I write generally about three topics on this site:

• Personal Finance
• Investing
• Economics

I list them in that order based on what I perceive as the general public’s interest level.  Most people are concerned with getting out of debt and maintaining a budget – Personal finance issues.  Those who have succeeded at those tasks become more interested in how to put their savings to work for them and become interested in investing.  Very few people proceed to an interest in policy and economics, and perhaps rightly so.  It’s certainly not immediately clear that an understanding of economics is beneficial to your personal wealth.

The Case for Economics

There are obvious reasons to believe that an understanding of economics should be a great asset in your financial life.  Inflation is one of the examples.  If I judge accurately what future inflation will look like, this can greatly improve my ability to choose good investments.  If I can look at upcoming legislation and see what its effects will be, I should be able to capitalize on that.  It seems like a slam dunk that an economic view should be a great boon to my financial freedom.

However…

Sadly, economists have a habit of being spectacularly wrong.  Even when they aren’t completely wrong, it’s very difficult to profit off of their decisions.  For example, right now treasuries are already priced very low because of a perception that inflation in the future will be high.  So even if that perception is correct, the expected price change is already “baked into the cake;” and if they’re wrong, there’s a chance for spectacular loss.

So Why Bother?

Despite all this I have a nasty habit of continuing to write about the big picture, particularly policy.  One reason I do this is because I believe that a basic understanding of economics can help you make wise decisions in your day to day life, not just in your investing life.  The law of supply and demand may not be useful in deciding whether to buy Microsoft, but it can be useful in starting a business or in deciding what political policies to pursue.  While the value of economic understanding may be questionable for investing purposes, its value in life is much less questionable.

The More Things Change

Many sage investing professionals have a saying:  The most dangerous words in the English language are this time it’s different. Each time that politicians proudly proclaim that we’ve defeated the boom and bust cycle for example, we know how the story always ends.  The more things change, the more things stay the same.

So perhaps the best things we can learn from economics are the basics.  There’s no point trying to guess what’s going to happen in the short term, and play the game for the long haul.  If you do the things that have always worked, you’ll likely meet with success.  Work hard, save, and be wise with your investments.  An understanding of the economy has many benefits, but probably won’t make you rich overnight.  That doesn’t mean it’s not worth having.

Photo Credit: Chi King

Post from: Personal Finance And Investing

Do Economics Matter?

As a general rule I think options are a terrible idea for the casual investor.  For those who are simply trying to match the markets without spending a tremendous time watching their investments, options represent a significant danger.  Even for those who have experience with options, understanding all the implications of buying or selling an option can be confusing.  Covered calls however, may have a useful place in the typical investor’s portfolio.

Option Terminology

Options are defined by several values.  For the purposes of discussing options here we will assume we’re talking about an options contract on a stock, which is not always the case.  First of all, be aware that an options contract is for 100 shares of the stock.  Thus you don’t deal in tremendously small lots when dealing with options.

Each option is either a call or a put.  A call option is an option to buy a stock at a particular price on or before a particular date.  A put option is an option to sell a stock at a particular price on or before a particular date.  In both cases the date by which the decision must be made is the expiration date and the price at which you have the option to buy or sell is called the strike price.  These options also have a price which is listed in terms of a price per share.  So for example if you see a price quoted as $0.25, that means twenty-five cents per share, or $25 for the full contract, since contracts are for 100 shares.

If all of this sounds confusing let’s look at an example:

Supposing we have a stock X which is currently trading at $35 per share and it is currently January 1^st.  Now suppose I buy 10 call contracts on this stock with a strike price of $37.50 and an expiration date of February 23^rd (Note that expiration dates are the third Friday of a month).  Let’s suppose I pay a price $1 per share for each of these options ($100 total for each and $1,000 total since I’m buying 10 contracts) and look at what happens depending on how stock X’s price changes in that time.

If stock X does not exceed $37.50 before February 23^rd my options will expire as worthless and I will lose 100 percent of my investment, assuming I do not sell the contracts before then.  If on February 23^rd the price of the stock is higher than $37.50, I will be able to buy the stock at a discount, which will hopefully exceed my $1,000 investment.  So for example if the stock is at $42.00 I will make $4.50 per share on the 100 shares per contract for 10 contracts, thus making $4,500 less my initial $1,000 investment.  This means I made $3,500 on a $1,000 investment.  As you can see, options have a high risk and high reward.

