficit, and supplied fewer dollars to the world, any shortfall in reserves could be made up by printing SDRs.

In fact, SDRs were printed and handed out repeatedly during the dollar crisis from 1969–1980. But then a new King Dollar age was started by Paul Volcker and Ronald Reagan, with some help from Henry Kissinger, the king of Saudi Arabia and private bankers like my old boss Walter Wriston at Citibank.

Under the new King Dollar system, U.S. interest rates would be high enough to make the dollar an attractive reserve asset even without gold backing. Remember those 20% interest rates of the early 1980s?

Henry Kissinger also persuaded Saudi Arabia to keep pricing oil in dollars. This “petrodollar deal” meant that countries that wanted oil needed dollars to pay for it whether they liked the dollar or not.

The Arabs deposited the dollars they received in Citibank, Chase and the other big banks of the day. The bankers, led by Wriston at Citibank and David Rockefeller at Chase, then loaned the money to Asia, South America and Africa.

From there, the dollars were used to buy U.S. exports like aircraft, heavy equipment and agricultural produce. Suddenly, the game started up again, this time without gold. This new Age of King Dollar lasted from 1980–2010.

Still, it was all based on confidence in the dollar. Triffin’s dilemma never went away; it was just in the background waiting to re-emerge while the world binged on new dollar creation and forgot about gold. The U.S. ran persistent large trade deficits during this entire 30-year period as Triffin predicted. The world gorged on dollar reserves with China leading the way in the 1990s and early 2000s.

The new game ended in 2010 with the start of a currency war in the aftermath of the Panic of 2008. Trading partners are again jockeying for position as they did in the early 1970s. A new systemic collapse is waiting in the wings.

The weak dollar of 2011 was designed to stimulate U.S. growth and keep the world from sinking into a new depression. It worked in the short run, but now the tables are turned. Today, the dollar is strong, and the euro and yen have weakened. This gives Japan and Europe some relief, but it comes at the expense of the U.S., where growth has slowed down again.

The new dollar-yuan peg with China has also contributed to a slowdown in China. There’s just not enough global growth to go around. The major trading and finance powers are cannibalizing each other with weak currencies. Soon the U.S. and China may devalue relative to Europe and Japan, but that just moves the global weakness back to them.

Is there no way to escape the room? Is there no way out of Triffin’s dilemma?

A new gold standard might be one way to solve the problem, but it would require a gold price of $10,000 per ounce in order to be nondeflationary. No central banker in the world wants that, because it limits their ability to print money and be central economic planners.

Is there an alternative to gold? There is one other way out. That’s our old friend, the SDR. The brilliance of the SDR solution is that it solves Triffin’s dilemma.

Recall the paradox is that the reserve currency issuer has to run trade deficits, but if you run deficits long enough, you go broke. But SDRs are issued by the IMF. The IMF is not a country and does not have a trade deficit. In theory, the IMF can print SDRs forever and never go broke. The SDRs just go round and round among the IMF members in a closed circuit.

Individuals won’t have SDRs. Only countries will have them in their reserves. These countries have no desire to break the new SDR system, because they’re all in it together. The U.S. is no longer the boss. Instead, you have the “Five Families” consisting of China, Japan, the U.S., Europe and Russia operating through the IMF.

The only losers are the citizens of the IMF member countries -- people like you and I -- who will suffer local currency inflation. I’m preparing with gold and hard assets, but most people will be caught unaware, like the Greeks who lined up at empty ATMs last month.

This SDR system is so little understood that people won’t know where the inflation is coming from. Elected officials will blame the IMF, but the IMF is unaccountable. That’s the beauty of SDRs -- Triffin’s dilemma is solved, debt problems are inflated away and no one is accountable. That’s the global elite plan in a nutshell.

We never take our eye off the IMF and its plans to expand the use of SDRs. The IMF will include the Chinese yuan in the SDR basket over the next 12 months to make sure the Chinese are “on the bus” when the endgame begins. That’s an important step in the SDR process.

We plan to report on the IMF annual meeting in Lima, Peru, so you have a front-row seat for these developments. This story has longer to run, but the endgame is already in sight. Stay tuned...

