Distressing News About ETFs

Many exchange-traded funds are not keeping up with their benchmarks. ETFs that try to match esoteric indexes such as the High Growth Rate Dividend Achievers Index, in the hopes of generating high returns, are likely to fall short.

There is a reason for this: These funds can't always buy all the shares they need in order to match the indexes because some of the underlying shares may be thinly traded or available only on indexes of certain foreign countries.

How can you protect yourself from having this experience? Stick with low-cost ETFs whose benchmarks are large, well-known indexes. ETFs that have low expenses and track major indexes like the S&P 500, usually match their benchmarks almost precisely.

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Are We Facing A REIT Bubble?

James Grant seems to think so as stated in a recent article in FORBES magazine. Grant points out that at the March, 2000 stock market peak the S&P 500 traded at 33 times earnings and could do no wrong. The Bloomberg Real Estate Investment Trust Index, on the other hand, traded at a multiple that was 40% of the S&P's and could do no right. But a funny thing happened on the way to tommorowland. REITs got hot, but the S&P didn't. By so vast a margin did the REITs subsequently excel that the blue chips would have to quadruple tomorrow simply to close the gap.

Income producing property can be a superb investment. So, too, can REITs, which pay out 90% of the income they earn from the assets in which they invest, buildings or mortgages or both - with the focus here being on buildings.

It almost goes without saying that no investment asset is either inherently good or inherently bad. Valuation is the all in all. At the low March, 2000 valuations REIT investors had that sleep-enhancing cushion known as a margin of safety. At the much, much higher prices now prevailing, they have no such protection, only the smug knowledge of past returns.

Just by going up, real estate has made believers of the former skeptics on America's investment-policy committees. What a difference seven years make. Now, ostensibly, no price is too high, because rents will go up forever and private equity investors will buy up any REIT not nailed down.

But hold on: As the return on buildings pushes lower, the cost of financing them edges higher. But not to worry, the bulls insist. Real estate isn't about the cash flow. It's about the price appreciation. An earlier generation of bulls once said the same thing about tech stocks.

So bottom line, what Grant is really saying is that realty trusts have done well - too well in fact for their own good. But yields are so-so, and in his view, the best course now is to short them.

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Hooray For The Dividend Payers!

After years of subpar returns, the dividend-paying stocks of the S&P 500 outperformed
the non-dividend payers, 14.8% to 8.3%, for the 12 months through February 28, 2007.
If you think this outperformance will continue, focus on stocks with dividend yields over 2%, the market's historic average.

From that universe, look for companies with a return on equity of over 5% that have recently reported a positive earnings surprise. In addition, eliminate stocks that have lagged the market over the past six months.

Stocks that have passed all these screens returned 18% per year from 1990 through 2006, far above the 12% annualized gain of the S&P 500.

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The Smart Way To Buy Munis

A broker's profit on municipal bonds comes from the spread - the gap between the price the firm pays and the marked-up price for which the bond is sold to investors.
Smaller purchases tend to have higher markups, resulting in lower yields.

To evaluate the deal your broker is offering you, go to www.investinginbonds.com, which lists all recent sales, as well as information on the bonds' yields. Click on Municipal Market at-a-glance and plug in the bond's CUSIP, it's alphanumeric ID. If the yield you're quoted doesn't look fair compared to what other customers are getting for similar-size transactions, your broker has some explaining to do!

NOTE: If you buy an individual muni, plan to hold until maturity so you can avoid worrying about the spread on a sale.

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Investing Abroad

Discount brokers are making it easier for investors to buy stocks on foreign exchanges. E*Trade Financial is the first major brokerage to allow investors to trade foreign stocks online in local currency directly on their home exchanges, starting with Canada, France, Germany, Hong Kong, Japan, and the U.K.

Investors pay an average of $20 for the stock trade, plus the fee for converting dollars into local currency. Charles Schwab, Fidelity Investments, and TD Ameritrade all have various restrictions and surcharges above their typical online trading fees.

These efforts give you access to smaller foreign companies, as well as large ones such as Samsung and Vivendi, that do not list American Depository Receipts (ADRs) on U.S. stock exchanges.

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Getting What You Pay For

Fierce competition has driven commissions to surprisingly cheap levels. Free trades are becoming available. However, trading costs are far from the only consideration when choosing a broker.

Speedy and accurate trade execution, research tools, margin lending policies, and solid customer service can outweigh the value of cheap trades. Moreover, getting a better interest rate on uninvested cash can more than makeup for any commission costs.

At some brokerage firms, cash paid in interest and dividends is swept into accounts yielding 1% or less, unless you request something different.