In general, people often close their position before the expiration date, which of course affects the economics as well.  If I have a call option, for example, with some time left before the expiration date and the option is already “in the money” (meaning the share price is higher than the strike price for a call), then I will probably be able to sell it at a premium to the difference in the prices, because of the potential to make more money before the expiration date.

Covered Calls

So now let’s suppose instead that I want to sell a call on stock X.  I can do this without owning one; I simply have to buy it back before the expiration date.  This is very similar to shorting a stock.  Let’s look at the economics of this.  If I sell a $37.50 call for $1 per share then I make $100 per contract.   As long as the stock doesn’t go above $37.50 before the expiration date, I will get to pocket that $100 per contract.  However if the stock goes skyrocketing I will have to pay the difference between the price and my $37.50 strike price.  As you can see, this is very risky.  However, I can make this a much safer bet if I already own the stock.

Suppose I have 1,000 shares of stock X and I do not expect the price to rise significantly.  I might go ahead and sell a call with a strike price a bit above the current price.  Thus if the stock price doesn’t move above that strike price I will pocket a little money.  If the stock price does move I will still make money because of the difference between the current price and the strike price and the premium I was paid when I sold the contract (the contract’s price).

Thus if the stock goes down, I’m better off than I would have been without the call because I get the money for selling the contract.  If the stock stays flat I’m better off for the same reason.  The only time I lose is if the price goes enough above the strike price to exceed the value I was paid for the contract.  Thus I’m limiting my downside, but I’m also limiting my upside.  If stock X doubles, I’m only going to get my strike price for it, which could be thoroughly discouraging.

Why Sell Covered Calls?

There are many reasons you might not be bullish about a stock price in the short term, but not ready to sell the stock.  Tax considerations could be one example.  Another might be that the stock pays a dividend, but you’d like to limit your exposure to the stock going down in the meantime.  In fact, combining covered calls with dividend stocks can be a good way to increase your yield and limit your risk.  You might also simply want to limit your risk when entering a position by reducing your downside and upside at the same time.

Obviously there is much more to understanding the risks and benefits of covered calls, however they represent one of the few options strategies that might make sense for a casual investor.  Be sure that you thoroughly understand them before considering them however.  The vast number of variables and outcomes can confuse even the most seasoned investor.

Post from: Personal Finance And Investing

Selling Covered Calls

A Subscription to the Economist – I have had subscriptions before, but I can’t ever get through them in a week so pretty soon I have a pile in my entryway.  That being said it’s SO much cheaper to get a subscription and if you giftee is a frequent reader of the Economist it could be a very appreciated gift.

A copy of Thomas Sowell’s Basic Economics – This is a great read for someone who is interested in economics.  While he occasionally dabbles in partisan politics, this book is much less “agenda driven” than many of his other books, particularly Economic Facts and Fallacies.

A Single Share of Stock Cerificate - Most of us trade almost completely electronically anymore and we almost never actually get to hold any physical symbol of our interests. You can get these from OneShare.com. Right now you can get $20 Off Complete Framed Stock: Use code HOLIDAY09.

Gold Coins – Much like the stock certificate, this gives us something physical to represent what we spend so much of our time doing.

Classic Books – Even if they’ve already read them, it can be nice to own a copy of something like one of Peter Lynch’s classics, or the Intelligent Investor.

Stress Relief – Get something to take the edge off during the trading day.  I like stress balls, but there are tons of options.

Report or Newsletter Subscriptions – If you’ve ever heard them mention a newletter or a research service they’d like a subscription for, this can be a great gift.  I’d never go out and buy one myself, but if I got one as a gift I’d use it.

Of course, in the end we know that we’re hard to shop for and will be happy with whatever you give us.  Especially if it’s not depreciating rapidly!

Post from: Personal Finance And Investing

Gifts for Investment Nerds

Photo by: stephen.moore

When it comes to investing, is America still the most sensible place to keep your money?  This question involves a lot of elements and has no simple answer.  There are however, some pieces of conventional wisdom that may deserve a little extra attention.

Is China the Future?

Listening to the media, you would think the ascendancy of the Chinese is all but assured.  They are one of the few economies to truly start enjoying an alleged rebound from the economic crisis and were already becoming a behemoth before the latest financial woes.  Surely Asia is where the future lies.

