2018 Forecast

    My 2018 forecast will not be an attempt to predict what will happen in Washington D.C. but rather what has actually happened so far in the Trump Administration and how it should affect your investments. There are two important things that have changed in the last year. First is the passage of the Tax "Reform" bill. Secondly, the reduction of regulation of certain industries. When looking for sectors that benefit the most from both factors, I think that the Banking sector will be the biggest winner. One way to invest in banks and financials is to buy an ETF (exchange traded fund) like the Financial Select Sector Fund, symbol (XLF). This is an easy way to achieve diversification and also pay low fees while maintaining liquidity. The alternative is to select a few bank stocks and buy them individually. Banks should also benefit from higher interest rates which the Fed has signaled are comming next year. Higher rates should give banks better margins (the difference between what they pay on deposits and what they charge on loans). The combination of less regulation, lower taxes, and higher margins, could be a powerful stimulus during the coming year.
     Another sector that I like is energy. Oil stocks have underperformed for years. It's only the last few months that they have shown any momentum. I own an ETF issued by Vanguard simply called Vanguard energy ETF symbol (VDE). it lost about 7 1/2% in 2017 but I am sticking with it because the price of oil has climbed in recent weeks and I think that it will stabilize in 2018. Just like last year's forecast, I don't see oil returning to historical highs. Some domestic drillers can profit from $50 oil and above due to improved productivity. There are many companies to choose from such as EOG resources, Whiting Petroleum, and Concho Resources. Before buying any of these companies, investors should research their valuation (PE ratio), debt level, production levels, dividend yield, and many other factors. An easier way to invest in energy to buy an ETF like the Energy Select Sector Fund (symbol XLE). That way you get diversification and a 3 1/2% yield in one trade.
     Another undervalued play in the energy space is Master Limited Partnerships (MLP's). They often yield in the 6-8% range and are tax advantaged. I do not recommend them for retirement accounts because of this. Be aware that MLP's report earnings on form K1 which will complicate your tax preparation. One way around the form K1 tax reporting is to buy a mutual fund or ETF which holds MLP's. That way your distributions will be reported on form 1099 instead of form K1. One ETF that I own is the Alerian MLP ETF symbol (AMLP) The current yield is over 10%. The long term performance is lousy, but the hope here is the improved price of oil will also help the price of AMLP.
     My last sector of interest is technology. The recent pullback in names like Micron Technology (MU), Apple Computer (AAPL), Intel (INTC), Alphabet (GOOGL), and Facebook (FB), may continue and present a buying opportunity. Be cautious because these names have led the market in 2017. The SPDR Technology ETF (XLK) will provide exposure to these names with only one trade.

Politics, Religion, Sex, and Money

     I heard on the radio the other day that 10% of married couples get into an argument before breakfast on Christmas morning. If I had to guess, it was over one of the four topics mentioned in the subject line:PRSM. Politics first, couples who cohabitate tend to blend their political views after a few years. Most people realize that arguing over it will not solve anything anyway. Second, religion, couples with different religious views usually don't even survive the wedding. Third, sex, most couples figure out if they are sexually compatible before they even get married. After all, you wouldn't buy a car without a test drive would you? That brings me to money, I doubt that most couples have had serious talks about their views on earnings, savings, investing, and spending before they tie the knot. I suspect that differences about how finances are handled breaks-up more marriages that the other three combined. Parents of adolescent children seldom take the time to educate their kids about how to handle money, if any reader is the exception, I applaud you. High schools and colleges usually ignore this very important subject too. It's no wonder that financial incompatibility wrecks so many marriages. The sad fact is that most couples are on their own when it comes to the family budget. In my household, like most, the woman is the main spender. My wife buys nearly all the groceries and supplies to run the house. If I get nervous about how much she is spending, I will compensate by pinching a penny even harder. If that doesn't work, we have the TALK. It's important to not let emotion enter into any financial activity. A couple who share intimate details about their sexuality can surely have a frank discussion about money, right?  It's also important to deal with any financial problems in a timely manner. A problem that is ignored can fester like a cut from a rusty blade. When a person finances household expenditures with revolving credit (cards) and makes no effort to pay down the balance, there will be a day of reckoning. A spouse who hides these balances from the other spouse is cheating on their mate. I realize that bad things can happen to good people and that some large expenditures are unavoidable. In the absence of that unexpected expense, there are a few things that couples can do: 1. control your spending. sometimes a simpler life is a happier life. 2. Avoid unnecessary debt. Interest on accumulated debt can wreck a budget and marriage. 3. Develop a savings plan. Even modest amounts of savings can add-up over time and create a cushion in case of the unexpected.

Crypto Mania

     There is something going on in the world of Finance that just cannot be ignored. It's very confusing and most experts admit that they don't understand it either. I'm talking about cryptocurrencies like Bitcoin. I have to admit that I know almost nothing about the technology and the currency but I would feel remiss if I didn't at least address it in this blog. First of all, Bitcoin is just one of many cryptocurrencies out there. Another popular "token" is called Ethereum. I called it a token because that is the technology that allows them to be bought, sold, and traded. There are currently about 1200 cryptocurrencies out there in cyberspace with more offered everyday. They are being introduced by what is called an "initial coin offering". According to the current issue of Barron's magazine (Dec 4,2017), investors have bought 3.6 billion dollars worth of these tokens just in 2017 alone. That's why it shouldn't be ignored. I would highly recommend anyone who is interested in this "mania" to buy a copy of this weeks Barron's to get educated on what is happening. Just to be clear, I do not recommend putting any money into crypto's yet. However, some money managers who I know and respect have considerable amounts of their clients money in Bitcoin. The sheer rocket-like appreciation of Bitcoin is staggering-1000% since the start of the year. Just because there is no basis for this asset to appreciate does not mean that it will stop anytime soon. Sometimes these manias can carry on for years. Some pyramid schemes have been around for many years and are actually listed stocks on the NYSE. Cryptos have been the most popular in some third world countries where there is little confidence in the official currency of the government. But now the mania has overtaken Wall Street and the Chicago Board of Exchange has committed to offer futures trading in Bitcoin in the near future. This gives Bitcoin a small amount of legitimacy, but in no way lessens the risk. According to the Barron's article, $300 billion have poured into crypto market so far. With so many tokens available, no one really knows which cryptocurrency will emerge as the dominate player in this asset class, but Bitcoin looks to have the early lead. It is my belief that the world is heading toward a cashless society sometime in the future so it makes sense that a cryptocurrency will fill most peoples virtual wallet.but I doubt that will happen in my lifetime. In the near future there will be many ETF's, mutual funds, closed ended funds, and other products offered that will mitigate the risks of cryptos. Only then will I be willing to consider an investment in cryptos.