Regards,

Jim Rickards

Source: Daily Reckoning

Follow us on Twitter: @blacklioncm

How the Chinese Will Establish a New Financial Order

How the Chinese Will Establish a New Financial Order By Porter Stansberry Friday, September 18, 2015

For many years now, it has been clear that China would soon be pull­ing the strings in the U.S. financial system. In July 2015, the American people owed the Chinese government nearly $1.25 trillion. I know big numbers don't mean much to most people, but keep in mind… this tab is now hundreds of billions of dollars more than what the U.S. government collects in ALL income taxes (both cor­porate and individual) each year. It's basically a sum we can never, ever hope to repay – at least, not by normal means. Of course, the Chinese aren't stupid. They realize we are both trapped. We are stuck with an enormous debt we can never realistically repay… And the Chinese are trapped with an outstanding loan they can neither get rid of nor hope to collect. So the Chinese govern­ment is now taking a secret and somewhat radical approach.  China has recently put into place a covert plan to get back as much of its money as possible – by extracting colossal sums from both the United States government and ordinary citizens, like you and me.  The Chinese State Administration of Foreign Exchange (SAFE) is now engaged in a full-fledged currency war with the United States. The ultimate goals – as the Chinese have publicly stated – are to cre­ate a new dominant world currency, dislodge the U.S. dollar from its current reserve role, and recover as much of the $1.25 trillion the U.S. government has borrowed as possible.  Lucky for us, we know what's going to happen. And we even have a pretty good idea of how it will all unfold. How do we know so much? Well, this isn't the first time the U.S. has tried to stiff its foreign creditors.  Most Americans probably don't remember this, but our last big currency war took place in the 1960s. Back then, French President Charles de Gaulle denounced the U.S. government's policy of print­ing overvalued U.S. dollars to pay its trade deficits… which allowed U.S. companies to buy European assets with dollars that were artificially held up in value by a gold peg that was nothing more than an accounting fiction. So de Gaulle took action…  In 1965, he took $150 million of his country's dollar reserves and redeemed the paper currency for U.S. gold from Ft. Knox. De Gaulle even offered to send the French Navy to escort the gold back to France. Today, this gold is worth about $5 billion.  Keep in mind… this occurred during a time when foreign govern­ments could legally redeem their paper dollars for gold, but U.S. citizens could not.  And France was not the only nation to do this… Spain soon re­deemed $60 million of U.S. dollar reserves for gold, and many other nations followed suit. By March 1968, gold was flowing out of the United States at an alarming rate.  By 1950, U.S. depositories held more gold than had ever been assembled in one place in world history (roughly 702 million ounces). But to manipulate our currency, the U.S. government was willing to give away more than half of the country's gold.  It's estimated that between the 1950s and early 1970s, we essentially gave away about two-thirds of our nation's gold reserves… around 400 million ounces… all because the U.S. government was trying to defend the U.S. dollar at a fixed rate of $35 per ounce of gold.  In short, we gave away 400 million ounces of gold and got $14 billion in exchange. Today, that same gold would be worth $450 billion… a 3,100% difference.  Incredibly stupid, wouldn't you agree? This blunder cost the U.S. much of its gold hoard.  When the history books are finally written, this chapter will go down as one of our nation's most incompetent political blunders. Of course, as is typical with politicians, they managed to make a bad situation even worse…  The root cause of the weakness in the U.S. dollar was easy to understand. Americans were consuming far more than they were producing. You could see this by looking at our government's annual deficits, which were larger than ever and growing… thanks to the gigantic new welfare programs and the Vietnam "police ac­tion." You could also see this by looking at our trade deficit, which continued to get bigger and bigger, forecasting a dramatic drop (eventually) in the value of the U.S. dollar.  Of course, economic realities are never foremost on the minds of politicians – especially not Richard Nixon's. On August 15, 1971, he went on live television before the most popular show in Ameri­ca (Bonanza) and announced a new plan…  The U.S. gold window would close effective immediately – and no nation or individual anywhere in the world would be allowed to exchange U.S. dollars for gold. The president announced a 10% surtax on ALL imports!  Such tariffs never accomplish much in terms of actually altering the balance of trade, as our trading partners simply put matching charges on our exports. So what happens is just less trade overall, which slows the whole global economy, making the impact of inflation worse.  Of course, Nixon pitched these moves as patriotic, saying: "I am determined that the American dollar must never again be a hos­tage in the hands of international speculators."  The "sheeple" cheered, as they always do whenever something is done to "stop the speculators." But the joke was on them. Within two years, America was in its worst recession since WWII… with an oil crisis, skyrocketing unemployment, a 30% drop in the stock market, and soaring inflation. Instead of becoming richer, millions of Americans got a lot poorer, practically overnight.  And that brings us to today…  Roughly 40 years later, the United States is in the middle of anoth­er currency war. But this time, our main adversary is not Europe. It's China. And this time, the situation is far more serious. Our nation and our economy are already in an extremely fragile state. In the 1960s, the American economy was growing rapidly, with decades of expansion still to come. That's not the case today.  This new currency war with China will wreak absolute havoc on the lives of millions of ordinary Americans, much sooner than most people think. It's critical over the next few years for you to understand exactly what the Chinese are doing, why they are doing it, and the near-certain outcome.  Regards,  Porter Stansberry  Source: International Man Follow us on Twitter: @blacklioncm

