Ponzi schemes are nothing new in the marketplace. Unscrupulous fund managers have always sought to dream up new ways of playing shell games with investor's money. Bernard Madoff's massive fraud exposed last year is simply the latest in a long history, though perhaps most shocking due to its sheer scale. The cost associated with this scheme is estimated to be somewhere in the neighborhood of 50 billion dollars. That's enough money to prop up a failing auto industry.
Who can forget the Ponzi scheme cooked up by Samuel Israel that was uncovered in 2004? Israel's company, Bayou Investments, bilked investors of over 450 million dollars. In the end, his fund was nothing but another elaborately concocted scheme. How can we avoid falling prey to the these Ponzi schemes?
Two words: Due Diligence.
It takes a back seat to the bad news, but some investors managed to escape getting bilked by the likes of Israel. Prudent investors decided to hire an investigator before parting with their nest eggs. The investigator recently spoke on NBC's Dateline regarding his detective work. He uncovered false educational credentials for Israel and a history of drug and alcohol abuse. Further research revealed an illegitimate accounting firm underpinning the fund.
A closer inspection of Madoff's scheme would have revealed similar tell-tale clues. A little due diligence could have saved untold investors. What should you be looking for when doing your own fact checking and how can it save you from a sophisticated scheme like Madoffs?
1) Any investment that offers amazingly consistent "too good to be true" yields is suspect. Madoff's fund relied on historically volatile trading practices but produced rock solid results. Don't just let people sell you a fund, make them prove it's worth. If you don't understand their explanation, find a neutral, knowledgeable party to evaluate it.
2) Be aware of the hard sell. If fund managers are courting you for your retirement dollars with free lunches, fancy gifts, or slick sales pitches be skeptical. Madoff frequently enticed clients by telling them the fund was "closed" but he could manage to "get them in".
3) Be sure to dig, dig and dig some more. Is the person approaching you properly licensed? Ask for their credentials; contact the issuer of those credentials whether it is the American Institute of Certified Accountants, the National Association of Personal Financial Advisers or other legitimate organization. Find out who employs them and where your funds go once in the hands of their company. Madoff buried his Ponzi scheme behind layers of "feeder funds". Follow the trail all the way to the top and start asking your questions there.
4) Finally, take a good look at the people who are supposed to be monitoring the company. Contact the SEC (Securities Exchange Commission) and ask for any information regarding the fund. By 2005 Madoff's fund already had a letter on file from a concerned financial advisor that the fund was a "Ponzi scheme". Further, Madoff's comptroller for the phony firm was based off-shore - most legitmate operations take care of this accounting in-house.
Monday, August 31, 2009
Monday, August 24, 2009
How to use Standard & Poor's 500 Index - Part 2
The total-return calculation of the S&P 500 Index has progressively become highly appreciated by the Association for Investment Management and Research's (AIMR) and the Securities and Exchange Commission. In order to calculate the total returns for any equity security of the S&P 500 Index for a given time period, an indexed dividend is added to the closing S&P 500 Index value for that period and the total is divided by the closing S&P 500 Index value at the beginning of the time period.
To calculate the indexed dividend, which is the dividend distribution of the companies in the S&P 500 Index, the total daily dividends for all of the stocks in the Index for a given time period are added. The total is converted into an indexed number by being divided by the Index divisor, which is the basis for comparability at any given time, and for any required adjustments due to changes in the equity composition of the Index. The calculations of the Indexed Dividend are based on the ex-dividend date and not on the payment date in order to consider any the market price adjustment occurring for the dividends.
The formula used to calculate the indexed dividend is:
Total Daily Dividends / Index Divisor = Indexed Dividend
What makes S&P 500 Index attractive is its high liquidity. This is due to the fact that S&P 500 comprises of a great variety of companies from several industries, which offers to investors the opportunity to buy stocks from Technology, Healthcare, Financial Services and Telecommunications sectors at a low cost since there is no need for active management to track, analyze and pick stocks.
