Dion Money Management Blog   Money Management for Retirees and Their Families

Just one week after setting new annual lows, the major stock indexes are significantly higher this week after a four-day, record-setting rally. Once stocks declined far enough to coincide with other bear-market levels, investors rushed in to bid prices much higher. The Dow Jones Industrial Average, for example, rose 1,174 points, or 15.6 percent, over the course of four days. Not only have we not seen a four-day spurt since April 18, but this rally was the largest point rise ever for the Dow and its biggest percentage point gain since August 1932, which is approximately when the historic bear market turned a corner.

One measure that is set to surpass the extremes of that historic crash is volatility, which peaked at 68 percent during the crisis. S&P volatility for the past three months has already reached 66 percent and could easily outpace the worst financial turmoil in the past century. The presence today of hedge funds and the growing use of exchange traded funds to time the market has undoubtedly elevated volatility during this downturn. But savvy investors will look past this and realize that such fear spells opportunity, because no matter where the bottom rests, there is value for the taking in this market. In fact, the Chicago Board Options Exchange volatility index, or VIX, is widely used to measure fear among investors, and the VIX has begun to decline.
Stocks gained widespread support from additional government bailouts this week. Citigroup is the latest bank to receive a major injection from the government, which announced it would infuse $20 billion of new capital into the company and absorb as much as $249 billion in potential losses in poorly performing securities tied to real estate mortgages.

Also this week, US officials agreed to pump an additional $800 billion into ailing credit markets. Unlike previous plans—which all told are now approaching $4 trillion in financial commitments—a good portion of these funds will come from the Federal Reserve rather than the Treasury. The Fed will purchase $600 billion of debt from government agencies (e.g. Fannie Mae, Freddie Mac, etc.) and in conjunction with the Treasury will provide $200 billion to investors buying securities that are tied to consumer debt, such as car, student, and entrepreneurial loans. All of this activity has taken the Fed far beyond its traditional role of setting interest rate policy and transformed it into an enormous lender.

All of these bailouts are expected to weaken the dollar once the dust settles, and that argument must have gained attention last week. Gold, a store of value during difficult times, jumped to $820 per ounce after a five-day run that ended Wednesday. Although there has been no lack of panicked stock-selling among the broader market in recent months, gold bullion and gold stocks had so far failed to live up to their safe-haven status during much of this period. Gold bullion had maintained enough of its value to outperform other commodities, however, but it had succumbed to selling with each upward move in the US dollar index. One portfolio holding with significant exposure to gold stocks is Federated Market Opportunity (FMAAX).

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You’ve worked hard to build your nest egg, and you want to make sure it lasts as long as you do. What’s more, you understand that making your money last means keeping it growing well into your retirement.

Occasionally, you’ll run into what seem to be opportunities for outstanding investments—chances to make a lot of money quickly, to cash in on “guaranteed” returns, or to “get in on the ground floor of the next big thing.” These offers are becoming more and more common as the richest generation of Americans reaches retirement.

Such “opportunities” may be tempting, but they frequently are not all they seem to be. The saying “If it sounds too good to be true, it probably is” may be a cliché, but it’s one that bears remembering.

Here’s a look at common investment scams and the keys to recognizing and avoiding them:

•    Pyramid scheme. Also known as franchise-fraud or chain-referral schemes, these scams promise tremendous returns as long as participants recruit other new investors. They often cast themselves as franchise or distribution operations and frequently tout the benefit of allowing one to work from home.

The key to identifying such a scam is to ask where the real money comes from. If the main revenue generator comes from signing up other distributors rather than from actually selling a product or service, it’s a pyramid scheme. Many so-called multilevel marketing operations are actually pyramid schemes in disguise, so eye them with suspicion.

Over the long haul, pyramid schemes are mathematically doomed to failure. Worse, the scheme will contain the overwhelming majority of participants at the very moment it collapses. For that reason participating knowingly in a pyramid scheme isn’t just bad business—it’s morally and ethically wrong.

•    Ponzi scheme. Technically a type of pyramid scheme, a Ponzi scheme promises outsized returns to a small group of investors, then recruits a second set and uses some of their money to pay profits to the first group (often without informing the original investors about the source of their “return”). The original investors, delighted with their success, tout it to another group, and so on. Eventually, this scheme breaks down and the scammer usually disappears.

•    Pump and dump. In this scam, a small group buys up a stock, usually of a small company. The group then pushes it to a larger group of people, typically by misrepresenting the actual condition of the firm or its prospects. If the scammers “pump” the stock hard enough, the stock price might rise quickly, allowing the lawbreakers to sell their shares at the peak. That selling pushes down the shares, which typically go into free fall when other investors discover their mistake.

•    Affinity scams. This name describes the scams’ methods more than their structure. They prey on members of a group and are often perpetrated by people who are, or pretend to be, part of the group. Often, the scammers will target a religious or ethnic group, earn the trust of its leaders, and then carry out a pyramid scheme or other con. The moral: Don’t trust someone’s investment advice just because you have things in common.