What is often forgotten in all of this is that China is not an open society.  In the modern era we assume that the wool can’t be pulled over investors’ eyes.  China however can easily give out misleading numbers to investors.^[1] Moreover, because of the amount of their economy that is centrally planned, they can essentially manipulate their own markets very easily.  Their current stimulus may largely consist of creating unused infrastructure to keep their populace employed.^[2]

Inflation: The Ugly Contest

Another supposed factor in why our money should be fleeing US Dollars is the hyper-inflation that will be driven by all the stimulus spending.  The thinking goes that any kind of recovery in the economy will be coupled with inflation from all the money that’s been printed to finance the stimulus.  While this seems reasonable, at the same time it’s been suggested that as much as 40 percent of the World’s wealth was destroyed by the financial crisis.^[3] With a good deal of that being in America, it seems that we may be able to survive some quantitative easing.

Moreover, those who are looking for another currency into which to move their funds may find it difficult to find another country’s currency that isn’t just as ugly as the Dollar.  Most of the European countries have used debt to finance significant stimulus as well.  Additionally these countries have less business-friendly policies than the US and may be just as slow to recover.  China and much of Asia suffer from the dangers of being net exporters, which is a dangerous position when the rest of the world isn’t buying anything.  While inflation remains a reasonable fear, it may not be quite as dangerous as it appears.

The Dollar as the Reserve Currency

Many nations are suggesting that the time has come to move away from the Dollar as the World’s reserve currency.^[4] Due to the staggering amount of money we’re printing, countries such as China have begun to suggest that banks should begin to use various other instruments as their reserve currencies.  While this is an understandable sentiment, several things impact this position:

• Most of these countries own a lot of US Dollars.  They don’t necessarily want to see the Dollar fall too precipitously.^[5]

• No one is forcing the Dollar to be a reserve currency right now.  Central bankers can hold their reserves in whatever they like; they simply tend to prefer dollars for a variety of reasons.  One of the most important is the openness of American finances versus other countries.

Hedging Your Bets

All of these dangers are real.  However they are far from sure bets.  While it makes good sense to hedge your bets and reduce your exposure to the dollar, it can be very dangerous to bet the farm on the failure of the American Dollar.  While we have certainly taken some lumps lately, it’s not clear who would be the beneficiary of the end of US hegemony.  It may be premature to bet on America’s demise.

Post from: Personal Finance And Investing

Is America Still the Land of Opportunity?

1. Economist: The Art of Chinese Massage
2. The Economist:: China’s Stimulus: Got a Light
3. Telegraph: WEF 2009: Global crisis ‘has destroyed 40pc of World’s wealth’
4. Wall Street Journal: Inevitable End to Dollar’s Reserve Role?
5. Treasury Department: Major Foreign Holders of Treasury Securities

Photo by: Chapek Sergey

Probably the most self-destructive thing that a person can do for their financial future is to pay undue attention to what those around them are doing.  Obviously this has limits, but using your friends, family or neighbors as benchmarks for “success” can manifest itself in many ways and almost all of them can sabotage your financial progress.  You should always remember that what a person presents as their situation can be very different from their true situation.  Let’s look at some ways the Joneses can sabotage you.

Status Symbols

Typically when talking about “keeping up with the Joneses” we’re referring to buying status symbols.  Maybe your neighbor bought a new BMW, and it sure looks nice.  Or maybe you’d like to host the football watching party sometime, but your TV just doesn’t match up to your friends’.  These types of situations can inspire us to make purchasing decisions that may provide a short-term high for a lot of pain.

Almost all status symbols are depreciating in nature.  Your car and that new TV are going to lose their value over time.  The more purchases like that you can avoid the better your financial future is going to be.  This isn’t really very tricky, and most of us are aware of this, even if we don’t always follow through.

Debt

Debt is a less obvious way in which our neighbors and friends can influence us.  The Joneses can convince us that it’s reasonable to carry credit card debt or car notes.  The Joneses can also convince us that it’s perfectly reasonable to stretch our budget to make these payments.  When you use debt to finance the status symbols, the damage is multiplied.  Carrying debt for an investment like an education is one thing, carrying it for a television is quite another, especially given the kinds of interest rates credit cards charge.