By and large, S&P 500 Index tracks also a large number of mutual funds, which employ short sales of securities listed in the S&P 500. By applying leverage through futures contracts and stock and index options, S&P 500 Index has become one of the world's most popular trading tools.
To calculate the indexed dividend, which is the dividend distribution of the companies in the S&P 500 Index, the total daily dividends for all of the stocks in the Index for a given time period are added. The total is converted into an indexed number by being divided by the Index divisor, which is the basis for comparability at any given time, and for any required adjustments due to changes in the equity composition of the Index. The calculations of the Indexed Dividend are based on the ex-dividend date and not on the payment date in order to consider any the market price adjustment occurring for the dividends.
The formula used to calculate the indexed dividend is:
Total Daily Dividends / Index Divisor = Indexed Dividend
What makes S&P 500 Index attractive is its high liquidity. This is due to the fact that S&P 500 comprises of a great variety of companies from several industries, which offers to investors the opportunity to buy stocks from Technology, Healthcare, Financial Services and Telecommunications sectors at a low cost since there is no need for active management to track, analyze and pick stocks.
By and large, S&P 500 Index tracks also a large number of mutual funds, which employ short sales of securities listed in the S&P 500. By applying leverage through futures contracts and stock and index options, S&P 500 Index has become one of the world's most popular trading tools.
How to use Standard & Poor's 500 Index - Part 1
Standard & Poor's 500 Index (S&P 500) is a stock index, which tracks changes in the value of a hypothetical portfolio of 400 industrial stocks, 40 utility stocks, 20 transportation companies stocks and 40 financial institutions stocks. The total of 500 different stocks is weighted proportionally to each stock's market capitalization relatively to a particular base period. S&P 500 Index accounts for the 80% of the total market capitalization of the New York Stock Exchange (NYSE), while two contracts on S&P 500 are traded on the Chicago Mercantile Exchange (CME).
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The base-weighted aggregate methodology used by S&P 500 is a set of combined variables, namely price and number of shares. By multiplying the stock price by the number of common shares outstanding, investors may calculate the market capitalization of a company. Then, they find the corresponding indexed number, which represents the results of each calculation and they can understand how the Index tracks the particular stock over time.
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The base-weighted aggregate methodology used by S&P 500 is a set of combined variables, namely price and number of shares. By multiplying the stock price by the number of common shares outstanding, investors may calculate the market capitalization of a company. Then, they find the corresponding indexed number, which represents the results of each calculation and they can understand how the Index tracks the particular stock over time.
Thursday, August 13, 2009
What you can learn from the Stock Market Crash - Part 2
4) HOWEVER, DON'T LET THIS SCARE YOU AWAY FROM STOCKS
Are you wondering how I can talk about stocks going to zero in one breath and then encourage you to own them in the next? The reason is that you will never earn large investment gains over the long term by investing in bonds or bankCDs . Just be sure to recognize the risks involved in stock investing, especially during severe bear markets, and allocate your money to this asset class accordingly. And always remember one of the most important and ironic truths of investing: asset classes that are hated by investors now typically outperform in future periods.
5) DON'T LIMIT YOURSELF TO "LONG-ONLY"
Most people invest in the stock market by owning mutual funds or holding shares in individual stocks. There's a fundamental problem with this: "long-only" investment vehicles like these only enrich investors during rising markets. I encourage you to add other investing tools to your investment toolbox so you can profit during all kinds of markets. Read up and learn how to short stocks. Learn how stock options work. Start small and gradually develop experience with these other types of investments, and you will become an all-weather investor.
6) STAY HUMBLE. RESPECT THE UNPREDICTABLE NATURE OF THE MARKET
The sectors, markets and companies that may seem like great investment opportunities today quite often end up being grave disappointments to investors who follow the herd. Remember tech stocks in 1999? Or real estate in 2006? Both seemed like great sectors at the time.