Growth vrs Value

     As a young man I took up the game of handball. We played outside at Wesselman Park almost every day. When I was first learning the game, I was practicing by myself when the best player in town showed up. He proceeded to teach me the finer points of the game. It seemed to him that I was playing the ball too close to him so we could volley longer. His advice was "hit it where I'm not". In other words, make him run for the ball. What's this got to do with investing in stocks? It seems that in today's stock market, everybody throws their money at just a few easy targets such as Amazon, Micron Technology, Alphabet, and so on. This is known as growth investing. The hope is that these stocks will just keep on going higher and higher and that the valuation doesn't matter. This trend has been going on for several years and lots of money has been made by doing what others do. But, some experts suggest that this style of investing is soon to go out of favor and that value investing is soon to be the rage. I believe in value investing for the most part. It's like hitting the ball where other investors aren't. The hope is that others will also discover these companies that successfully carry out their business plan every day and buy the stock which drives up the price. To be a value stock, the company must trade at a reasonable valuation as expressed by the P/E ratio, P/B ratio, PEG ratio and other measures of valuation. What really ices the cake is a good story about why the business is about to take off. Examples of this would be 1. Changing government regulation, 2. Changing consumer behavior, or 3. An exciting new product launch. Famous investors like Benjamin Graham and Warren Buffet are champions of the value style of investing. In today's schitzo market, what gets punished today is loved tomorrow and vise versa. This tells me that too much money is chasing too few stocks so the money makes quick circles around the growth stock names like a dog chasing his tail. Instead of focusing on the most recent quarter's earnings, value investors tend to have a longer view. When researching for my next value play I also look for a nice dividend that appears sustainable. The dividend payout ratio will tell you if the dividend is starving the company of necessary internal capital. In today's low interest environment, a 3% dividend will keep me interested until value investors wake-up.

You Can Do It

     In our society, self-help is becoming increasingly rare. Most people don't believe that they can do auto or home repairs themselves. Calling a repairman for everything can get very expensive pretty quickly. The pros who perform the work can often go right to the source of the problem and get it fixed because they see the same problems every day. It would be bad for business if they told their clients just how easily and cheaply the washer, dryer, stove or air conditioner can be fixed. Some things are better left for the pros, but many things are doable with a little education. Recently, my daughter was having trouble with her washing machine. She told me how it wasn't pumping all the water out of the tub and leaving her clothes with a funky smell. I have repaired many washers with the same problem and knew with a 90% certainty just what the problem was. It usually takes me about 30 minutes and a $10.00 part to fix the condition. For my daughter, who hasn't ever done this repair before, this was a huge job. With limited tools and limited mechanical knowledge, she overcame her fear of failure and tackled the job, saving her family $175 in the process. Such tenacity can and should be applied toward your investing activity. Why should you pay for the services of  a financial advisor to manage a modest retirement account when a little knowledge can save hundreds or thousands in fees? The fact is that about 80% of professional money managers cannot beat the unmanaged index of stocks that they compete against. That makes a case for just buying an unmanaged index fund that tracks the market, like the S&P 500 index. Most mutual fund companies like Vanguard and Fidelity have such funds. The fees are low and you aren't paying someone to underperform with your hard earned money. Investing is not rocket science. I have laid-out some commonsense rules to guide you toward financial independence. As you become more comfortable with investing, try your hand at buying individual stocks to complement your mutual fund portfolio. I personally get bored with mutual funds and enjoy buying and following stocks. Just like fixing the washer, the hardest part is to get started.

Mistaken Profits

     Years ago, when I had a job, I would often have free time to do some Internet research of  potential investments. I would also keep a close eye on my current portfolio in case something was happening to a position. By using yahoo finance or my discount broker's website, I could type in symbols of any company that I owned or had read about. One day I made a mistake when typing-in the symbol of Intel which is INTC , instead, I typed-in INT, which is a company called World Fuel Services. Instead of backing out  and correcting my error, I read about this company to find out what they were about. Turns out that I was fascinated by their business. They would provide any kind of fuel to any company or government anywhere in the world-for a hefty price. This means that if a government was waging a war somewhere in the world and needed aviation fuel, diesel fuel, gasoline or anything else, WFS was johnny on the spot. If an ocean-going freighter needed fuel on the high seas, WFS was there also. This company had been in business for many years and even paid a dividend. I was looking for potential investments and I found one entirely by accident. I pulled the trigger on ITC because it fit my criteria for a new addition to the portfolio: Stable management, reasonable valuation (PE ratio), good business model, regular dividends, reasonable debt ratio, WTH I'm in. I had a good run with INT for about 2 years, then I sold it for a nice gain which was long term to ease my tax burden. The reason I sold it was that fuel prices were starting to decline because new supplies of crude were coming on line due to hydraulic fracking in the USA. Fuel prices alone should not have hurt their business because they were basically a service business but investors don't always see it that way. Sometimes stocks fall because they are too close to a declining commodity. Anyway, I made a profit from a mistake. Why am I telling you this? Good things happen when you do your research-even if you make a mistake.

It's Different This Time

     Have you ever heard that before? How about "There's nothing new under the sun" or "The check's in the mail". Here's another one "Buy in May and go away". My point here is that cliche's have no place in investing. Every period in the investing timeline is unique. The "dotcom" era ended in 2000 with a severe correction in the new technology companies, most of whom had no earnings and little revenue. They were cash rich from selling stock to investors who bought the IPO (initial public offering). These companies were often analyzed by such measures as their "burn rate" which measured when they would run out of money. Another measure of a dotcom company was "eyeballs". This was a measure of how many people simply looked at the web site of the company. The theory was that eventually, those visits would produce revenue for the company, but it usually never happened. Just before all this nonsense came to a screeching halt in 2000, people were saying "It's different this time". Fact is that eventually investors came to their senses and stopped feeding money to these scammers. There is no substitute for a thorough analysis of an investment, which includes an examination of the balance sheet, income statement, and ratio analysis, including price to earnings, price to sales, price earnings to growth, and an understanding of the business you are about to fund.
     As I write this post, the average P/E of a stock in the S&P 500 stock average stands at about 20X earnings, historically, 15X is the norm. This means that stocks are expensive on a relative basis. Why is this? Well, interest rates are at a historically low level. That means that CD's, bonds, and other fixed income investments have really low yields. Investors are finding the best returns in the stock market. Many blue chip stocks have a dividend yield of over 3%. This beats a 5 year CD that yields 2% at best. The stock also has capital gain potential and is very liquid, meaning it can be sold at any time without incurring a penalty. Is it different this time? Is is safe to pay-up for a company to get a reasonable return? The answer is maybe. There are a few game changers in the universe of stocks such as Amazon, Facebook, Alibaba, Netflix, and Google (now called Alphabet). I just listed what is commonly called FANG stocks, they have rewarded investors for having the foresight of recognizing game changers. I would also include Tesla in this group. Do I currently have any of these stocks? No. My bad. I just own stocks that produce gas for your car, produce blockbuster drugs for disease, manufacture vehicles, write security software code, and manage the financial system of our country. Is it different this time? Not for me.

Debt

     I have always considered debt to be a four letter word. It is something that I avoided at all costs. My philosophy has always been that debt was the bane of the working class. Getting out of debt is the single most financially liberating experience of my life. I am proud to say that I have never financed a car and made my last mortgage payment in 1986. Just these two things have saved me many thousands of dollars over the years. These are dollars that I have and can invest, or use to fund my retirement or other cash purchases. Taking out a mortgage on a home that fits your lifestyle and is within your budget is something that is reasonable and often necessary. The difference between a mortgage and financing a new car is that the house you buy is usually going to hold its value or increase in value over the years. Financing a car is an automatic money loser. The value of that car, boat , ATV, camper, or any other toy is going to start depreciating as soon as it is driven or pulled off the lot. This means that you are making payments on the full value of an asset but you actually own something of lesser value. Not my idea of a good investment! Even banks that make a lot of auto loans are suffering now. Why? Every time large purchase incentives are offered for a model or make of a new car, the value of recently sold cars of the same model declines. Those cars are often held as collateral on the loans and the bank has less collateral in case of a default. When the default occurs and the bank has to repossess the vehicle and sell it at auction, there is usually a capital loss. Unlike a house, which often times holds its value, cars are usually an automatic loss. Housing is not always in a bull market but autos never are. If I could buy a new truck every year and drive it for 12 months, then sell it for a profit, I probably would. This is why I drive a 15 year old Chevy truck. A program of  "deferred gratification" will keep a person out of hoc and allow any new purchases to be made in cash. Make payments to yourself and earn interest on the money until you spend it, instead of paying interest on a loan for an asset that declines in value. You will find it harder to justify that new purchase if your hard earned cash is on the line.