Risk

One of the most insidious and pervasive ways your acquaintances can affect your financial future is by affecting your investment choices.  This is in many ways one of the driving forces of asset bubbles.  Take the dot-com boom and bust.  You neighbor might have bought a stock and is now making 50% per year on it.  He’s telling you you’re a fool to stay out of this market.  You know that those kinds of returns aren’t sustainable or realistic, but it seems like everyone else is reaping them.  Maybe it really is a new economy and you’re the only one being left out.  So of course you join in the bubble just in time for the bust and get the worst of it.

Letting other people’s returns affect your investment decisions is very dangerous.  When it comes to investments we seem to suffer a form of mass insanity.  Look at all the people buying houses with no money down and interest-only payments because everyone knows house prices always go up.  Deep down everyone knows there’s no such thing as a free lunch, but when it seems like everyone else is getting one, we can start to make very bad decisions.  It never pays to abandon your own principles just because the Joneses seem to be beating the system.  The system has a nasty habit of catching up with the Joneses.

Post from: Personal Finance And Investing

The Joneses Are Your Enemy

Photo by: mvhargan

I often hear people tell me that they’ve stopped contributing to their retirement account because they don’t think the stock market is going to go up.  It seems many of these people assume that a retirement account and the stock market are one and the same.  Most plans have many options, and nearly 64% have actively managed bond funds as an alternative.^[1]

The fact that many people don’t even know what their options are in their retirement accounts suggests to me that they probably shouldn’t have been in the stock market in the first place.  Many people were initially sold on stock market-based retirement account options by claims that the stock market returned 8%, or 11%, or whatever their advisor was telling them. They put their finances on autopilot and never looked back.  At least they never looked back until 2008.

The Risk Premium

The philosophical rationale for why stocks should outperform “safe” investments, like government treasuries, is something called the risk premium.  In theory, if equities did not outperform safe investments, then rational actors would cease to buy the equities. The prices would decrease to a level where there would be an adequate risk premium.

This theory was put to the test during the recent financial crisis when, at the nadir of stock prices, there essentially was no risk premium for the previous thirty years.^[2]  Since then, stocks have rebounded a good deal and the risk premium has returned. However, it points out an important fact: the risk premium is only likely in the long term and is not guaranteed.

Risk Tolerance

Because of the wild variability of the risk premium, the value proposition of equities decreases as you get closer to an expected retirement date.  Once you have a near-term window for beginning withdrawals, the amount of time your returns have to “average out” decreases, and your exposure increases.  As you get closer and closer to retirement, equities should become a smaller and smaller portion of your portfolio.

The Macroeconomic Picture

The final, and most important, question is:  Do you still believe in the American Economy in the long term?

Ultimately there are many other fish in the sea and there’s no reason you have to be invested in American stocks, or even in stocks at all.  In an era of declining stock prices, being flat is better than losing less than others.  The macroeconomic picture can be conflicting and confusing right now, so it can be hard to decide; but there are plenty of things to fear.  If you haven’t measured your thoughts on these subjects or discussed them with your advisors, the sooner the better.

You should never approach the stock market as your only investment option.  Think about your position in life and whether your goals are the same as when you started your investment plan.  Automatic investing in the stock market has been a solid choice for many years now, but before you commit any more money to the plan, clarify in your mind why you’re doing so.

Post from: Personal Finance And Investing

Should You Be In the Stock Market?

1. PSCA.org – 51st Annual Survey of Profit Sharing and 401(k) Plans
2. Bloomberg.com – Bonds Beat Stocks in ‘Earth-Shattering’ Reversal: Chart of Day

Photo by: Rob Lee

The term “Dollar Cost Averaging”, or DCA, can have many different meanings.  Oftentimes when referring to “Dollar Cost Averaging,” people actually mean “Automatic Investing.”  DCA typically refers to investing over a period of time an amount you could have invested initially.  So for example, if you had $10,000 to invest, instead of putting it all in now, you invest it over a period of several months in equal dollar amount increments.  Automatic Investing on the other hand is simply taking a set amount out of your income and investing it every month.  This is what the majority of people think of as Dollar Cost Averaging.

The Theory

Proponents of DCA claim that it reduces risk, because you tend to buy more shares when prices are low and fewer shares when prices are high.  This argument makes some sense in an oscillating market that isn’t moving overall in any particular direction.  One question remains, however: why would you want to be investing in an oscillating market that isn’t trending in one direction?  Typically most people’s faith in investing in stock markets is that over time they go up.  If the market is on average going to move upwards, why am I holding back investing a portion of my investment?  On average this simply means I’m going to get a higher price.