Three Steps to Protect Your Portfolio from the Next Bear Market

Three Steps to Protect Your Portfolio from the Next Bear Market

ALEXANDER GREEN, CHIEF INVESTMENT STRATEGIST, THE OXFORD CLUB

In one of my recent columns, I noted that investment analysis has gotten far trickier over the last few years. 

We have entered a period of “administrative markets,” in which equity returns are affected as much by government policies as they are by economic growth and corporate profits. 

In the last few years, we’ve seen large-scale bailouts; trillions in fiscal stimulus; massive quantitative easing; nearly seven years of zero short-term rates; heavy-handed regulation; and sharply higher taxes on income, dividends, and capital gains. 

Our corporate tax rate is the highest in the developed world, driving even iconic American companies like Burger King to move their headquarters to Canada. 

These policies distort markets... and lately equity investors have been paying the price. 

A Shot Across the Bow

The S&P 500 recently plunged more than 10% in four days. 

Don’t shrug this off. According to Bianco Research, this has happened only eight other times in the last 80 years. 

Yes, the markets took a significant bounce. But I still view this as a shot across the bow, a warning. 

Here’s what makes the smart money nervous right now... 

In the past, when the economy (and the stock market) went into the tank, the traditional policy response was to stimulate the economy with lower interest rates and deficit spending. 

But interest rates are already at zero. And under the Obama administration, the national debt has soared from $7.4 trillion to $18.4 trillion. 

What’s next? Are we moving to negative interest rates (like Europe), creating a situation in which you have to pay to leave your money in the bank and even more stupendous deficits? That policy prescription didn’t work well for Greece. 

Don’t put me in the gloom-and-doom camp. I’m not a pessimist. But I’m no Pollyanna either. 

I consider myself a skeptical realist who looks at both the positives and negatives. Despite the many government policy missteps over the last decade, there are factors to appreciate as well. 

For instance, the U.S. economy posted a much bigger rebound in growth during the spring than previously reported… (The Commerce Department adjusted the annual expansion rate in the April-June quarter sharply higher to 3.7%.) 

Plunging energy prices are a huge plus for everyone outside the oil and gas industry… 

Inflation is negligible… 

Housing is roaring back… 

Unemployment is falling… 

The dollar is strong... And the outlook for corporate profits is improving...

