Investment business is losing a generation of investors

That's the question the head of the world's largest mutual fund company asked in a speech last week. William McNabb, president and chief executive of the Vanguard Group, told an audience at the Morningstar Investor Conference in Chicago that a growing number of Americans are unwilling to invest in stocks or stock funds because their faith in the financial system has crumbled.

"We are on the brink of losing a generation of young investors," McNabb said. "As I talk with young people, I hear it. They don't like this volatility." And their belief in the system has been shaken by everything from the collapse of Lehman Brothers in 2008 to the "Flash Crash" in May.

The stock market started the second quarter on a strong footing but it's ending with a whimper as investors cope with less government stimulus and the prospect of slower global growth. Where does it leave the outlook for markets in the third quarter?

In truth, every generation has moments when it suffers through a crisis in confidence. But past generations lived in a different environment, and typically were able to see events that brought them back from the edge. That's why the current situation is so alarming: nothing on the horizon appears to have the potential to attract young investors to the market.

After the market malaise of the late 1960s and early 1970s, interest rates moved to double digits, which attracted savers and brought assets into money-market funds. By the 1980s, as rates were returning to normalized levels and savers were looking for a little more, the market entered a long bull cycle that barely was disrupted by Black Monday in 1987, the build-up to the Gulf War in 1991 and other life-changing events. Even the bear market that popped the Internet bubble was answered with a mid-2000s rebound.

Moreover, the last time a generation stayed mostly out of the market, a life's work was rewarded with a pension. Now people are largely responsible for their own retirement through 401(k) plans and other savings vehicles. That makes the danger of losing a generation of young investors bigger than in the past, because it's hard to see how they will adequately grow retirement savings without a lifetime of the long-term benefits of investing.

The issue, of course, boils down to capturing the long-term benefits of investing at a time when the short-term picture is ugly and emotions are dominated by current events.

"This is a generation with a very short attention span," said Herbert Daroff of Baystate Financial Planning in Boston. "They're used to changing the channel whenever they don't like what they see. A 10-year time horizon, for them, is very long-term, when in fact they need to be investing for 20 or 30 or 40 years or more.

"This is also a generation of six-digit college loans, where many people start off their financial life in a deep, deep hole," he added. "If what they understand right now is that they will be better off paying off their college loans than putting something into the 401(k), at least they will be making progress. But there must be a way to give them hope for their future."

There's not a lot of good feeling and hope in the market right now.

The last decade's stock market performance has been rough and flat, so there is plenty of talk about how people spent 10 years earning nothing, which seems right, but probably isn't.

For starters, market indexes don't factor in dividends, which have generated some income despite the decade of doldrums. Secondarily, diversified investors had big chunks of money invested outside of the Standard & Poor's 500-stock index (MARKET:SPX) , which is the proxy for "the market" in these discussions.

"Only the S&P 500 was flat for 10 years, nothing else," explained Judy Shine of Shine Investment Advisory Services in Lone Tree, Colo. "But since no one who really invests and diversifies had a portfolio that was all S&P 500, you don't actually know people who lost a decade. They may feel like it -- I always say if you poke our clients in the right place, they still scream over the pain of the tech wreck -- but they have done better than they think or feel."
Dividend drivers

Many experts believe the next decade will be more about finding solid dividend yields that generate consistent returns while the market is waffling and direction-less. With interest rates at historic lows, dividend yields can be a way to goose a portfolio's returns, although they can be hard to hang on to when there is no capital appreciation -- or even near-term downturns -- to go with them.

What's more, dividend yields are attractive at these levels only for as long as Congress keeps taxes low. Qualified dividend income is taxed at a maximum rate of 15% under current law, but unless there's an extension or new rules are enacted -- the Obama Administration has proposed a 20% tax rate -- dividends will be taxed at ordinary income rates in 2011. That will make dividend yields much less attractive, further confounding investors on what to do now and next.

McNabb's point in Chicago is that the financial services industry can only win back investors by proving that it's trustworthy. That's increasingly difficult at a time when the long-term investor feels like the corporate community is skinning him a penny here and there every day. In fact, the only thing that historically wins investors is strong returns.