Mid Year Report Card

     I would rather take the SAT test than back test my picks for 2017, There is little to crow about here. I wish I would have stuck with my conviction to not recommend any specific stocks and just stuck with the basics. Anyway, here I go:
     The Trump agenda has been a bust. The promised infrastructure build-out has been nonexistent. Last December, I mentioned four companies that could benefit from the increased spending on our infrastructure.
  1. ASTEC Industries- down 30% YTD
  2. JACOBS Engineering- down 10% YTD
  3. VULCAN Materials-flat YTD
  4. AECOM-down 15% YTD
The only bright spot in government spending has been in the defense issues which I will cover later in this post.
     I predicted that interest rates would go up this year and I was right about that. The FOMC raised rates twice this year for a total of 50 basis points (half of one percent). As predicted, bonds did poorly in this increasing rate environment. I had recommended a couple of financial stocks that benefit from rising rates. I will use an ETF as a benchmark for the financial sector-XLF- which holds many bank stocks and financial companies. XLF returned 6.9% so far this year. I expect the good performance to continue for the second half of the year.
     Energy did poorly for the first half of this year but I mentioned in December that I did not expect any large gains. I did mention that I thought crude would stay in the $50 range but instead, it has struggled to get there. I still believe it will end the year higher than it is now, and I still believe in the midstream MLP's which are not as dependent on crude pricing. The XLE which is a proxy for energy prices is down 12 3/4% this year.
     The Pot trade has been a bust too. The only stock I liked in the space was Scotts Miracle Grow, which is an indirect bet on marijuana, was flat on the year.
     The defense sector has remained hot this year for many reasons: Our military is overdue for increased spending on weapons, tensions from North Korea's missile testing, and Trump's campaign promise for increased defense spending . So far this year, Boeing is up 50% and Lockheed Martin is up 15%. Buying stocks with high multiples (P.E. ratios) makes me nervous, so I still don't hold these.
     In summary, I don't see the Trump agenda working for investors this year given the turmoil in the White House and both houses of Congress. However, even in this pricey market, I have bought a few value stocks that have been taken to the woodshed for missing their earnings call. Most recently I bought Goodyear Tire, symbol (GT). My reasoning is that no matter what the car of the future runs on, it will probably have wheels. I also liked the fact that it was trading at 7 times earnings-a huge discount to the market. I also bought McKesson because I thought this medical supply company was just too cheap. I don't know what my next post will be about but I hope that I don't have to mention the Donald.

On Vacation

     I recently returned from a vacation to Canada where I spent the week fishing and relaxing. I rarely worry about my investments while I am away from TVs and computers because summertime is also when money managers also are on vacation. Institutional money managers often trade in millions of shares of stock, sometimes moving markets. Between Memorial Day and Labor Day, the top brass of the big mutual funds turn over management of the funds to their subordinates  who have limited authority to make any large changes to the portfolio. This is why summer seems a little subdued for the stock market. The movers and shakers of the financial world are chilling out in Martha's Vineyard, enjoying the perks their incomes affords them. A major news story about politics or an individual stock can still roil the market, but generally, things are quiet. Summer is a good time to do some reading in financial publications for ideas that will help you build a list of investments to buy when the time is right. Some articles that I have read recently were about the emerging autonomous auto transformation. The implications of this technology are enormous. All these vehicles will also be electric powered and recharged by plugging into household current. I have heard it said that our existing electric grid is currently unable to handle the extra power demands of a large scale conversion to electric vehicles. If this is true, then the purchase of Solar City by Elon Musk was a stroke of genius. Elon is the CEO of Tesla motors, which plans to produce 1 million electric cars a year within 5 years. I don't know for sure if he can pull-off this feat but I wouldn't bet against a guy who routinely launches rockets into space and supplies the International Space Station. I have already been in Tesla stock and sold it for a quick profit but now I am looking for an entry point again. The transformation of the auto industry could be the biggest story of the last 100 years. Another point I would make about this is the technology required to make it happen. Computer chips that help the driverless cars navigate are being manufactured now by Micron Technology (MU). Lam Research makes the equipment which manufactures the memory needed by autonomous cars. Lam has been on a tear lately so buy it on a dip.

Acrophobia

     Acrophobia is a big word meaning "fear of heights".  I am beginning to suffer from this disease. It usually affects me when I research stocks that I might be interested in adding to my portfolio. The PE ratios of many stocks are at unsustainable levels currently. What is driving this unusual level of interest in common stocks? Several factors have contributed to these high valuations. First, extremely low interest rates for fixed income investments like bonds and CD's have steered investors to the equity (stock) market for dividend yield and capital appreciation. The second factor is simply supply and demand. There are too many dollars chasing too few stocks, creating an imbalance and causing stock prices to rise.When interest rates start to normalize (return to historic levels) , stock valuations should moderate. Currently, the Federal Open Market Committee (FOMC) is expected to raise rates again this June. Any weakness in the stock market or economy in general may delay this move. I recently looked at a chart of the Dow Industrial Average from 1980 to present. The upward slope is staggering. The only real deviation occurred in 2008-2009 during a severe recession. Interest rates were slashed during the recession to stimulate the economy which was on the brink of collapse In addition to already low interest rates, the FOMC began a program of Quantitative Easing. This flooded the capital markets with liquidity so loans could continue to be made and businesses would stay open. Now the Feds would like to unwind all this stimulus and return to normal. My fear is that stock valuations have been propped-up by all this artificial stimulus and may react badly to any attempt to normalize interest rates. Hopefully the transition will be gradual enough to avoid any severe repricing of stocks in general.. Therapy for my Acrophobia includes raising cash by selling some positions that appear to be richly valued and making a list of potential buys in case the market corrects in a meaningful way. I also am watching local CD rates and buying into a laddered CD strategy which is what a retired guy my age should do. I still hold plenty of stocks and a few bonds,  which I will hold to maturity, but my cash and fixed assets will help insulate me in a market downturn.

Panic Mode

     Today the Dow Industrial Index is down over 370 points. There are three things an investor can do in this situation: 1 Sell in a panic, 2 Buy more stocks at a discount, 3 Relax and have a glass of your favorite beverage. I chose option #3. My preference is Wild Turkey bourbon on the rocks with a slice of lemon garnish. Institutional investors and market makers on Wall Street would like for you to choose option #1. Why? Because panic selling by retail investors cause prices to fall on good stocks, giving the Pros a bargain price. The Pros on Wall Street are always looking for a way to generate short term gains for their clients. It's the client who is responsible for the tax on these gains. To sell into a panic means that I have lost control of my long term strategy and that I am willing to sell at any price just to exit a position. Readers of my last post will remember that I was selling (with limit orders) some of my big pharma (drug) stocks last month. All of those orders were filled at the price I specified. I wish I could say that I knew The Donald was going to do something stupid and cause a panic, but the truth is that the drug stocks just got pricey as expressed by the PE ratio. I like to sell into strength while the market is going up instead of weakness (when people are panic selling). Since this blog is about finance and not politics, I only have one thing to say about the events this week at the White House: Trump's outrageous behavior is not accepted in government like it was in the business world. End of political analysis. Now about option #2-buy more stocks at a discount. Let's put today's action into perspective- the Dow only fell 1.78% today, hardly a huge discount to previous levels. I don't know if there is more pain to come or not so I am not willing to catch a "falling knife" by buying a stock on its way to lower levels. When Richard Nixon was caught breaking the law and lying about it in 1973, the Dow fell 50% in about a year. Funny thing is this country, the economy, and the stock market all survived the resignation of Nixon. If this is what happens to Trump, I suspect my long term strategy to survive also.