The Worst-Case Scenario

If we think about this matter anecdotally it seems intuitive however that by holding back some money to invest we’re reducing our worst-case scenario.  Suppose for example that we invest all our money today and tomorrow the stock drops precipitously.  We’ve avoided that risk.  At the same time however, what if the stock rises sharply and never returns to our original price.  While we may be reducing our worst-case scenario somewhat, we’re also risking leaving a lot of money on the table.  Still there seems to be some merit to increasing your exposure over time.

In Practice

In reality the way most of us “Dollar Cost Average” is that we invest a certain amount each month out of our paycheck into the stock market.  This is what is more accurately referred to as “Automatic Investing,” and is sort of a no-brainer.  However if you do receive an influx of funds and are trying to decide what to do with them, Dollar Cost Averaging may not be all it’s cracked up to be.  There can be psychological advantages to moving your money in over time, but transaction fees can add up quickly, depending on how your brokerage charges.  Think carefully before assuming Dollar Cost Averaging is right in all situations.

Post from: Personal Finance And Investing

Some Thoughts on “Dollar Cost Averaging”

Photo by: foxspain

Many people are looking for various ways to invest in foreign companies.  Whether they’ve lost faith in American companies, want to hedge or simply want  some diversity, ETFs can be an easy answer to eachieve this.  I’ve listed 76 ETFs that provide you exposure to the stocks of certain countries, groups of countries or the world as a whole.  Some things to remember:

• Many countries are highly dependent on a particular sector. For example if you’re buying a Russian ETF in many ways you are buying a lot of exposure to energy as that country is highly dependent on energy income.
• Many of these funds have run up tremendously in the previous few months.
• Some of these funds are not particularly liquid.
• Many of these funds have high fees associated with them.
• Each of these funds implements their exposure in different ways, be sure to read the prospectus.
• This list is far from exhaustive, although it was exhausting to compile.

My summary of all this is:  Read the Prospectus, Read the Prospectus, Read the Prospectus.  Make sure you know what you’re actually buying if you buy one of these ETFs.  I’m not recommending or endorsing any of them, I’m just compiling some resources to help you start your research.

Single Country ETFs

If you’re looking to roughly match the results of another single country here are some ETFs for some specific countries.  Bear in mind that these don’t all necessarily track just the country’s most popular stock market index.  They can track other indexes or even subsets of those companies and may balance them in a variety of ways so be sure you understand exactly what they invest in before you buy the ETF.  Many of these funds are limited by market capitalization as well as particular country, once again be sure to read the prospectus.

• Austria – EWO
• Australia – EWA
• Belgium – EWK
• Brazil – EWZ, BRF
  
• Canada – EWC
• China – FXI,PGJ, HAO and GXC
• Chile – ECH
• France – EWQ
• Germany - EWG
  
• India - EPI, PIN
• Indonesia – IDX
• Israel - EIS
• Italy – EWI
• Japan – EWJ, PJO, SCJ
  
• Malaysia – EWM
  
• Mexico – EWW
• Netherlands – EWN
• Russia – RSX
• Singapore – EWS
• South Africa – EZA
• South Korea – EWY
• Spain – EWP
• Sweden – EWD
• Switzerland – EWL
• Taiwan – EWT
• Thailand – THD
  
• Turkey – TUR

Regions and Groups

These are not individual countries, but groups of them.

• Africa – AFK
• Asia – AIA, IFAS, AAXJ
• Europe – IFEU, EIV, DFE, PEF
  
• Gulf States – MES, GULF
  
• Latin America – ILF
• North America – IFNA
• United Kingdom – EWU

Emerging Markets

This list is for emerging market specific funds that are not purely regional.

• BRIC (Brazil, Russia, India and China) – BKF, BIK, EEB, DEM
  
• General – GMM, EEM, PXH
  
• Small Cap - EWX, DGS

Global and Non-US Sectors

These are worldwide market sectors, or worldwide market sectors excluding the US.

• Consumer Discretionary – GXI, IPD
• Consumer Staples – KXI, IPS
• Energy – IXC, IPW
• Financials – IXG, IPF
  
• Healthcare – IXJ, IRY
  
• Industrials – EXI, IPN
• Materials – MXI, IRV
• Technology – IXN, IPK
• Utilities - JXI, IPU
• Telecommunications – IXP, IST

Feel free to suggest more and I will keep adding to this list.