While I do believe the market will reward long-term investors, I can't blame younger generations for not being able to see it. Their experience suggests that they are better off on the sidelines than in the market.

http://www.marketwatch.com/story/story/print?guid=24FC3883-1C40-4B4F-9616-3BCDCB5C5BA9

Do Hungry People Take Bigger Financial Risks?

Forget the Volcker Rule, a Tobin tax, bonus caps and other Washington proposals intended to make our financial system more stable. Maybe what Wall Street’s risk-loving bankers really need is a better diet.

That is one possible implication of a fascinating new study, which finds that people who are hungry are more risk-seeking, and people who are sated are more risk-averse.

Researchers put study subjects on different diets to affect their metabolic states, and then week after week gave them options to participate in different kinds of lotteries. Some of the lotteries were riskier than others, in terms of their expected and potential payouts. Generally speaking, when subjects were in hungrier states, they chose the riskier lottery options, and when they were full, they choose safer lotteries.

The authors suggest that this means metabolic states, and the hormones associated with them, can affect our appetite for all sorts of risks. From the study:

Changes in metabolic state systematically altered economic decision making …

A direct comparison can be made with Prospect Theory, where changes in wealth below a reference point induce risk-seeking behavior, while earnings above a reference point promote risk-aversion. Similar reference-dependent change in risk attitude for food rewards has also been seen in animals.

The study is based on a small sample — about 20 students — but it seems destined to inspire further research on the evolutionary advantages of financial risk-taking.

http://economix.blogs.nytimes.com/2010/06/29/do-hungry-people-take-bigger-financial-risks/?pagemode=print

Dividends Are Back

We are just months removed from one of the worst years for corporate dividends on record. Uncle Sam is expected to take another big bite out of that income in 2011 in the form of sharply higher taxes.

And yet dividend investing has rarely looked better.

This year through mid-June, there were at least 135 dividend increases or initiations among the companies in the Standard & Poor's 500-stock index, up roughly 55% from the first six months of last year.

If the economy continues to gather strength, analysts say, many more companies will likely gain the confidence to boost dividends this year.

So what has changed? Corporate balance sheets, which were squeezed during the recession, are once again brimming with cash. S&P 500 nonfinancial companies had a record $837 billion in cash at the end of the first quarter, up from $665 billion a year earlier, according to S&P.

Of course, there are plenty of headwinds. The tax rate on qualified dividend payments, capped in 2003 at 15%, is set to expire at the end of this year along with some other Bush-era tax cuts. Absent congressional action, the top dividend tax rate will jump to 39.6% next year. It also could end up somewhere in between.

But for investors looking to generate steady income, the alternatives to dividends don't stack up well. With the Federal Reserve keeping its key interest rate at a historic low, the roughly 2% average dividend yield of the S&P 500 looks attractive relative to many bond and cash-like investments. The average taxable money-market fund, for example, offers a paltry seven-day yield of 0.04%, according to iMoneyNet, which tracks the funds. Bonds carry risks of their own, and must be rolled over and reinvested when they mature.

The long-term case for dividend investing, meanwhile, remains sound. Some research suggests that companies tend to boost these payments ahead of significant increases in cash flow. And dividends often provide a cushion when stock returns sag. That can be especially valuable for income-focused investors like those looking to cover regular living expenses during retirement.

Wall Street Journal

Personal savings increased 29 percent in Jacksonville since 2007

Pay cuts, layoffs and mounting debt have made it difficult for many local families to make ends meet, but research shows that they have started saving more.

Personal savings, known in banking circles as nontransaction account totals, increased for the 17 community banks based in Northeast Florida by 29.4 percent from $3.4 billion in the first quarter of 2007, before the economy’s downturn, to $4.4 billion in the first quarter of 2010, according to the Federal Deposit Insurance Corp. Nontransaction accounts are those typically used as savings vessels, such as money market accounts, savings accounts and certificates of deposit. Personal savings totals also increased 1.1 percent from the first quarter of 2009 to the first quarter of 2010.