Handyman Investing

     I recently went for a walk in my neighborhood and found an antique table discarded on the side of the road. The table had one leg broken-off and another leg shattered. I could not resist bringing it home to repair and refinish it. A few days later, the table looks worthy of my living room. What someone else saw as trash, I saw as treasure (with a little work). Stock investing can work the same way. For each purchase of a stock I make, someone is selling those shares to me. Beauty is in the eye of the beholder in women, goods, and stocks. I like to acquire broken things and either fix them myself or let someone else fix them (like the CEO in the case of stocks). Just like my antique table was very cheap (free), good stocks sometimes get cheap and deserve a second look. Even with the stock market at record highs, there are some stocks that are unloved right now. I recently ran a stock screen for stocks with a PE ratio below 10X and a PEG ratio of 1 or less. There were over 40 such stocks listed. There will always be a reason for a stock to be that cheap, the key is to decide whether the reason is temporary and fixable. One company that I am willing to take a chance on is Gilead Sciences. It is trading at 6 times earnings and has many sell recommendations on it, however, I am confident that they can develop new therapies for some of mans worst diseases. Gilead is guilty of selling drugs that actually cure hepatitis C, losing a customer every time. As usual, I placed a limit order for Gilead because tomorrow they report earnings. If earnings disappoint and the stock falls, I will get it even cheaper. If earnings are above expectations, my order will not be executed. I recently sold some big pharma stocks because their PE's were at nosebleed levels. I am more comfortable with a stock with a very low valuation for several reasons: if there is a market correction, value stocks will probably fall less than growth stocks, and any good news for Gilead could generate a nice pop for the stock. Exploiting the PE ratio would reveal the potential for Gilead. I am not recommending Gilead as an investment for most people because of the risk, I am just using it as an example of how I choose my investments. I need to be patient with this one because new drugs take a long time to develop and become accepted therapies but there is a 3% dividend in it for me while I wait.

Invest Like You Dress

     About a year ago my wife dragged me to Macy's to get outfitted for some new clothes. We were attended by a well groomed salesman who did a great job of selling me some new threads. I asked him what was currently in style and he gave me some timeless advice: "Buy clothes that are age appropriate for you".  Why should I care what the latest style is? I'll let the millennials worry about that. I just don't want to look like a rag-tag bum and be laughed at. As long as I am comfortable and look decent, I am happy. An investment portfolio should also be "Age Appropriate" and as individual as the owner. There is no "one size fits all" in investing. A person needs to be comfortable with their investments and not worry about them at night.  In general, as a person ages, the risk in their investments should be gradually eliminated so they won't be wiped-out by any market corrections. If you were to look at a graph of age vrs risk, where age is the horizontal axis and risk is the vertical axis, the slope would look like a toboggan run with the bottom of the hill in retirement age. Again, this is highly personalized. An example would be the funds that I manage for my mother who is 92 years old. I have lots of stocks, fixed investments like municipal bonds and CD's, and even some Master Limited Partnerships in her portfolio. Why should I take so much risk with my mothers savings? Two reasons: diversification and liquidity. I keep lots of cash on hand to pay her huge monthly costs at the nursing home and her holdings are diverse enough to insulate against any stock market shocks. I wish I could get a good return in federally insured bank accounts so Mom could get some safe income but that is not the case right now. That is why I have her invested in stocks that produce dividends and potential capital gains. The important thing is that I am comfortable with the investments for her situation. Just like wearing the latest fashions, chasing after the hottest stocks at this point in my life for me or my Mom would just not be age appropriate for either of us. We like steady businesses with a record of increasing dividends and below market valuations.

I Hate Rules

     Some rules are necessary in civilized society. You shouldn't steal, you shouldn't kill anyone (in most cases), and you should pay your taxes. However, when it comes to my nest egg, I believe that the fewer rules that I have to follow, the better. Most people have a qualified retirement account of some kind, like an IRA, 401k, 403b and so on, but in my last post I stressed the importance of saving for the future with after-tax money too. Those qualified retirement accounts are constrained by reams of rules about how much you can contribute, when and how much you can withdraw, what you can invest in, and on and on. In exchange for following all the rules, you get to allow your money to accumulate tax deferred until age 59.5, at which time the rules tell you how much you have to pay tax on. At age 70.5 the rules tell you how much you have to withdraw every year as a required minimum distribution (RMD) and pay taxes on.  I don't have a problem following these rules because if there is one thing I hate more than rules, its paying taxes. In my opinion, any time I can defer or eliminate paying taxes, its a good thing.Why am I bringing this up? Well I recently read an article in the local paper by a well known financial guru who thinks any after tax savings should be put in a Roth IRA. I beg to differ. First off, full disclosure: I own a Roth IRA. It's relatively small and accumulates tax free. It also will not be taxed when I decide to withdraw the money. A Roth is a good idea for someone who follows the rules. There is a 5 year rule, order rules for distributions, rollover rules, contribution rules, and even more rules. The older I get, the fewer rules I want to follow. Hell, I might even forget some rules. I could order publication 590a from the IRS to remind me about all the rules for the Roth IRA. It would make great reading before I fall asleep. I could even order publication 590b if I am still awake and need more reading material. Maybe it's just me but I just want to follow enough rules to keep my ass out of jail. That is why I like to have some investments that are not restricted by IRS rules. With my stock portfolio, I buy what I want, when I want, sell what I want when I want and settle with the government at the end of the year. I try to offset my gains with losses to mitigate my tax liability. The dividends are taxed at preferable rates (if qualified dividends).  What really scares me about the rules for the Roth IRA is that the brainiacs in Washington D.C. could change the rules at some point during my lifetime. Then I would have to order more IRS publications to help me fall asleep.

A Note to GenXers

     I just read a chart that identifies the generational differences between GenX, Millennials and Baby Boomers. It stated that the GenX generation is the first generation in US history to be less well-off than their parents. I have written about the reasons for this in past posts, but it doesn't have to be this way. I agree that the work environment is more difficult now that it was 25 years ago, but a little education about finance and proper preparation for the future can mitigate the changing climate. First, about saving for retirement, there are many retirement plans available to workers: 401k, IRA, SEP, HSA, and so on. A google search will reveal all of them. HSA's also can be used like a IRA, you just have to read the rules in an IRS publication like Pub 17. At age 65, (almost) I have a few things to share with the younger generation about retirement: Take advantage of the matching funds that your employer offers you, its free money. Don't fall for the regular (weekly) investments in your company's stock,( I lost my ass in this one). Have an investment or savings program outside of a Qualified Retirement plan. Money saved or invested outside of any retirement plan has already been taxed and does not produce a tax liability during retirement. Only the earnings on these funds are taxed, remember that dividends are taxed at a lower rate than other income. Any redemptions or distributions from a retirement plan are taxed as ordinary income. By owning after tax assets, you can avoid the 1099R that comes from any distributions from retirement accounts. Just like Millennials hate to pay taxes while working, they will really hate the tax burden in retirement. Most of the retirees that I worked with in the past still do not need the money in their 401k's at age 80 because they have other funds to live on. At age 70.5, retirees are required to start taking funds out of retirement accounts, this is callled a RMD (required minimum distribution) and is taxed at ordinary income rates. Many seniors resent this requirement because they don't need the money and don't want the tax burden. The funds in the retirement accounts are used as a safety net in old age. I don't know what will happen to social security or medicare in the future, but that is why saving in a retirement account can produce peace of mind. Bottom line, millennials will only be less well off than their parents if they don't prepare for the future. Not all Boomers are enjoying a comfortable retirement either, just the people who planned for the future can live out their lives on their savings.