Markets can be highly counterintuitive, and risks are often only visible after the fact. Try to avoid consensus investment thinking, and don't fixate on the risks that are obvious to investors today. Instead, train yourself to anticipate what risks investors are likely to think about in the future.
7) SAVE MORE
I apologize for closing this essay with such an unpalatable final piece of advice, but the easiest way to make up for investment losses is to increase your personal savings. Most investors will need a combination of investment returns and significant savings to reach their financial goals, whether those goals are early retirement, a certain level of net worth, or a college fund for a young child. When your investment returns have been below your expectations, you can make up the difference by spending less of your income and allocating the extra savings to these longer-term goals.
We may live in a society that collectively saves and invests very little of its discretionary money, but if you save aggressively, take prudent risks, and remain mindful of the various strengths and weaknesses of stocks as an asset class, you will achieve your financial goals. Good luck!
Are you wondering how I can talk about stocks going to zero in one breath and then encourage you to own them in the next? The reason is that you will never earn large investment gains over the long term by investing in bonds or bankCDs . Just be sure to recognize the risks involved in stock investing, especially during severe bear markets, and allocate your money to this asset class accordingly. And always remember one of the most important and ironic truths of investing: asset classes that are hated by investors now typically outperform in future periods.
5) DON'T LIMIT YOURSELF TO "LONG-ONLY"
Most people invest in the stock market by owning mutual funds or holding shares in individual stocks. There's a fundamental problem with this: "long-only" investment vehicles like these only enrich investors during rising markets. I encourage you to add other investing tools to your investment toolbox so you can profit during all kinds of markets. Read up and learn how to short stocks. Learn how stock options work. Start small and gradually develop experience with these other types of investments, and you will become an all-weather investor.
6) STAY HUMBLE. RESPECT THE UNPREDICTABLE NATURE OF THE MARKET
The sectors, markets and companies that may seem like great investment opportunities today quite often end up being grave disappointments to investors who follow the herd. Remember tech stocks in 1999? Or real estate in 2006? Both seemed like great sectors at the time.
Markets can be highly counterintuitive, and risks are often only visible after the fact. Try to avoid consensus investment thinking, and don't fixate on the risks that are obvious to investors today. Instead, train yourself to anticipate what risks investors are likely to think about in the future.
7) SAVE MORE
I apologize for closing this essay with such an unpalatable final piece of advice, but the easiest way to make up for investment losses is to increase your personal savings. Most investors will need a combination of investment returns and significant savings to reach their financial goals, whether those goals are early retirement, a certain level of net worth, or a college fund for a young child. When your investment returns have been below your expectations, you can make up the difference by spending less of your income and allocating the extra savings to these longer-term goals.
We may live in a society that collectively saves and invests very little of its discretionary money, but if you save aggressively, take prudent risks, and remain mindful of the various strengths and weaknesses of stocks as an asset class, you will achieve your financial goals. Good luck!
Sunday, August 9, 2009
Intermediate guide to the stock market - Part 2
Index funds (also known as Exchange Traded Funds) are stocks which track a given index, like the S&P 500, the Dow, or the Nasdaq. They allow you to own an entire market in one stock, and they have a great history of beating most mutual funds over the long term. You can buy many different markets using index funds. For example, you can buy index funds which track: clean energy, agriculture, water, the performance of the dollar verses other currencies, oil, stocks in China, in India, in emerging markets like Eastern Europe and Latin America, and a huge variety of other types of markets!
You can find information about index funds at www.etfconnect.com
While you can't go wrong with a portfolio of index funds, you can do yourself a huge favor by buying shares in large companies. Many large companies, such as Johnson and Johnson, Procter and Gamble, Wal-Mart and General Electric have a long history of not only paying reliable dividends, but also increasing their dividend every year. The power of this cannot be over emphasized. Take, for example, General Electric. The dividend yield on their stock is currently around 4%. But, they have a 30 year history of increasing their dividend by around 12 percent per year. So you can expect the yield on your initial investment to double after six years, to 8%! After 12 years, the yield on your initial investment has become 16% - and this does not take into account the power of compounding. If you were to reinvest the dividends received, your investment would generate over 20% on your initial investment in dividends alone.