Jacksonville Business Journal - 25 June 2010

4 Things Financial Reform Won't Do for You

Sweeping new rules on banks are meant to protect consumers against greedy lenders and risky financial offerings. What they won’t do is protect consumers from themselves.

There’s a long list of villains who contributed to the financial meltdown of 2008 and the economic blowout that followed: shady lenders, reckless Wall Street firms, naïve policymakers and torpid regulators who couldn’t find a rat in a sewer. But American consumers weren’t exactly innocent bystanders. Millions of Americans fueled the problem by bingeing on debt, living beyond their means and using their homes as piggy banks. For every booby-trapped mortgage, there was a borrower happy to commit to monthly payments his income couldn’t cover.

The sweeping Dodd-Frank financial-reform legislation will make it harder for banks to prey on vulnerable consumers eager to hear they can afford luxuries far beyond their means. It will set up a new Consumer Financial Protection Bureau designed to police the soundness of financial products the way other agencies safeguard pharmaceuticals, toys or the food supply. Regulators from Washington will now sniff out financial scams, rein in usurious lenders, unearth hidden fees and limit loans to people who can afford them. Jubilation. Washington rides to the rescue. Again.

But a new army of protectors won’t make consumers smarter, and the mere presence of a fresh government watchdog could persuade some people that they don’t need to worry about protecting themselves. That would be a big mistake. Many Americans are in precarious financial shape, and there will always be risks the government can’t do anything about. Here are four things consumers still need to do for themselves, without relying on the government or anybody else:

Learn more about money. Financial illiteracy is a major problem. Many of the bad loans that boomeranged back on the banks wouldn’t have happened if borrowers knew they were agreeing to a ballooning interest rate or taking on mortgage payments way beyond standard thresholds for affordability. The new law recognizes this, setting up an “Office of Financial Literacy” meant to make consumers smarter. But no government agent is going to come to your home at a convenient hour to offer a free tutorial on personal finance. People still need to do the work themselves and learn how to spot scams, manage debt, invest safely and resist foolish enticements.

How many times do we need to be told that if a deal seems too good to be true, it probably is? Every day, apparently. There were dozens of excellent personal-finance books and Web sites before the recession—including a government Web site, established in 2006—and they did nothing to prevent an epidemic of bad decision-making. One more government agency devoted to the cause probably won’t make a difference.

Save more. In the halcyon years after World War II, Americans routinely saved 10 percent of their after-tax income. How quaint. Beginning in the mid ‘80s, the savings rate drifted down to the low single digits, bottoming out near a paltry 1 percent in 2005. It’s rebounded since then, but is still less than 4 percent. Most families should be saving 6 to 10 percent of their income, to pay for their kids’ college and prepare for retirement. More would be better. The government, however, wants people to spend money, because it will boost the economy today—allowing politicians to take credit for it during the next election. So don’t expect Washington to encourage saving, even though it’s what most people need to do.

Reduce debt. Since we save less these days, we borrow more—staggering amounts, actually. Americans on average have a debt-to-income ratio of about 122 percent, which means the average amount of individual debt equals nearly 15 months’ worth of earnings. That has come down a bit from a peak of 133 percent in 2007, but economists feel it should be 100 percent or lower. (Between 1960 and 1985, it never went above 70 percent.) The government is actually doing its part here—but not intentionally. Tougher rules on banks are reining in risky loans, which means some profligate spenders can’t add to their debt even if they want to. But if you’re only paying down debt because the bank lowered your credit limit, you haven’t really reformed your finances. You’ve just hit the limits of tolerable spending, and you’ll probably keep pushing those limits when credit gets looser.