•    Investment mismanagement. Unscrupulous brokers and agents cut corners, charge excessive fees without explanation, or make unauthorized trades. Some of these ne’er-do-wells are recruited by scammers with the promise of big returns. Before investing with anyone new, make sure he or she is properly accredited and fully discloses fees and trading policies.

•    Variable annuity scam. The right variable annuities can be appropriate for certain investors. But crooked agents increasingly sell seniors hugely expensive annuities with a plethora of hidden fees, often pitching them at “free” investment seminars. Bear in mind that variable annuities are generally a bad idea for investors who may want to draw on the money within the next decade or so. Only purchase variable annuities issued by reputable, well-known providers, and research them carefully. (The Fidelity Independent Adviser’s VIP Portfolios provide guidance for investors with Fidelity annuities.)

•    E-mail and Internet fraud. Phony investment firms for years have enticed victims through telemarketing or official-looking mail campaigns. But they’re using the Web more and more, often seeking investors through bulletin boards, newsletters, or spam.
Some pitches are so outlandish that they’re easy to dismiss with a chuckle and label as “junk” (we’ve all received pleading e-mails from Nigerian princes who need our help reclaiming their fortunes). Many e-schemes are more sophisticated, however. They may seek personal information (a strategy known as “phishing”), which they’ll use to steal your identity and ring up enormous debts. Alternatively, they might offer to send you a large check as long as you promise to wire back only a portion of it (you find out the check is bogus only after you’ve wired the money).

Those are just a few of the most common schemes to be aware of. Generally speaking, they can be avoided by following a fairly simple set of rules:

1. Don’t trust anyone you don’t know, especially if the person is making unsolicited offers. Be especially skeptical of offers from foreign countries, which can be harder for law enforcement to trace.

2. Don’t provide such personal information as Social Security numbers or account numbers.

3. Never wire money to or cash checks from people you don’t know.

4. Beware of high-pressure sales pitches and demands for immediate decisions, as well as aggressive or bullying responses if you raise doubts.

5. Watch out for key phrases like “guaranteed profits;” “no risk”; “Don’t tell anyone else about this; or “Act now, because only a few lucky investors can get in before the deadline.”

6. Expensive “training” sessions or materials should raise a red flag.

7. When presented with an opportunity, make sure you understand the offer and know the company behind it. Request written information about any investment you’re considering, and take the time to read it.

8. Find out what state or federal agency regulates the firm, and check with those agencies to see if the offering party is properly licensed and legitimate.

In the end, it comes to the “too good to be true” rule. The relationship between investment risk and reward is one of the few sure things in life: The potential for high returns almost invariably comes with a high level of risk. Fortunately, a well-diversified portfolio of securities built for your individual circumstances can help you navigate some investment risk while generating the growth you need to make your money last throughout retirement. More important, it’s risk you can measure historically and manage with a higher likelihood of success.

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As the stock market searched for a bottom this week, the major indexes have diverged somewhat. The Dow Jones Industrial Average threatened for much of the week to surpass the closing lows set in 2008, and it finally relinquished this floor on Thursday. Yet this particular index remains above its previous bear-market low established in October 2002. The Standard & Poor’s 500, on the other hand, has managed to maintain its 2008 floor despite heavy selling in the financial sector.

The backdrop for recent weakness is the reality of government initiatives recently revealed or unveiled in Washington. Investors have not been too impressed. Confidence in the Federal Reserve, President, and Congress is low and sinking. Treasury Secretary Geithner’s non-plan spurred fear, not stability. President Obama’s first major legislative effort was received with cautious optimism, because the reality is that any true spending is delayed until later in 2009 and that two-thirds of the stimulus will be focused on the years 2010 to 2012. Nevertheless, the proposal has brought additional stability for investors and, combined with other global initiatives, these measures will raise the global GDP by 2 percent. The beneficiaries include healthcare, defense, clean energy, and, above all, transportation.

Wholesale inflation numbers made headlines this week with a 0.8 percent rise, but it was mainly due to an increase in gasoline prices. Several factors have combined to raise gas prices again, but this is not expected to be permanent. A combination of environmental regulation and not-in-my-backyard attitudes from the public means refiners have a difficult time building new plants. Under normal conditions, the refiners can supply the market for gasoline. When there are fires, maintenance or other disruptions, shortages can develop. Additionally, these wholesale numbers often spike in January, as they have done each year since 2003.

Although inflation may be a few months off, it is likely to return sooner rather than later. The natural temptation during a correction or a bear market is to seek a safe place to park your money, such as moving assets to cash. This might shelter you from a fluctuating stock market, but it does not eliminate risk. The new risk you assume by moving to cash is outliving your money. If you are saving for retirement or other long-term goals, cash traditionally has failed to keep pace with rising prices, causing you to compromise your lifestyle over time. Instead, stocks have proven historically to be excellent hedges against inflation, and I have little reason to believe that this will change in the future.

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There sure was a lot of talk about ‘change’ during the 2008 election. Well, some of that change may be coming along soon. Here’s what it might mean for you.