Questions Answered

     I mentioned in a previous post that some investors would be better-off putting their money in a portfolio of laddered CDs. The question has been asked several times "what's a laddered CD?" This is a very simple and timely concept, one that I personally am employing. You simply buy CDs in staggered maturities so that every year or so you have one that matures. This works well in an increasing interest rate environment like what we are experiencing now. The premise is that every time a CD matures your renew it at a higher rate, especially if you lengthen the maturity. Lets say I've saved up $50,000 and I want it in a safe and federally insured investment. I go to my favorite bank or credit union and tell my banker that I want to build a ladder of CDs. Then I ask about any specials they may be offering at that time. I always take advantage of specials if they meet my investment objectives. My ladder might look like this: $15,000 in a 1 year CD,  $20,000 in the 18 month CD which is their special bonus rate, and $15,000 in the 3 year CD. The staggered maturities does several things for me: it gives me a higher yield than just buying one short term CD, it gives me flexibility if I might need the money for something, and it allows me to renew at higher rates in the future. A new product being offered by banks is the "bump up CD". This CD allows you to increase the rate you are receiving on your CD one time during the life of the instrument. The trick here is to take advantage of this feature somewhere around the middle of the term. If you wait too long there won't be much time to enjoy the higher rate. It's important to not forget about your right to raise your interest rate, so mark your calendar to call the bank. Financial Institutions offer CD specials from time to time to increase their assets and capitol. Funds with a stated maturity are preferred because they won't fly out the door during any crisis. Specials don't last long because savers are hungry for yield and flock to them. When the bank meets it's capital requirement, the special is over. Knowing your money is safe and sound and insulated from any stock market shocks makes for a good nights sleep. Good night.

Go With What You Know

     There are two things in life that are certain: Death and Taxes. As a volunteer tax preparer, I often get asked "how long do I have to keep doing this". The elderly client thinks that at a certain age, they can stop paying taxes.Wrong! I usually respond with another question "How long are you going to live". Just like Uncle Sam wants his due each year, the Grim Reaper is also waiting for each of us. What does this have to do with investing? Well, investors are always looking for a sure thing, here it is. Every day, 10,000 Baby Boomers turn age 65. This trend will continue for another 10 to 12 years according to the Pew Research Center. By year 2030, fully 18% of all Americans will be age 65 or older. Younger generations need to think about investments that will benefit from this demographic trend. The first thing that comes to mind is the health care sector. Demand for health care will be very strong for the foreseeable future. The current uncertainty around Trump's Repeal and Replace legislation may create a buying opportunity for hospital stocks. Pharmaceutical stocks should also outperform during this period.  Insurance companies are filling my mailbox each day with offers to sell me a Medicare Supplement policy (they wouldn't do this if it wasn't profitable). A larger and larger part of our economy is going to be dedicated toward the aging Boomer generation.  Finally, the death of Boomers will also be a growth industry. There are about a dozen public companies that handle final arrangements for families of Boomers. One growing trend is cremation instead of traditional embalming, which saves money. One thing I didn't mention is the massive transfer of wealth to widows and children of the decedents. This should benefit financial companies that offer wealth management products like annuities, mutual funds, ETFs and management of funds.
     I have been writing  this blog for several months now and have had a good response in the amount of traffic to it. However, I am sure that by now I have confused some of you. There is a feedback feature with this Google blog and I would love to read some comments or questions. I try not to offer specific investment recommendations but like to point my readers in what I think is the right direction. So let me hear from some of you.

"I Want to Hold Your Hand"

     This song by the Beatles, first sung live on the Ed Sullivan Show in 1964, had the teenie bopper girls screaming and fainting with derision. Today,  this same song is being sung by a different group, called Full Service Brokers. The same girls who swooned to the Fab Four are now in their 70's and need help with their life savings. Many are widowed and not of entirely sound mind. They think they have found "a guy" who will always act in their best interests financially. WRONG! Most brokers are in the business for their OWN best interests. Are they all bad? No! If I were a broker, I would want a six figure income too! I would be reluctant to tell an elderly female client, who knows virtually nothing about finance, to take her money elsewhere and buy a laddered CD portfolio. But that is exactly what most seniors should do. It's not sexy, it has no bragging rights, and the current yields are low, but it's the right investment for many seniors. As a volunteer tax preparer, I see many cases where a senior has a brokerage statement (1099 consolidated) where there are 30 plus pages of transactions. Usually, the individual trades don't amount to much money, but the annual amount of proceeds is a major percentage of the person's portfolio. More often than not, a capital loss is the result of this "churning" of assets. Each trade generates a commission for the broker in addition to fees charged for "managing" the account. The client is usually oblivious to the scam. Not every widow has a son who likes to manage assets. I see my job managing Mom's money as simply protecting her from the Wolves of Wall Street. At 92 years of age, blind and with severe dementia, she needs some protection from these guys. Do I detest these Full Service Brokers? No. I actually use one for a portion of Mom's assets and also some of my assets. The key is that I carefully evaluate their recommendations before making a purchase. Managing a portfolio is like owning a home, you should have the skills and tools to do a proper job. If you have no stomach for finance, you should not own a stock portfolio, buy a low cost mutual fund with a good track record instead. Bottom line, hand holding in the financial world is expensive and can result in yearly stock losses so if you don't know an ETF from an ATM, then do yourself a favor and take your money to your local bank.

More Investing Ideas

     Over the past 40 years or so, I have developed many strategies or "themes". Some have proved profitable, some were losers and many were forgotten. One that has produced proven results and will most likely continue to outperform is investing in Spin-offs. A spin-off is the creation of a whole new company by a large corporation. The new company was a division of the parent company that was determined to be better-off as a stand-alone company. The shares of the new company are usually distributed to the existing shareholders as of a certain date. The share price is determined based on the amount of assets and the valuation of other business in that sector. As soon as the independent new company starts to trade on a stock exchange, the market will determine what the share price will be.Why would a large company decide to spin off one of its divisions? One obvious answer is that an activist shareholder like Carl Icahn takes a large position in the parent company and demands that they unlock shareholder value by spinning-off divisions that are not related to the core business. Another example could be that the spun-off company just was not profitable enough. What often happens is that the newly independent company is freed from the constraints of the larger corporation which allows it to pursue more profitable businesses. One reason that this presents an investing opportunity is because the new shares often drop in price and offer an attractive valuation compared to other companies in the same sector. Just imagine the many large mutual funds that hold shares of the parent company because the parent fit the investment objective of these funds. Now they hold a smaller company that possibly is not in the same sector. Many funds will sell the new shares because this new company does not fit their stated investment objectives. The selling causes the new shares to fall in price temporarily creating a short term buying opportunity. One study done in 2012 compared spun-off companies over 1 billion dollars in size to the performance of the S&P 500 index over a seven year span. The spin-offs almost doubled the performance of the  index. Is this strategy a sure thing? Of course not, there are many spin-offs that won't outperform. Make sure that the new company wasn't saddled with a ton of debt by the parent just to clean-up its balance sheet. A google search of  "corporate spin-offs" will reveal many examples to review. There is also an ETF which just invests in spin-offs, if you want to take a safer more diversified approach.