Come up with creative financing. While clamping down on risky lending, banks and their government overseers have also denied credit to many who legitimately need it. Scarce credit is especially hard on small-business owners, who often use bank loans or credit cards to pay suppliers or stay current on rent. The stranglehold on small business is one reason hiring is weak and the whole economy is fragile, because small business accounts for an outsized portion of new jobs. The government thought it would solve this problem by bailing out the banks, which in turn would inject more money into the economy, but it hasn’t worked out that way so far. So, many people who desperately need credit have had to tap friends or family, mortgage assets, hastily improve their creditworthiness and find unconventional sources of money. The government might make the loan itself simpler, but getting to the bargaining table is up to you. Get used to it.

http://seekingalpha.com/article/211986-4-things-financial-reform-won-t-do-for-you?source=article_lb_author

7 Lessons the World Cup Offers on the Stock Market

You can learn a lot from watching the World Cup–and not just about soccer. In many ways it's just like the stock market–and how it can actually teach you a useful thing or two about making money.

Here are seven lessons that can teach you about the money game:

1. Don't be shocked by "shocks."

Who would imagine that France, finalists four years ago, would crash out in such humiliation? That England would draw with Algeria? That Switzerland would beat Spain?

Yet these "shocks" happen all the time. The gambling public typically underestimates the chances on an upset.

And so it is in the investing world. Nassim Nicholas Taleb calls such unlikely events "black swans." As English comic novelist P.G. Wodehouse once put it, "never confuse the unusual with the impossible." Not long ago it seemed impossible that, say, Lehman Brothers or General Motors could go bankrupt.

As we have been reminded in recent years, the unusual happens. The only thing surprising is that so many people are surprised.

2. You need a strong defense.

There's a saying in soccer: "It only takes a second to score a goal." But as England's hapless goalkeeper could tell you after his schoolboy blunder against the United States last week, the truth is slightly different.

It only takes a second to concede a goal. Scoring one at the other end can take forever.

Investors know how it feels. The profits of a brilliant trade can be thrown away in a moment by a careless blunder.

Offense, trying to make money, is much more exciting than defense, trying not to lose it. But smart money management starts the other way around. After all, it takes a 100% profit to recover from a 50% loss. Or as value investors might put it: Rule number one, concede no goals. Rule number two? Never forget rule number one.

3. You have to think globally.

The World Cup is one of the few times fans everywhere drop their obsession with the sporting events, players and teams at home and start to pay close attention to everyone else.

Investors need to learn the same trick. "Home equity bias" has long been identified as a big problem in most portfolios. Most people keep way too much of their money in their home stock market. Studies have found that U.S. investors typically keep more than 80% of their equity portfolio in U.S. stocks. According to the Investment Company Institute, fewer than half of households that invest in mutual funds even own a fund that invests overseas.

It makes no sense. You already have big economic bets on the U.S. economy–your home, job and support network are all here. The U.S. only accounts for a third of the world's stock markets by value, so if you just stick to the home market you're missing out on two-thirds of the action.

Investing globally spreads your bets and gives you maximum diversification. A recent paper by AQR Capital Management, found that a global portfolio has typically given investors better long-term returns with less short-term turmoil.

4. Don't get blinded by hope.

I understand why someone from North Korea would choose to cheer for North Korea (0-for-2, nine goals allowed), no matter how badly the team does. After all it's their country.

What I don't understand are investors who stick with terrible investments all the way down, hoping and praying that bad management, bad strategy and bad products will somehow produce a good result. Hoping isn't expecting. Unless they actually worked at the company, no one needed to be stuck with their shares in Washington Mutual or Fannie Mae or General Motors. If it's not making you happy, stop complaining or praying. Sell.

5. Patience wins.

Once again the England team has proven, so far, a monumental disappointment to its fans at home.

Brazilian soccer legend Pele once explained the problem to a British TV reporter some years back. England, he said, needed to develop patience on the field.

They aren't alone in this. Too many teams try for the quick kill–kicking the ball up field and hoping for the best. Great soccer teams–especially the Brazilians–take a very different approach. They are famous for passing the ball around dozens of times, waiting for just the right moment to strike. It works.

And so it is on the stock market, which Warren Buffett–possibly the Pele of investment–once called an efficient mechanism for transferring money from the active to the patient. Like most great investors, he'll bide his time almost indefinitely, waiting for the chance on goal. It's a better plan.