Post from: Personal Finance And Investing

76 ETFs For Foreign Stock Exposure

Photo by: Ryan McFarland

U.S. Treasuries surged in popularity during the recent crisis.  In fact at one point people were so anxious to buy up treasuries that the short-term yield dropped to 0%.  At this point Warren Buffet emailed his directors:

This should be bullish for Berkshire. With great foresight, I long ago entered the mattress business in a big way through our furniture operation. Now mattresses have become fully competitive as a place to put your money, and sales will soon take off.^[1] 

People were anxious to find a safe place to put their money, which is one of the strong suits of U.S. Treasuries. 

Treasuries have a very different risk profile than many other investments.  There is a very low risk of default compared to other types of bonds, but you are exposed to risks like inflation.  ETFs can provide a way to introduce this risk profile into our portfolios more easily than actually buying the bonds.  There are several ETFs which allow you to do this and many concepts that can be pivotal to understand before doing so.  

Understanding Yields and Prices

Bond prices and yields can be a bit opaque to those without experience; however they are a fairly simple concept.  When a bond is issued, it pays a certain amount and has a certain cost.  Say for example I buy a $10,000 bond that will pay me $300 per year.  Thus it yields 3%.  Now many would think that since the bond will repay my $10,000 at the end of its life, it would be a risk-free investment.  However suppose that interest rates go down at that 3% becomes more attractive, people will be willing to pay more for that same bond.  As the price goes up, the $300 per year becomes a smaller fraction and the yield of the bond goes down.  Meanwhile if interest rates go up, my bond becomes less attractive and the price will go down.  

This is very important when considering inflation.  Generally if inflation is high, you will see higher interest rates.  As such in an inflationary environment, bond yields tend to increase, meaning the price of any bonds you own may very well go down.  This means that the term of the bond becomes very important.  While over a short period of time, inflation may be predictable; over long periods any number of things can happen to affect interest rates.  Obviously because of this, longer dated bonds tend to pay higher yields.  

Treasury ETFs

There are many treasury ETFs and will likely be many more in the future.  Some of the more popular ones include:

TLT – Long Term Treasuries

This fund “seeks to approximate the total rate of return of the long-term sector of the United States Treasury market as defined by the Barclays Capital US 20+ Year Treasury Bond Index.”^[2] Thus if you want to buy long-term treasuries, this could be a good fund for you.  When buying a fund like this it is important to consider how inflation may affect yields over a long period of time.  These bond funds are committing money for long periods of time, so if we have inflation or high interest rates, these funds can lose considerable value.  Also, because of their long period they can be much more volatile than shorter dated bonds.

Currently the market has been reflecting fears about inflation as TLT prices have been dropping and yields improving.  This suggests that the market thinks inflation is a serious concern at that these bonds need to be lower priced to be competitive.  This may be a result of increased optimism about an impending recovery in the US.  

SHY – Short Term Treasuries

This fund “seeks to approximate the total rate of return that correspond generally to the price and yield performance, before fees and expenses, of the short-term sector of the United States Treasury market as defined by the Barclays Capital 1-3 Year US Treasury Index.”^[3] Because of its short term, this ETF is not very volatile at all.  For example, during the 52 weeks from the time of this writing its range has been 82.07 – 85.17.^[4]  One would not expect to see a tremendous price change in such short term notes, which can be either a good thing or a bad thing depending on your objectives. 

IEF – Intermediate Term Treasuries

This fund “seeks to approximate the total rate of return of the intermediate-term sector of the United States Treasury market as defined by the Barclays Capital 7-10 Year US Treasury Index.”^[5] Thus this fund runs the middle ground between the other two.  It tends to be more volatile than the SHY, but less than the TLT. 

TIP – Treasury Inflation Protected Securities

Another popular type of treasury is Treasury Inflation Protected Securities.  These bonds have their principal adjusted annually to reflect changes in the Consumer Price Index.  The TIP “seeks results that correspond generally to the price and yield performance, before fees and expenses, of the inflation-protected sector of the United States Treasury market as defined by the Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L).”^[6] This provides an interesting middle ground where your investment is not as exposed to the risk of inflation.  At the same time these bonds have a differing tax-treatment and are likely to pay lower base yield. 