When to Let Go

     One of the hardest things about investing is the decision of when to sell a particular position. It's important to not let emotions enter this decision. One thing I agree with Jim Cramer about is the notion that when a stock appreciates, the investor should sell a portion of his position gradually, until the whole position is gain. This is because your initial investment has been returned to you, resulting in you playing with "house money". The danger here is that if the stock continues up rapidly, you will have fewer shares to profit from. Maybe its just me but I think being conservative will win out in the long run. Another reason to sell is if the reasons that you bought the stock in the first place are no longer valid. Remember the "theme" investing strategy from a previous post? Well themes don't last forever. That is why I write a new forecast each year. Sometimes themes last for several years and sometimes they are very temporary. Last year I noticed that everywhere I went, I saw young mothers with babies. It seemed to me that the baby-boomer's children were starting families and even their grandchildren were starting families. The one thing that most parents will spend money on is their kids. I decided to invest in the struggling toy company Mattel. With an 8% dividend and increased demand for their products, I had a good year holding Mattel. However, they could not compete with industry leader Hasbro so I sold out and moved on. I will continue to watch Mattel in the future for another possible buying opportunity. Just yesterday, I placed about seven limit orders to sell some of my holdings.A limit order allows you to name the price you are willing to sell at. I always use limit orders for all buys and sells unless there is some special circumstance. Why am I selling some shares? Actually, I am concerned about several things: increasing interest rates, high valuations, political unrest, changes in trade relations with our trading partners, and so on. I still believe in stocks but it just seemed like a good time to lighten up on some positions, It is also a good idea to look at your portfolio for some losing positions to offset your gains. The tax code allows capital losses to offset capital gains entirely and even up to $3000 excess losses over gains. Any losses above $3k will have to be carried over to the following year. In conclusion, with today's low cost brokerage commissions, selling is not the costly move it once was. Just consider your tax consequences and the timing of dividend payments or distributions.

Executive Compensation

     This may be my most controversial post to date. I'm writing about it because of a telephone conversation with my daughter about the recent Snapchat IPO and who makes money from these Initial Public Offerings. The conversation soon morphed into the high pay of top executives and specifically the CEO. As a guy who punched a timeclock his whole working career, and who always held stocks for investments, I have a unique perspective on this subject. First, I am not envious of the folks who draw huge salaries. Some actually are worth the millions they receive each year. Need some examples? How about Steve Jobs. He returned to Apple Computer after a series of CEO's tried to return the company to profitability, only he knew how to resuscitate the company he founded. Even years after his death, his vision lives on for the future of the company which has one of the largest market caps of all stocks. Jobs returned to Apple in 1997 and worked for $1 a year but by 2010 his stock compensation amounted to $1.2 billion. I can also remember the outrage over Michael Eisner's salary at Disney, however, the wealth he created for shareholders during his tenure justified his pay. History is littered with high paid executives who proved their worth by navigating their company through difficult or challenging times. There are also many CEO's who have managed to destroy wealth at an amazing rate. Unfortunately, they were also highly compensated. The good news is that the Board of Directors would usually can the slacker after giving him a reasonable amount of time. It's important to remember the huge responsibility these top exec's have to employees, shareholders, customers, and affiliated businesses. One boneheaded move could destroy thousands of jobs and billions in stock value. My point here is that the person leading the company you invest in, is just as important as the business itself. Since you can't personally know all the CEO's in your portfolio, diversification is the key to keep one jerk from spoiling your retirement. One guy who does get to know all his CEO's is Ron Baron who founded Baron Asset Fund. The annual report of this fund reads like a "Who's Who"of the business world. Although Ron has turned over management to an employee, I know Ron still has personal relationships with his top exec's. Ron's philosophy is that he invests in people first and businesses second. It has served his fund well. I am not recommending this particular fund because it may not be suitable for all investors, mainly because of high management fees, but the investment style has been a valuable lesson.

Home Ownership, Inflation and Banker Relations

          Owning your own home can be a very rewarding experience, especially during inflationary times. Usually, home prices adjust to reflect inflation. Back in the 1970's home prices appreciated at the rate of 12% + per year. Some people bought and sold within one year and doubled their money. My belief is that housing should not be viewed as an investment. Everyone needs housing of some sort and owning a home satisfies that requirement. There are costs to owning a home that must be considered : Mortgage interest, taxes, maintenance, lawn mowing, water and sewer, capital improvements like a new roof, and so on. If you are the type of person who cannot do many of these things and does not have the extra income for the expenses, then maybe you should consider renting. President George W Bush decided that every American should own their own home. He established policies that made it easy to get a home loan with little or no money down. Bad idea! Within a few years, people were defaulting on mortgages by the millions. The abandoned homes became a blight in many neighborhoods, bringing down property values for neighbors. If you are a person who wants to own a home, can afford the taxes and repairs, go for it, try not to use your house as your ATM by borrowing any equity from it. It's ok to have equity in your house. You will find that your house offers a reasonable hedge against inflation. Speaking of inflation, I suspect that it will pick-up slightly in the coming years. Stocks also offer some inflation protection if the dividend is increasing and the business is strong. Gold has traditionally been a hedge against inflation also. I like to hold a small amount of gold just as speculation-about 5% of my assets or less. I have always believed that the best strategy against inflation is to control my spending. Inflation only hurts the buyer in a transaction. Finally, about Bankers, if you are considering buying a house, it is important to have a banker in your corner. Establishing a good relationship with your local banker can make the process of financing much easier. What I look for in a financial institution, whether its a Credit Union, S&L, or Bank is that they will service your mortgage. Some banks sell the mortgages and the servicing of it to other companies, which means that you may have to send payments to the new owners, wherever they may be. So stick with a reputable banker and make his bank your PFI (primary financial institution).

Building A Foundation

     Just like building a home, a portfolio must have a solid foundation. This means selecting a few solid stocks that pay a decent dividend and have a sustainable business model. Look for companies that have been in business for 50 years or more and have a record of increasing their dividend for most of that time. Be careful to not choose companies that are cyclical in nature. Choose companies that can sustain sales in good times and bad. Some would call these defensive stocks because consumers will continue to use their products no matter what the economy is doing. People will always take the medicine needed to keep chronic illness at bay, homemakers will always buy soap and cleaning supplies, millions of cars on the road will need gasoline, online merchants will need delivery services like UPS and FedX. Modern life demands these products. I don't see our society suddenly rejecting cell phones and the internet. These things have become what we consider necessities. The foundation of your portfolio should be in large-cap stocks that provide some of these products and services. Their size is a guarantee that they will survive competition from smaller companies. Many large technology companies simply buy out serious challengers. The dividend is important because after several years of holding one of these foundation stocks, your yield could top 10,20 or even 30%. How could that be? Remember, your yield is based on the price you paid for the stock, not the current price. If your stock has appreciated and the dividend has been steadily increased each year, the annual dividend divided by the price you paid for the stock is your yield. Eventually, you will enjoy hefty yields on solid companies that resist downturns. In a bear market, usually all stocks suffer, but defensive stocks should hold up better. This is also an opportunity to buy more of your favorite foundation stocks at fire sale prices. Once you have a solid foundation, then the more speculative issues can be added to round out the total portfolio. My next post will talk about home ownership,inflation and relationships with financial professionals.