To see the dividend history of a company, you can use Yahoo! Finance's "Historic Prices" feature, on the information page of a stock.
Once you have this core portfolio of high quality, sensibly chosen index funds and large dividend paying stocks, use the remaining amount in your portfolio to choose some high quality smaller stocks to give your portfolio the power of growth. To find smaller companies, use a stock screener, and specify a market capitalization of no more than a billion dollars. To be sure you're choosing quality companies, check out the "More Ratios from Reuters" link near the bottom of the company page on Google Finance. Make sure all the ratios on this page are nearly the best in the industry, and be sure the company is not too expensive (look for low price ratios compared to its industry, like the p/e, p/s, p/b, and price to free cash flow - all at the "More Ratios from Reuters" link).
With the proper portfolio construction, you can depend on your portfolio to generate great returns in a variety of market conditions. Decide the risks you're willing to take, arrange your portfolio as described here, sit back, relax, and watch your money grow!
You can find information about index funds at www.etfconnect.com
While you can't go wrong with a portfolio of index funds, you can do yourself a huge favor by buying shares in large companies. Many large companies, such as Johnson and Johnson, Procter and Gamble, Wal-Mart and General Electric have a long history of not only paying reliable dividends, but also increasing their dividend every year. The power of this cannot be over emphasized. Take, for example, General Electric. The dividend yield on their stock is currently around 4%. But, they have a 30 year history of increasing their dividend by around 12 percent per year. So you can expect the yield on your initial investment to double after six years, to 8%! After 12 years, the yield on your initial investment has become 16% - and this does not take into account the power of compounding. If you were to reinvest the dividends received, your investment would generate over 20% on your initial investment in dividends alone.
To see the dividend history of a company, you can use Yahoo! Finance's "Historic Prices" feature, on the information page of a stock.
Once you have this core portfolio of high quality, sensibly chosen index funds and large dividend paying stocks, use the remaining amount in your portfolio to choose some high quality smaller stocks to give your portfolio the power of growth. To find smaller companies, use a stock screener, and specify a market capitalization of no more than a billion dollars. To be sure you're choosing quality companies, check out the "More Ratios from Reuters" link near the bottom of the company page on Google Finance. Make sure all the ratios on this page are nearly the best in the industry, and be sure the company is not too expensive (look for low price ratios compared to its industry, like the p/e, p/s, p/b, and price to free cash flow - all at the "More Ratios from Reuters" link).
With the proper portfolio construction, you can depend on your portfolio to generate great returns in a variety of market conditions. Decide the risks you're willing to take, arrange your portfolio as described here, sit back, relax, and watch your money grow!
Wednesday, August 5, 2009
What you can learn from the Stock Market Crash - Part 1
With most global stock markets down 30-50% year to date, and many individual investment accounts down even more than that, now is a particularly good time to see if there are any lessons we can learn from a period that, quite frankly, has been an awful experience for almost all investors. Here are seven lessons to take away from the recent stock market crash:
1) ALWAYS BE LIQUID
No matter how good things may seem in the market, and no matter how confident you are in your future, always keep a healthy amount of liquid assets available at all times. These assets can be in the form of cash, short-termCDs or money market funds. Ideally, this money should be in addition to a fully funded 6-12 month emergency fund. You never know when you might need extra capital for an attractive investment opportunity, or to fund a large unplanned liability, or to support your family during an unexpectedly long period of unemployment. And most importantly, you never want to be in a position where you are forced to sell your long-term investment assets during a severe market correction.
How much liquidity is the right amount? A good rule of thumb is to keep 20-30% of your investment capital in risk-free, shorter-term interest bearing investments, but I often suggest to people to keep up to two years of expenses in readily available, liquid form.