Three Essential Steps

Given the mixed outlook, what should you do with your portfolio now? Start with these three essential steps: 

1. Check your asset allocation. The roaring bull market of the last six and a half years has almost certainly increased – and perhaps more than doubled – your exposure to equities. If it’s now larger than you’re comfortable with, pare back to the point at which you’ll be able to sleep at night. How much in stocks is enough (or too much)? Investment great Benjamin Graham used to say that no one should have more than 80% of their portfolio in stocks – or less than 20%. Look at your age, time horizon, and risk tolerance, and adjust accordingly. 2. Move those trailing stops. Make sure they are no more than 25% below your holdings’ recent highs. And if you’re using “mental stops” – no actual stop orders entered – be sure to maintain your sell discipline when your stocks trade through your predetermined price. 3. Adopt a late-stage bull market strategy. That doesn’t mean move to cash. (This bull market could last five more weeks, five more months, or five more years.) History shows that as a bull market ages, the safest and best-performing stocks tend to be recession-resistant, mega-cap value stocks, preferably ones with growing dividends. (Those dividends both support your shares and provide income during the bad times.)

All this government meddling with the market makes this a challenging time for investors. We can only wait and see what policymakers dream up next, whether it’s higher rates or QE4 or something entirely new. 

Investment legend John Templeton used to point out that no matter how strange things look, economic and market cycles are all essentially the same. 

He famously noted that “this time is different” is the most expensive phrase in the annals of investing. That statement is generally true. 

But check your history. When was the last time the national debt was bigger than our GDP and the Fed held rates at zero for nearly seven years? 

This time really is different. Govern your portfolio accordingly. 

Good investing, 

Alex Green 
Chief Investment Strategist, The Oxford Club 

Source: Bonner and Partners

Follow us on Twitter: @blacklioncm

Don't Let 'The Glidepath Illusion' Ruin Your Retirement

Don't Let 'The Glidepath Illusion' Ruin Your Retirement By Dan Ferris, editor, Extreme Value Friday, August 28, 2015

The traditional notion of retirement says you should take bigger risks in the stock market when you're young. You have more time to make up for losses than when you're older. As you age, you should take less and less risk, so you won't lose your retirement money. This strategy is called "Glidepath investing." And it could ruin your retirement. Let me explain… The emotional appeal of Glidepath investing is obvious. Young people feel like they're going to live forever, so it feels better to them to take more risks. Buying more risky stocks and fewer safe bonds feels right.  Older people feel they have more to lose and might not be able to support themselves one day, so they tend to be more risk averse. For them, buying fewer stocks and more bonds feels safer.  There's an army of financial planners and other "helpers" out there selling products designed to get you to retirement with a big, safe nest egg, based on this feel-good notion.  However, research suggests that what feels good isn't necessarily what you should do…  Investor and researcher Rob Arnott of Research Affiliates published a report in September 2012 called, "The Glidepath Illusion." Arnott says Glidepath investing will make you less money because it will lead you to put less money in higher-return investments (stocks).  Arnott studied 141 years of stock and bond returns from 1871 to 2011. From these data, he hypothesized a range of possible outcomes. In general, Arnott found evidence that the range of outcomes from doing the opposite of Glidepath investing was superior to the range of Glidepath-based outcomes.  It's well documented that stocks outperform bonds over the long term.Glidepath investors wind up putting a bigger percentage of their assets in stocks when they're younger and have less to invest. They put a higher percentage into bonds when they're older and have more to invest.  That's the basic error. Investors put fewer dollars into higher-return investments, then interrupt the compounding process to put more dollars into lower-return investments. So they make lower returns than if they had done the opposite of Glidepath investing.  Glidepath investing is a good recipe for feeling good, but a poor one for making as much money as possible in stocks and bonds. Arnott's conclusion is worth quoting and keeping close at hand as a reminder…  Investors who are prepared to save aggressively, spend cautiously, and work a few years longer (because we're living longer), will be fine. Those who do not follow this course are likely to suffer grievous disappointment… No strategy can make up for inadequate savings or premature retirement.  Save aggressively. Spend cautiously. Let your investments compound as long as possible before drawing them down. That's sound advice.  Sadly, it makes perfect sense that the financial services industry is once again doing exactly the wrong thing for clients. Don't trust financial planners and brokers. They're commissioned salespeople. They're incentivized to sell investments, NOT to make you money in stocks and bonds.  For as long as my health holds out, I'll stay productive and hopefully get well compensated for my efforts, saving aggressively and spending cautiously. I recommend you do the same.  Good investing,  Dan Ferris Source: Daily Wealth Follow us on Twitter: @blacklioncm