Go With The Flow

     To every thing there is a season and a time to every purpose unto heaven. These words were written two thousand years ago but they are still relevant today. Just like farmers follow the seasons for planting and harvesting their crops, stocks follow predictable cycles also. Just like the tides in the ocean, money flows from one asset class to another based on the political, monetary, and fiscal climate. For example, right now we are entering a phase where the Federal Reserve is increasing interest rates. What does this mean to the investor? A lot of things! First understand that when rates go up, bond prices go down. Why is this? Imagine you own a bond that pays a coupon of 3% Suddenly new issue bonds of the same quality are paying 4% Who would want your bond that pays less? How do you get rid of it? The buyer of your bond will pay you less than par for your bond, creating a capital loss for you. The lower price that he paid you boosts his yield to the going rate of 4%. Increasing rates creates a toxic climate for bond investors. That is why the stock market is experiencing large inflows of cash. Even though Donald Trump is taking credit for the market's rise, there is more to the story than he is letting on. Stocks can only go so far on political rhetoric. The tidal wave of money flowing into stocks is a natural occurrence. Valuations are near record highs. Money is desperately looking for a home. One thing that works near the end of long bull markets is stocks of small companies. These small and mid cap names can go long periods without much investor interest but now they are red hot. How long can they outperform? The easy answer is until money stops chasing their performance. My experience is that these trends usually last longer than you would think. Once people invest their money into the small and mid cap mutual funds, they tend to hold for too long. This is not an asset class to buy and forget about. At the first sign of trouble, reduce your exposure. When interest rates near a top, safer investments like cd's start to attract the tidal flow of money. My next post will talk about why every portfolio should have some "core" holdings of  large cap stocks.

More on Strategies

     As I've stated before, my main strategy is "theme" investing. This is where I forecast trends then buy stocks of  companies which should benefit if my thesis is correct. But what if I am wrong about both the trend and my investments? It is always a good idea to hedge your bets with some other strategies. Think of your total portfolio as separate buckets of money where the buckets are different strategies. This will provide you with diversification among industries, company size and style, (growth vrs value). It's important for the strategy to fit the times. At this time, overall stock multiples as expressed by the P/E ratio are near record highs. My thought is that record low interest rates justified these lofty valuations. However, interest rates are on the rise and expected to go higher. This means that at some point lots of money will leave the market in favor of lower risk alternatives such as CD's (certificates of deposit), bank accounts, and money market accounts. I don't know what level of rates will cause this migration but I know it will happen. That's why I like a strategy that avoids the high valuation stocks. There is an old strategy called the "Dogs of the Dow" portfolio. This is where the highest dividend payers in the Dow Industrials index are bought at the first of the year and held until the first of the next year. Usually the high dividend is a result of the stock price declining over the past year or longer. If the dividend had not been cut or reduced, the yield soars. Companies are reluctant to reduce or cut the dividend because that may be the only reason the stock doesn't decline more. Typically, these dogs have low P/E ratios (valuation) because investor demand is low. I like high yields combined with low valuations. I am not recommending this strategy or any of its variants, which are many, to my readers.  I just think it is important to know about it and research it further to see if it is right for one of your "buckets" at this time. In my next post, I will talk further about fat dividend yields and my thoughts about saving for retirement.

Why I Do This

     Before I publish any more posts on how to profit in stocks, I thought it would be appropriate this Valentines  Day to explain why I bother with this blog. First of all I do it for my daughter because she asked me to. Secondly I do it because I enjoy it. It takes less than 1 hour to make a post. If my daughter can learn some of these concepts that I have learned over the last 40 years, then it was a success. I have made this info public so anyone with a desire to learn more about investing can read my short and to-the-point lessons at will. I am not an expert at investing. I have never worked in the industry and now I am too old anyway. It has always amazed me that money management is not taught in junior high and high schools. I have recently heard of some progressive private schools offering this subject but they are the exception. When a young person leaves school and goes to work making money, they are not prepared to invest any savings. Our school systems are doing a great disservice to our young. It is especially important today because the traditional pensions my generation earned are becoming more and more rare. Instead, self funded retirement plans are the norm today. Not only is the employee forced to fund his own retirement, he must invest the funds so they will be there for him at his retirement. In addition, the social security benefits that I enjoy today may not be there for future generations. The contributions made today to social security by the working folks are being used to fund my benefits. Bottom line: The deck is stacked against every generation born after the Baby Boomers. What to do about it? Get wise about investing! Use this blog as a start but not an end. Read about financial matters anywhere you can, your future may depend on it.

The Short Sale

     There is a way to profit from a stock if you know that it is going to fall in price by using a technique called a short sale. The premise is simple, borrow shares and sell them. If you are right and the stock falls, you simply buy back the shares and replace them to the rightful owner. The difference between the sale price and the purchase price is profit. BUT what if you are wrong and the stock goes up instead of down? Your losses are only limited by how high the stock can go. How high can it go? Unlimited! While you suffer from losses while the stock rises, you have to pay the lender any dividends that come due and the brokerage firm where you borrowed the shares gives you what is called a margin call. That means that you have to put-up more assets as collateral in case the sold shares keep appreciating. Can you see why I don't sell short? Its best to let the pros play this game. Instead I will keep with my "buy long" strategy, where I buy shares and hope and pray they go up. My next post will be about some strategies I know about and what I think about them.

Forecasting and Stock Strategies

     Forecasting market movements is a fools game. Nobody knows what the stock market will do in the next 12 months. This doesn't keep every so-called expert from trying though. Instead of predicting what the market averages will do, I just want to try to predict what stocks are likely to do well if the market does continue its steady assent. If the market does poorly, then I just wait until it reverses while cherry-picking bargains amid the rubble. It always pays to have a buy list in case stocks do go on sale. How do I assemble my list? First I read financial publications like Barrons and The Wall Street Journal for ideas. I don't believe everything I read but I appreciate the information. Look at the political environment, the direction of interest rates and changing trends in technology and consumer behavior. Think through the implications of these changes. What industries are likely to benefit from these changes. This is VERY important: write down your thoughts and keep a record of them, you may be exactly correct but forget everything. Next, after determining what industries (sectors) will benefit under your assumptions, search for the best and most undervalued companies in that sector. Watch them for a period of time before buying them. If they are still falling and you buy too early, you have caught a "falling knife" and will suffer. Basic forecasting is not rocket science, for example, interest rates have recently bottomed at the lowest levels in decades. They are bound to go up as long as the economy is improving. Is this a sure thing? No, but it is as close as it gets to one. What benefits from higher rates? Banks and companies that invest large amounts of cash obviously. What drives rates up? Inflation and a hot economy. What benefits from inflation? Gold and fixed assets like real estate. You get the picture, its common sense. I call my assumptions for the future Themes. One of my current Themes is my expectation of increased defense spending. There are about a dozen of large defense contractors who will benefit under this scenario. A google search will reveal them. My concern is to not pay too much for them. You might have guessed that I am very cost conscious when buying. I can be called a Value investor as opposed to a Growth investor. A Growth investor will pay a higher multiple for a stock because his basic premise is that a stock in motion is likely to stay in motion. The Value investor likes "fallen angels" or stocks that have stumbled but are fixable over time. Also by paying attention to valuation (P/E ratios), and buying low P/E stocks, a level of protection is built-in if the market tanks. Think "less distance to fall". There are an unlimited number of strategies to pursue stocks. You are only limited by your imagination. Next I will discuss a strategy that I have never tried and never want to because it is too risky. Just because you don't use it doesn't mean you shouldn't know about it. It is called Selling Short.