NOTE: Pay attention to the rates you are paid, and if your cash is earning a low interest rate, have cash distributions swept into a money market fund paying a competitive yield.

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Know This About Closed-End Funds

The portfolio manager of a closed-end fund does not have to worry about redemptions. Therefore, closed-end municipal bond funds don't hold cash to meet redemptions so they can put 100% of their assets into long-term bonds.

Indeed, closed-end muni funds often invest more than 100%: they might buy $1.50 of long bonds for every $1 that fund shareholders put in, borrowing the extra 50 cents in the form of floating-rate notes that pay tax-exempt interest.

If short-term rates are lower than long-term rates, this leverage kicks up the fund's yield. The yield on a closed-end fund also may be enhanced if it trades at a discount to the value of the portfolio.

Also note that leveraged closed-end muni funds can be volatile but they may pay off because short-term interest rates normally are lower than long-term rates.

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Finding Your True Net Worth

Knowing your net worth is an essential step in fine-tuning your financial plan. It can help you more accurately decide how to invest, how quickly to pay off debt and how to plan your estate and other financial matters, such as whether to lend money to family members.

Calculating your net worth may seem basic at first glance: add up assets and subtract liabilities. But the net worth equation is a bit more complicated. Costs such as real estate brokerage commissions, taxes and other expenses triggered by liquidating non-cash assets can affect the final figure. As a result, always remember to factor in these expenses so that you don't overestimate your true net worth, which could potentially lead to ill-informed financial decisions.

When you set about determining your net worth, consider what it would cost to turn the following assets into cash:


Investment securities. Drawing on assets held in taxable accounts or conventional retirement accounts triggers both federal and state income taxes. And in most cases, they'll trigger a 10% federal penalty for investors who are younger than 59-1/2 (a state penalty may also apply). Sales from Roth IRAs or Roth 401(k) accounts do not trigger taxes.


Real estate. An accurate picture of your real estate assets requires more than an estimate of your property's current market value. You also must account for the effects of brokerage commissions and taxes. Brokers typically charge up to 6% to help sell buildings, and may charge up to 10% for sales of undeveloped land.


Personal property. It's easy to overestimate the value of personal property such as automobiles, boats, jewelry, furniture or art. For an accurate picture of the value of cars or trucks, visit the websites for Kelley Blue Book (kbb.com) or the National Auto Dealers Association (nada.com).

Effective financial planning requires an accurate picture of your net worth. Factoring in the costs of liquidating non-cash assets can help you zero in on the true value, giving you the information you need to make the right decisions for managing your wealth. And don't forget to consult with a tax advisor for any questions you may have.

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ETF Errors To Be Aware Of

There are now more than 450 exchange-traded funds (ETFs), including 75 which were launched in the first quarter of 2007 alone. ETFs are designed to be low-cost index funds, and those that track major indexes such as the S&P 500 generally do a good job. But misfires can occur when ETFs try to match more esoteric indexes like the High Growth Rate Dividend Achievers Index.

These niche indexes may have big stakes in fewer stocks or hold small companies that are harder to trade. Tracking error may result, meaning that investors are not getting the performance of the underlying index.

Another point to bear in mind is the fact that these esoteric ETFs also may be more expensive than those tracking familiar indexes.

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Is The Tech Wreck Over?

The tech-heavy NASDAQ Composite Index peaked at nearly 5,050 in March 2000, then plunged to less than 2,350 by the end of 2000, and was barely above 1,100 two years later. Both tech stocks and the NASDAQ have recovered a bit since then but that index is still just barely more than half of the high-water mark reached seven years ago - closing at 2,558.45 this past Friday.

Currently, tech stocks offer a combination of relatively low valuations and strong fundamentals. Technology companies have slimmed down, cut costs, and cleaned up their balance sheets since the 1990s. Moreover, many corporations have cash they are likely to use for capital spending, and that spending may be largely on technology.

If your current allocation in tech is relatively low at this time, this may be an opportunity to stock up.

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THIS IS MORE IMPORTANT THAN INVESTING!

I've gone on record as stating that I would never use this Blog for any purpose other than discussing investment-related topics. However, you should be aware of what is going on with respect to illegal immigrants, and the "I-BOMB" that George Bush and Senators John McCain R-AZ, Arlen Specter R-PA, Lindsey Graham R-SC, John Kyl R-AZ, Mel Martinex R-FL, and Congressman Jeff Flake R-AZ, are trying to pull off on an unsuspecting American public!

PLEASE... IF YOU VALUE THIS NATION AND WANT TO KEEP IT FROM BECOMING A SATELLITE OF LATIN AMERICA, TAKE A FEW MINUTES AND SEND THE SIX QUIZZLINGS I MENTIONED AN E-MAIL WITH THIS MESSAGE:

"NO AMNESTY, OR WE WILL VOTE YOU OUT!"