The Ultimate Cash-Management Guide

The Ultimate Cash-Management Guide By Dr. David Eifrig, editor, Income Intelligence Thursday, August 27, 2015

No one talks about how to manage your cash. As regular readers know, we suggest holding cash in an emergency fund and in your portfolio. If you've followed our advice, you likely have tens, and maybe hundreds, of thousands of dollars in cash. But you need to give some thought to where you put it… As with every investment, when you look at where you put your cash, you need to balance yield and risk.  Some of these cash accounts I'm going to cover today are 100% risk-free. Others claim to be low-risk, but may have hidden risks that are difficult to understand.  We'll start with the lowest-risk, most "pure" cash accounts… And we'll proceed through investments that could offer a higher yield.  Checking and Savings Accounts The safest cash accounts are FDIC-insured checking and savings accounts with banks.  FDIC insurance means that even if the bank makes disastrous loans or a bank manager absconds with the money in the vault, the Federal Deposit Insurance Corporation will make depositors whole, up to $250,000.  These accounts are liquid, meaning you can access your cash almost instantly via online banking or at a branch office.  Checking accounts are a good example. You can write checks directly from your account. However, they pay little in interest. I recommend keeping your checking balance just high enough to avoid any overdrafts. Or do what I do and link your checking accounts to your savings account for overdraft protection.  Savings accounts offer better yield, with the same safety.  Were it not for historically low interest rates, this would be a Golden Age for savings accounts. The advent of secure online banking has removed geography from the equation. So smaller banks looking to boost deposits often offer higher rates to anyone.  Big national banks, like Bank of America and Wells Fargo, offer savings accounts that currently yield 0.01% and 0.03%, respectively. You can do much better with a little searching. Websites like Bankrate.com orNerdwallet.com/rates can help you find the best rates.  A word of caution: Always read the fine print to be certain that your account is FDIC-insured. Just because you've walked into an FDIC-insured institution (or visited their website), it doesn't mean every account is insured. These banks offer all kinds of products and many don't fall under the FDIC's watch.  Money Market Accounts One such FDIC-insured product is a money market account, or MMA.  MMAs, sometimes referred to as money market deposit accounts, will usually have higher minimum deposit requirements than savings accounts, though this can be as low as $500 in some cases.  If you meet those minimums and have your checking accounts covered, MMAs almost always pay a higher rate than savings accounts. So use them when you can.  Again, you can use the tools at the websites we've mentioned to find the highest rates on MMAs.  For both savings accounts and MMAs, regulations state that you can't have more than six transfers per month into or out of the accounts. So it takes a little planning to make sure that your checking balances can handle whatever you need.  Certificates of Deposit Certificates of Deposit, or CDs, have many of the benefits of savings and money market accounts… For example, they're FDIC-insured, with no risk of loss unless our entire government collapses… with just one drawback.  However, that drawback comes with a higher yield, and it just may be the perfect place to place your cash depending on your needs.  The risk they do carry is liquidity risk. When you put your cash in a CD, you agree to leave it there for a particular amount of time, between three months to five years.  If you want to get it back before then, you need to pay a penalty.  Since the money is locked up, the bank will give you a higher interest rate. You can collect about 1%, or even 1.15%, on a one-year CD from some of the more competitive banks… with higher yields for longer time periods. Check the websites we've recommended to find the best rates.  Given that your money is locked up, CDs work better for the cash allocation of your portfolio as you approach retirement, not your emergency fund.  Money Market Mutual Funds All the prior cash accounts have a major advantage: They are FDIC-insured. The peace of mind that should give you can't be overstated.  When you branch out into money market mutual funds (or MMMFs), you do not have an FDIC guarantee. You now face the risk of loss. You have become an investor, and not a saver.  That's not how MMMFs are sold, though. They are sold as ultra-safe places to hold your cash savings. You'll see language from fund companies like, "[the fund] seeks to provide current income and preserve shareholders' principal investment by maintaining a share price of $1."  