6. Watch your margin of safety.

The Slovenians looked pretty comfortable after securing a two goal lead against the U.S. half way through the match. But in the end they were lucky to escape with a draw. These kinds of turnarounds happen all the time. You can't get too comfortable. Almost anything can happen.

Ben Graham, the godfather of cautious "value" investing, reached a similar conclusion about his portfolio after the crash of 1929. Stock prices plummeted far further than he ever thought possible. (Real estate investors in the past few years have had a similar experience). That's why Mr. Graham turned his attention to the concept of "margin of safety." He recommended investors buy stocks when they are at least a third below their intrinsic value. Just in case.

7. Don't pin all of your hopes on the referees.

Financial regulators–including the Securities and Exchange Commission, the Treasury and the Federal Reserve–have come in for severe criticism in the wake of the financial crisis, and no wonder. They didn't believe there was a housing bubble. They didn't know the banks were playing shell games with their balance sheets. They didn't know what was really going on in the derivatives market. The list is pitiful.

But if they want to feel better about themselves, they should probably tune in to some of the World Cup matches. Some of the refereeing has been simply extraordinary. First-time referee Koman Coulibaly has been left out of the next round after the controversial, and probably blown call in the USA-Slovenia game that cost the U.S. a win. It wasn't the only controversy of the Cup. And if experience is any guide, it won't be the last. Dubious refereeing is as much as feature of soccer as it is of the stock market. As for Mr. Coulibaly: Maybe we could find him a job on Wall Street–as a regulator.

7 Percent Dividends

For new investors, trying to select which stocks to invest in can be a daunting task. At last check, there were over 3,000 stocks offering dividends of some shape or size. Given the wide range of investment choices, it’s hard to know which dividend stocks are the best value.

Many investors end up just focusing on the stocks that pay the highest dividend yields. Sure a stock with a double-digit dividend yields looks attractive, but these stocks generally contain the greatest risks. Typically their dividend yield is so high, because their stock price has been falling. Often times, this is a warning signal that the dividend is likely to be cut anyway (BP anyone?).

Possibly the most attractive area for dividend investors are stocks with dividend yields around 7%. These are typically companies that are committed to returning cash to their shareholders, but they don’t include the high risk of double-digit dividend stocks.

The most attractive aspect of these stocks maybe the compounding power of 7% dividend yields. Any investment that provides a 7% annual return will double in 10 years. By buying a dividend stock with a 7% yield, you stand to double your investment in a decade even if the stock price doesn’t budge. A 100% return sounds really good when you consider that the S&P 500 index has fallen 24% in the last 10 years.

Here are 3 stocks with dividend yields near 7% for you to consider:

Altria (MO) – 7.0%

The addictive power of Altria’s products makes MO quite possibly the safest dividend stock in the S&P 500.

AT&T (T) – 6.6%

The telecom giant has the second highest dividend yield in the Dow Jones index. And don't underestimate the power of iPhone 4G.

SeaDrill (SDRL) – 8.4%

With virtually no presence in the Gulf of Mexico, this offshore driller has been unaffected by the recent BP fiasco.

Disclosure: I hold a position in Altria.

Estate Taxes

The federal estate tax has been repealed for 2010. That's good news for high-net-worth individuals and their heirs, right? Well, sort of.

Depending on the wording of your will or trust, the lapse of the estate tax could have a variety of unintended negative consequences. The issues are complex, so be sure to consult a tax attorney if you believe you might be affected.

Also, the estate tax is scheduled to return in 2011 with a $1 million exemption at a rate of 55% (only assets in excess of that amount are subject to the tax), compared to the $3.5 million exemption that was in effect for 2009 with a top rate of 45%.

The situation is fluid, however, and could change significantly before the end of the year. Many experts expected Congress to act before the end of 2009 to prevent the estate tax from lapsing in 2010. That didn't happen, but Congress could pass a measure this year and make it retroactive to Jan. 1, 2010. Whether the retroactive provision would survive a court challenge, however, is an open question.

The Obama Administration supports the retroactive plan and is proposing reinstatement of the 2009 exemption levels for 2010 and beyond. If the Administration's proposal is not enacted, a provision currently in place that hasn't gotten much recognition could spell tax trouble for some heirs.