THE SIX (6) QUIZZLINGS ARE:

JOHN McCAIN, R-AZ

ARLEN SPECTER, R-PA

LINDSEY GRAHAM, R-SC

JOHN KYL, R-AZ

MEL MARTINEZ, R-FL

JEFF FLAKE, R-AZ


NOTE: Each one of these rascals has a web site where you can leave your comments, and it can be found quite easily by simply typing his name into the GOOGLE search engine.

Re: Last Night's Meeting

Well I have to comment about our speaker last evening, Mr. Paul Nolte, of Hinsdale Associates. While the discussion moved along fairly well, I certainly have to take issue with his sentiments that "fees really don't matter, it's the return that counts." That was a bogus comment because he was speaking as someone who sells investment products, i.e. stocks, bonds and mutual funds; so from his perspective that statement would make sense because the higher the fees, the greater the commission!

But as an investor, part of your actions must include a conscious effort to keep fees/expenses to a minimum - if for no other reason than the fact that when you are dealing with a broker, or as in his case a financial adviser, or even with a mutual fund, that person (or firm)you are dealing with is making money as the result of your trade - even if you are losing money - so keeping fees and expenses as low as possible will always be in the investor's best interest!

Anyone else care to comment?

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The Wisdom of Warren Buffett

"I want to be able to explain my mistakes. This means I do only the things I completely understand."


With those words, Warren Buffett is telling us that: If you don't understand what you are doing, then why are you doing it?

The proper investment approach is not intuitive - it is rational mixed with the right temperament. Ignorance is bliss unless you are investing. Then it usually leads to nightmares.

If you want to be able to explain what you did wrong, you need to know how to explain what you did right, and why you did it in the first place.

You need to know a good business from a bad one, and you need to be able to determine if a company is underpriced or overpriced. If you can't do that, then you should find someone who can do it for you, otherwise you are just throwing dice at a craps table where the odds are always stacked against you.

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How Do YOU Measure Up to the "Average Wealthy American?"

If you are an average wealthy American, you would have $1,400,000 in assets, and $275,000 in debts, for an overall net worth of over $1.1 million. And your assets would be fairly evenly split between "financial" assets like stocks, bonds, mutual funds and/or ETFs and cash, and "non-financial" assets such as real estate, a personal business, and collectibles.

Of the $275,000 in debt, about 80% of it is on properties, and less than 1% of this debt would be on credit cards.

For a closer look at the assets of the average wealthy American, 15% of his assets are in individual stocks, 40% is in retirement accounts or mutual funds where somebody else is managing it. The remainder is spread among bonds, cash value life insurance, savings bonds, retirement accounts, and cash.

The median home mortgage of the average wealthy American is $135,000 and the median home value is $350,000. Car loans and credit cards - which are the usual killers of the middle class - don't even make a dent in the wealthy person's debt load. Wealthy people generally seem not to live above their means, and car loans and credit card balances are almost non-existant among the wealthy.

Some other interesting facts about the average wealthy American:

The self-employed are the wealthy folks of America. The average net worth of a family where the head of a household works for someone else is $65,000. When it comes to the self-employed, the average net worth is $352,000.

Another interesting wealth statistic: all the wealth in America is concentrated among homeowners. The average homeowner's net worth is $171,700, while the average renter's net worth is a measly $4.800. Quite a stunning difference!

And finally, education is also valuable. The net worth where the family head didn't graduate from high school is only $25,500, while the net worth where the family head has a college degree is $213,200.

So what - if anything - should you do with all the figures I've given you about the Average Wealthy American? Well, first, you should take a look at your own assets and see how you stack up. It can be either an eye-opening experience - or - you may be pleasantly surprised. In any event, it's never too late to roll up your sleeves and examine your own financial picture, or to make some difficult decisions, if that's what you need to do!

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NEXT MEETING: Thursday - May 17, 2007

This month we welcome as guest speaker Mr. Paul Nolte, CFA of Hinsdale Associates - located in Hinsdale, Illinois. Mr. Nolte will give us his take on the current market as well as his views on what to expect in the near term future ahead. And of course there will be plenty of time for your questions and comments, so do plan to join us for what should prove to be an interesting and informative evening.
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We meet at DePaul University, located at 150 West Warrenville Road in Naperville, Illinois. The meeting runs from 7:00 to 9:00 P.M., and the room number will be posted on the easel standing near the reception desk in the main lobby.

Anyone who shares our interest in learning and talking about investments is welcome, and you need not be a member of AAII in order to attend.

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