Other ETFs

In addition to other ETFs that seek to emulate the exact same returns, there are also leveraged ETFs which seeks to return some multiple of the movement of these funds.  One example would be TBT which seeks to return double the inverse of the TLT.  Thus if the TLT goes up 10% in a day the TBT would go down 20%.  There are a wide variety of ways to invest in treasuries.  These funds can provide additional options to your investment playbook, but should be thoroughly researched before used.  

[Disclosure:  I am currently long TLT with offsetting call options sold to hedge my position]

Post from: Personal Finance And Investing

Treasury ETFs

1. Forbes – Buffet Bets On Mattresses
2. iShares TLT Product Information
3. iShares SHY Product Information
4. Yahoo! Finance – Shy
5. iShares IEF Product Information
6. iShares TIP Product Information

Photo by: Mel B.

2009 is a dreadful year to try to invest.  While we have seen a massive rebound in stocks, there are a variety of factors that make long term planning very difficult.

Asset Class Difficulties

The first thing that makes the current economic climate so difficult is the correlation between asset classes.  Under normal circumstances declines in one asset class involve money moving to another asset class.  Thus when stocks go down, bonds or gold or another asset class is usually the beneficiary.

What makes the current economy so difficult is that you see capital essentially being “destroyed” by the deflationary spiral.  Forced liquidation on the part of many funds caused by redemptions and margin calls contribute to this problem as well.  While this problem was particularly pronounced in 2008, you continue to see deflationary pressures affecting all asset classes.

Government Intervention

One of the most obvious difficulties of building a long term plan in 2009 is the frequency and fervor of government intervention.  Policy makers are attempting to walk several fine lines and thus are constantly exerting strong forces upon the market.  In their zeal they make it very difficult to draw long range conclusions about what makes sense.

Take for example the Treasuries market.  One might be inclined to think that prices would drift lower in this market, given the massive amount of debt the government is planning on issuing.  The Federal Reserve however, is actively purchasing some of these treasuries, driving prices up.^[1] The dramatic influence of the government on the markets is a serious deterrent to investing in 2009.

Differing Long-Term and Short-Term Dangers

This problem is particularly severe and affects both investors and policy makers.  We are faced with the exact opposite problems in the long term and the short term.  Right now the government is facing deflation and economic slowdown.^[2] Under normal circumstances, this suggests increased spending, even at a deficit.  At the same time in the long term we have an incredible debt burden which is just part of a number of reasons to fear inflation.^[3]

Thus the government wants to stimulate our consumer driven economy in the short term, but doesn’t want rampant inflation to destroy us in the long term.  At the same time the massive amount of total credit market debt our country has may make inflation unavoidable.  This can affect the ways in which the government interferes with the markets as well as how the markets themselves price assets.

The government can seem to affect the market very capriciously because they are trying to walk a fine line.  Because our economy is highly consumer driven, they want to stimulate spending and consumption.  At the same time we have to get our debt under control before it buries us.  Thus they can appear to make conflicting policy decisions.  As we’ve already discussed, the scope of this interference is vast, so it’s particularly distressing for it to be so difficult to predict.

For an investor it is difficult to price assets, even without government interference.  For example, let’s discuss gold.  Its long term prospects may be fairly good because of the dire threat of inflation.  However with the short term calling for deflation, you have no idea how much your asset might depreciate before the inflation kicks in.  It’s very difficult to tell when that corner will be turned, and markets are erratic accordingly.

How to React

One approach is to simply “go to cash.”  Unfortunately that is not a neutral decision.  If you have the majority of your net worth in cash you are betting against rampant inflation.  What all these competing factors suggest to me is a balanced and conservative approach.  It may be time to add some variety to your portfolio, including both inflation and deflation hedges.  I also think it is pivotal to take a long range view and not try to maximize in the short term.  This is an economy without historical precedent, so it makes sense to take a defensive approach.

It is a good time to start learning about how to hedge your stock market positions.  While you may have only invested in stocks up to this point, the time may have come to learn about other opportunities.  ETFs in particular can offer an easy way to create some balance in your portfolio.

Post from: Personal Finance And Investing

The Difficulty of Investing in 2009

1. Fed To Buy Long Term U.S. Governmnt Debt – Reuters
2. Fed Warns of Global Slowdown That Adds to U.S. Deflation Risk – Bloomberg.com
3. US debt sets stage for inflation – MSN Money