When the estate tax was in force, heirs would figure their investment cost basis on assets such as stock or real estate at their value at the time of inheritance, not when they were originally purchased. That can make a major tax difference when heirs sell the assets and realize a capital gain.

But if the repeal of the estate tax stands, the stepped-up basis treatment will be limited to the first $1.3 million in capital gains pertaining to inherited assets. The limit is $3 million for assets transferred to a surviving spouse. Anything above those levels is valued at the original basis that the deceased paid for the assets. Note: The provision limits the stepped-up basis valuation of appreciated assets that are part of an estate only for those individuals who pass away in 2010.

Possible strategies: If there was ever a reason to work with a professional in preparing an estate plan, this is it. Because of the range of variables and the high stakes involved for wealthy individuals, consulting a trusted estate planner is the best strategy for anyone who might be subject to either the estate tax or the limitation on stepped-up basis treatment.

Should the estate tax not be reinstated for 2010—and depending on the health status of your parent or spouse--you might want to begin tracking down any investment documents that will help your heirs determine the original cost basis of any assets they stand to inherit, and make sure they are stored in a safe place.

3 Million iPads Sold

Apple Inc. sold its three millionth iPad Monday, 80 days after the tablet computer's introduction in the U.S. and giving further insight on how the device will boost current-quarter results for the tech giant.

Some analysts last month projected about half that would be sold in Apple's fiscal third quarter, which ends next week. They went on sale April 3 in the U.S. and become available internationally at the end of May, weeks later than planned after the stronger-than-expected U.S. debut.

The announcement comes as Apple's iPhone 4 is also shaping up to be a blockbuster. The company took preorders for more than 600,000 of the devices on its first day of availability, while carrier AT&T Inc. had to stop taking advance orders because of inventory issues and unexpectedly high demand.

Apple's shares rose 1.4%, or $3.68, to $273.85 in Nasdaq composite trading. The stock has about doubled over the past year and has the second-highest valuation among U.S. companies, behind just Exxon Mobil Corp.

Disclosure: I hold a position in Apple

A Simple Way You Can Boost Your Nest Egg

Most investors know (or should know) the tried-and-true methods to help nest eggs grow.

Shift money automatically from your paycheck to a savings plan; take advantage of your employer's matching contributions to 401(k) plans; eliminate (virtually) all consumer debt; track and trim household expenses; reduce investment fees; and, of course, save more than you're saving now.

But with the economy and markets still struggling, investors are seeking, additional steps to shore up retirement savings.

Here is another tip. Dividend paying stocks:

In 2009, more companies cut their dividend payouts -- and fewer companies increased them -- than in any year since 1955.

Now, though, the tide is turning. Many companies, after recent spending cuts, are flush with cash. And, as such, dividends are likely to be restored or increased.

In April alone, 25 companies in the Standard & Poor's 500-stock index raised their dividends, and none cut them.

How can dividends help your nest egg? Even in tough economic times, many companies continue to make payouts, generating a steady stream of income. And that income tends to grow over time as companies boost their dividends. Payouts on stocks in the S&P 500 grew at an annual compound rate of 4.7% between 1980 and 2009, compared with an annual inflation rate of 3.7%.

Of course, dividend-paying stocks have risks. A handsome payout is no guarantee that the share price of the stock itself won't fall. In 2008, an investment of $10,000 in S&P's "Dividend Aristocrats" -- companies in the S&P 500 that have raised their dividends every year for at least 25 years in a row -- would have generated a respectable payout of almost $400. But the value of the stocks would have fallen to about $7,800.

Still, getting some form of return on an annual basis appeals to more and more people especially given low yields elsewhere.

Turning to a mutual fund that focuses on dividends is a prudent approach. Among individual companies with solid fundamentals, shares of Coca-Cola, Johnson & Johnson and Procter & Gamble currently yield 3% or more. Selected other companies yield even higher. Call me for additional information.

Disclosure: I hold positions in Coca Cola and Johnson & Johnson