This $1 share price is the central focus of MMMFs. You buy shares for $1 and the fund invests that cash in short-term securities. By law, the investments must expire within 90 days.  When the fund makes money, its share price doesn't rise. Instead, it creates more $1 shares and adds them to your account. If you check your balance, it doesn't look like you're an investor. It looks like your dollars are growing.  Here's the trick with MMMFs…  They are exceptionally safe… until they aren't.  MMMFs use a wide range of securities to generate their returns. There is a massive market of short-term securities that you've likely never explored.  They use securities like short-term Treasury bonds and T-bills, but they also use things like overnight repurchase agreements, or repos. This is a complex system whereby a bank will borrow $99.99 overnight and pay back $100 the next day. Of course, this is happening on the scale of trillions of dollars.  This system is called the "shadow banking" system. It works flawlessly almost all the time. But when things go wrong, there's trouble.  This is what happened in the financial crisis. In 2008, the short-term paper markets froze up. People were too scared to lend to one another, even overnight loans to the biggest banks. The market was in a panic.  A few funds got themselves into trouble. The Reserve Primary Fund was one of the largest and most respected funds, with $68 billion in assets. In particular, it had a big pile of securities issued by Lehman Brothers. Since everyone was in a panic, the fund couldn't figure out what these loans were worth.  The fund was unable to maintain its $1-per-share value. This is known as "breaking the buck."  Investors in the Reserve Primary Fund had their cash frozen while the fund sorted things out. It was more than a year before a court ordered the fund to pay out whatever funds it did have to shareholders.  Some people had hundreds of thousands of dollars in "cash"… but they couldn't access a penny.  Now, trouble like this doesn't happen often. Prior to 2008, not a single fund broke the buck in the 37-year history of MMMFs.  So you shouldn't fear MMMFs… but you do need to understand what's happening with your cash when it no longer has FDIC insurance.  There are also some tricks you can use to ensure you get the best MMMFs.  The shadow banking system is a highly efficient market. That means if a fund has a higher yield than its competitors, it's taking on more risk.  You should also back out the fees. For instance, take two funds that each yield 1% after fees. You would think that they have the same risk. However, one might charge a 0.5% management fee and the other might charge 0.25%.  That means the fund with the higher fees has to use riskier investments to get the same yield. In this case, the low-fee fund is unequivocally better than the high-fee fund.  And diversification will benefit you here as well. If you have a substantial amount of cash and you don't want it frozen during a crisis, spread it around a few different MMMFs managed by different investment companies. Three different funds should be enough.  MMMFs do have some remote risk, and right now their yields are not high enough to justify taking those risks relative to FDIC-insured accounts.  MMMFs, on average, yield only about 0.01% today. When you look up funds, you'll see it quoted as the seven-day yield. This uses the fund performance from the last seven days to determine its annual yield.  Considering you can earn much better than that in an FDIC-insured savings account, we consider MMMFs mostly off the table until interest rates rise.  MMMFs might not be such a great investment then, either. The U.S. Securities and Exchange Commission has drawn up a new set of rules for MMMFs to make them safer. The trouble with MMMFs comes partly when everyone tries to withdraw their funds at the same time.  So, effective October 2016, MMMFs used by individual investors can deny you access to your money for up to 10 days, or they can charge a redemption fee of 2%.  To make that worth it, MMMFs are going to have to yield a heck of a lot more than they do today. To sum up:  Most people don't spend too much time thinking about their cash.  But sitting down and taking a rational look at your cash needs can provide for emergencies and immediate needs without sacrificing long-term returns.  And making sure you hold your cash in the right place can help you sleep well at night while keeping inflation off your back.  Here's the good thing about getting your cash investments in order: Once you do, it takes little time to keep things in order.  If you're an income investor, you should be successfully generating cash month after month and quarter after quarter. This essay should help you know what to do with it.  Here's to our health, wealth, and a great retirement,  Dr. David Eifrig  Source: Daily Wealth Follow us on Twitter: @blacklioncm