2) AVOID CATASTROPHIC LOSSES AT ALL COSTS
If you happen to suffer losses of 50% in a mutual fund or in your retirement account (something not uncommon to many investors this year), a curious thing happens: in order to get back to even, you will need to double your money. And assuming an average annual return of 7% (which is looking more and more like an optimistic assumption for stock market returns going forward), doubling your money will take you roughly ten years of compounding time.
Recognize that it can take many years to claw back to breakeven after heavy losses. When you decide what percent of your investment dollars to allocate to stocks, particularly when you are nearing retirement age, keep this concept in the very front of your mind. During certain periods of aninvestor's life, stocks can be far riskier than you might think.
3) ANY STOCK CAN GO TO ZERO (OR GET VERY CLOSE)
A year or two ago, it would have seemed laughable that a company like AIG, trading at above $70 a share with all of its enormous competitive and economic advantages, could have close brush with bankruptcy and have its stock nearly wiped out. And yet that is exactly what happened: the stock is down 97% from its all time high and thecompany's prospects are permanently impaired.
Unfortunately, this isn't as unusual an occurrence as it may seem, especially during severe bear markets. So far in 2008 alone, several airlines, a number of retailers (including Circuit City and Linens'N' Things) and more than 20 financial companies (including major names like Lehman Brothers, Bear Stearns and WaMu Bank) fell into bankruptcy. And in each of these cases, stockholders were left either with nothing or very close to nothing. As a stockholder, you are the first to be wiped out if a serious event occurs to a company in which you hold stock. Respect this fundamental risk inherent in owning stocks.
1) ALWAYS BE LIQUID
No matter how good things may seem in the market, and no matter how confident you are in your future, always keep a healthy amount of liquid assets available at all times. These assets can be in the form of cash, short-termCDs or money market funds. Ideally, this money should be in addition to a fully funded 6-12 month emergency fund. You never know when you might need extra capital for an attractive investment opportunity, or to fund a large unplanned liability, or to support your family during an unexpectedly long period of unemployment. And most importantly, you never want to be in a position where you are forced to sell your long-term investment assets during a severe market correction.
How much liquidity is the right amount? A good rule of thumb is to keep 20-30% of your investment capital in risk-free, shorter-term interest bearing investments, but I often suggest to people to keep up to two years of expenses in readily available, liquid form.
2) AVOID CATASTROPHIC LOSSES AT ALL COSTS
If you happen to suffer losses of 50% in a mutual fund or in your retirement account (something not uncommon to many investors this year), a curious thing happens: in order to get back to even, you will need to double your money. And assuming an average annual return of 7% (which is looking more and more like an optimistic assumption for stock market returns going forward), doubling your money will take you roughly ten years of compounding time.
Recognize that it can take many years to claw back to breakeven after heavy losses. When you decide what percent of your investment dollars to allocate to stocks, particularly when you are nearing retirement age, keep this concept in the very front of your mind. During certain periods of aninvestor's life, stocks can be far riskier than you might think.
3) ANY STOCK CAN GO TO ZERO (OR GET VERY CLOSE)
A year or two ago, it would have seemed laughable that a company like AIG, trading at above $70 a share with all of its enormous competitive and economic advantages, could have close brush with bankruptcy and have its stock nearly wiped out. And yet that is exactly what happened: the stock is down 97% from its all time high and thecompany's prospects are permanently impaired.
Unfortunately, this isn't as unusual an occurrence as it may seem, especially during severe bear markets. So far in 2008 alone, several airlines, a number of retailers (including Circuit City and Linens'N' Things) and more than 20 financial companies (including major names like Lehman Brothers, Bear Stearns and WaMu Bank) fell into bankruptcy. And in each of these cases, stockholders were left either with nothing or very close to nothing. As a stockholder, you are the first to be wiped out if a serious event occurs to a company in which you hold stock. Respect this fundamental risk inherent in owning stocks.
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