Closed-End Funds

   The Closed-End Fund (CEF) is an ancestor to ETF's. There are important differences between the CEF and ETF and open ended funds. When the CEF is created, the fund company raises a specific amount of money from new investors in an IPO (initial public offering). Then the money is invested in the assets specified in the fund's objective sector: stocks, bonds, MPL's or whatever. No new money is allowed in. The fund does not issue new shares to new investors. They also do not buy back shares of existing investors. If you hold shares in a CEF, then to sell, you must sell them on the secondary market just like a stock. The shares are priced throughout the day, allowing for a liquid market. Now here is the interesting part, the shares may trade at a price that is different from NEV. Remember that NEV (net asset value) is the sum of the value of the assets in the fund divided by the shares outstanding. Usually, a CEF trades at a discount to its NAV. This means that you can own the asset for less than they are worth. It also means that if you bought the IPO you have a loss. DON'T BUY IPO'S. If you buy a CEF at a discount, say 10% to NAV, you probably feel pretty smart. It may not last. Some CEF have traded at a discount for their whole lives. The trick here is to identify an asset class that is currently out of favor but you suspect that it will be in demand in the future. Even buying a CEF at a deep discount and selling at less of a discount will result in a profit. Premiums for CEF's are rare. Usually CEF's are purchased for the income they generate. Some asset classes I like for the CEF structure is Preferred Stocks and Convertible Stocks. These are hybrid shares that are not easily understood by many investors. Letting a professional manage them makes sense. Closed End funds can be selected from lists in Barrons weekly publication or The Wall Street Journal. The premium or discount from NAV is listed as well as the last years performance. Some funds in the asset classes I mentioned had returns of 30% or more last year and still traded at a discount. I would not chase an investment unless the outlook is still superior. My next post is about how I forcast the next market winners.

Exchange Traded Funds (ETF)

Before I get into ETF's, and how they differ from traditional Mutual Funds, I need to explain how mutual funds work. First of all, there are two basic types of mutual funds: open ended and closed ended. Normally, when mutual funds are discussed, we are talking about open-ended funds. These are funds that hold stocks, bonds, or whatever and the investments in the fund can change based on the decisions of the manager. He may find new investments that he adds to the fund at any time. "Open-ended" refers to the flexibility of the investment portfolio to change. On the other hand, a Closed-Ended fund starts life with a basket of stocks and keeps them for the life of the fund. I will discuss the Closed-End fund in my next post. Both of these types of funds are priced at Net Asset Value (NAV). Net Asset Value is calculated by multiplying the number of shares times the closing price of those shares and added up, then divided by the number of mutual fund shares outstanding. That's a lot of math. Imagine the fund has 600 stocks, there is no way that NAV could be calculated and published throughout the trading day. This is why the NAV is only calculated at the end of  the trading day. So how does that affect you? Well, if you owned an open-end fund and had a nice gain in it and one morning you turned on the T.V. and saw that the stock market was falling dramatically, you would want to sell your fund to preserve your profits, right? Too bad, you can't. You have to wait until the market closes before your order to sell gets executed. However, if you owned an ETF, it can be sold during the trading day. It trades like one single stock. The mechanics of an ETF are complex but the end result is that it gives you trading flexibility, low fees, tax advantages and transparency. There are now over 1500 ETF's  currently traded and they cover almost every asset class,ie, stocks, bonds, commodities realestate, etc. I use ETF's to make sector bets based on my forecasts. For example, if I think that defense stocks will outperform the market, I will buy an ETF  that holds defense related stocks. This one trade provides me with diversification in the sector with low fees.In my next post I am going to talk about Closed-End mutual funds which are the unloved cousins of ETF's.

MUTUAL FUNDS

As I mentioned in previous posts, I sometimes use mutual funds rather than investing directly in stocks. Some sectors of the market are more difficult to analyze due to unique accounting or business traits. Sectors like banking, real estate investment trusts (REITS), master limited partnerships (MLP), are good canidates for using a mutual fund for investing. There are some things to know before handing over your money to a mutual fund company. The first thing I look at in a mutual fund is the fees they charge to manage your money. Naturally, you will have to pay for the expertise they bring to the table, your job is to not overpay. Some mutual fund families specialize in low fees which is good for the investor, however, be aware that customer service may be lacking. The second thing I look at in a mutual fund is what is in the portfolio. I "kick the tires" by checking some of the stocks in the top ten holdings. Basically, if I wouldn't buy these stocks (due to high valuations) or any other reason, I look elsewhere. I also look at past performance even though this is not predictive of future returns. The fact is that 80% of mutual fund managers cannot beat the performance of an unmanaged index which is their benchmark for performance. If a fund has had superior returns than the index and other competing funds, look to see if the same manager is still there. Long tenured fund managers with index beating performance are rare. Don't buy a fund based on the performance of a hot manager who is no longer in charge. Finally,pay attention to when distributions are made to fund shareholders. If a fund usually makes a distribution in December, I would not buy into it before the distribution date. The reason is that some of your investment is just handed back to you, creating a tax liability and reinvestment task. This is only true in taxable accounts, retirement accounts don't have this problem.
     This is just a brief overview of mutual funds. Investing through mutuals can be an easy way to gain exposure to stocks but can also be a way to get mediocre returns with high fees. The pitfalls are many so learn the basics. A very popular way to invest in mutual funds for the last 20 years has been to buy a low fee index fund from a company like Vanguard or Fidelity. These are unmanaged funds that will track the general market like the S&P 500 index. Some experts predict that managed funds will outperform in the coming years. Only time will tell. A competing product to mutual funds has emerged in recent years. It is called an Exchange Traded Fund (ETF). Billions of dollars have left traditional mutual funds and flowed into ETFs. I will explain the differences in my next post.

Ratio Analysis

I have talked about the P/E ratio and how to manipulate it to predict future stock prices based on changes in earnings or multiples. What if a company does not have any earnings? Sometimes young companies are so busy selling and developing products that they are not yet profitable. Usually these are smaller companies with limited resources to accomplish profitability yet. This can be a rich area to mine for investment. So how do we analyze such companies? Another tool in the Ratio Analysis tool box is the Price/Sales ratio. This ratio is best used as a comparison with other companies in the same business. If nothing else, it can give the investor an idea if the stock price is too high compared to other businesses. What this ratio is telling you is how many dollars you are willing to pay for $1 of sales in this company. The hope here is that if sales growth is high, then earnings are soon to follow.
     Another ratio that may be used is the Price/Cash flow. Cash flow may also be expressed as EBIDTA which stands for earnings before interest, depreciation, taxes and amortization. Sometimes, companies have a lot of depreciation which clouds the earnings picture. This accounting measure cuts through the crap to determine whether this company can actually pay its bills.
     As a conservative investor, I like to stick with established companies with a long record of earnings and increasing dividends. However,  I also recognize that the really spectacular growth comes from young companies on the cutting edge. This is why I bring up these two ratios. I would only consider a small portion of my portfolio in these small-cap names. That being said I would point out that late in a bull market, small caps tend to outperform the large cap stocks. The current bull market in stocks is over 7 years old, nearly a record. I usually invest in small caps through mutual funds because the names in this space are unfamiliar to me and I don't have time to sift through the hundreds of stocks to identify potential winners. Sometimes its best to leave the heavy lifting to the pros. My next post will be about investing in mutual funds. Its not as simple as"investing and forget it". I will talk about pitfalls that should be avoided.