President Obama and the new Congress have a litany of pressing issues to address. Trying to spur the nation out of its economic doldrums is front and center on that list, which also includes health care reform and managing conflicts in the Middle East. Some potential financial policies may affect you directly, such as a shift in the capital gains rate or new rules governing withdrawals from retirement savings accounts. Other changes, such as a large fiscal stimulus package, probably will have less-direct but meaningful effects. Below is an overview of some of the most important policies likely to come out of the new Administration, and the impact they may have on you.

Fiscal stimulus: With the economy deep in recession, passage of a sweeping economic stimulus package rated high on the list of priorities for the new President and Congress, and the size and scope of the package grew in recent months.

The response to the fiscal package, however, has been guarded, which reflects the reality that spending will not begin until later in 2009 and that two-thirds of the stimulus will be focused on the years 2010 to 2012. Nevertheless, the proposal has brought additional stability for investors and, combined with other global initiatives, these measures will raise the global GDP by 2 percent. The beneficiaries include healthcare, defense, clean energy, and, above all, transportation.

Taxes: On the campaign trail, candidate Obama pledged to reduce taxes for many low- and middle-income Americans. He said he would offset those tax cuts by raising taxes on higher-income taxpayers.

Taxpayers in the highest brackets are likely to see their rates increase—eventually. President Obama’s plan would boost the tax rate from 33% to 36% for individuals earning between $164,550 and $357,700 (and joint filers earning $200,300 to $357,700). Individual and joint filers earning more than $357,700 a year would see their top rate rise from 35% to 39.6%. That said, there is some question about when those increases would go into effect. Many analysts expect the new Administration to delay tax increases for the highest brackets until 2010, when the current rates are set to expire. You may want to review your tax strategies with your financial advisor when rates do increase.

Capital gains: The tax rate on long-term investments also is likely to get an overhaul. Long-term capital gains and qualifying dividends currently are taxed at 15% for most investors, but the legislation that established that rate expires in 2010. Many observers expect President Obama and Congress to increase the capital gains rate for some investors, particularly those in higher tax brackets. For individuals earning more than $200,000 a year and families earning more than $250,000 annually, the capital gains rate would jump from 15% to 20%.

Retirement savings: The new Administration is likely to propose changes to retirement savings plans such as 401(k)s and IRAs to help investors cope with the market’s decline and the economic recession. For example, President Obama has proposed temporarily suspending required minimum distributions from retirement accounts. If his proposal becomes law, you’ll be able to leave your savings in place after age 70 ½ to continue earning tax-protected investment returns (provided you don’t need the money from your RMDs).

Another proposal would temporarily allow investors to withdraw 15% of their savings, up to $10,000, from qualified retirement accounts penalty-free, for any reason. (Regular income taxes would still apply.) Penalty-free withdrawals today are generally available only in cases of severe financial hardship. Bear in mind that making early withdrawals from retirement plans can be costly even in the absence of penalties, because you’ll lose tax-protected compounding on any money you take out.

The new President and Congress’ to-do list is long and complex. Before making any changes to your finances based on likely policy changes, consult your investment advisor. He or she can help you determine the best course of action, based on shifting policies and your personal situation.

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After stumbling on Tuesday’s disappointing announcement from Treasury Secretary Timothy Geithner, markets rebounded. A small gain on Wednesday was followed by a sell-off on Thursday morning, but markets rallied back into positive territory. The gains weren’t enough to reverse all of Tuesday’s losses, however, so in the past week, the market has dropped 1.3 percent.

Lifting the markets was news that the Obama administration was working on a plan to reverse foreclosures. From a low of 808 points, the S&P 500 Index rallied to close at 835, a gain of 3.3 percent. Today, Citigroup and J.P. Morgan said they will temporarily halt foreclosures until the Treasury Department releases its plan, which may take several weeks.

Positive retail data didn’t affect shares yesterday. January sales increased 1 percent, which was a pleasant surprise, even though it was met with skepticism. Today, U.S. consumer confidence numbers for February revealed a public that believes the recession will last at least a year, and “nearly two-thirds anticipated that the downturn would last five more years.” Retail data showed that many of the areas increasing in sales are needs rather than wants, which suggests that consumers are acting on their beliefs. Whether sales fully reflect that belief is a separate question, but it’s hard to see how consumers can become more negative in their thinking—a positive sign in an otherwise bleak report.

This leads me to my main points for today: the market turns when you least expect it to turn, meaning recoveries can come as quickly as sell-offs do. According to research provided by Ibbotson and AllianceBernstein, most stock returns during the 1970 to 2008 period came from just 48 out of 468 months, or 10 percent of the time. Capturing the best 48 months meant a 9.6 percent annualized return, while missing them resulted in no gain at all and inflation eating away the value of your principal.

What previous bear markets have taught us is that patience is a virtue. Holding onto your investments has traditionally been a better long-term strategy than selling into weakness. We only need to remember March 2003 or October 1974 to know that five years later, each of these bear-market bottoms returned 72.6 percent and 118.0 percent, respectively.

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While mutual funds have long dominated the retirement savings landscape, in recent years many investors have turned to ETFs (exchange-traded funds) in an effort to add diversity and transparency to their portfolios. As the ETF industry grows, a new breed of mutual funds has emerged that incorporates the benefits of ETFs with the fundamental oversight that has made mutual funds an enduring investment approach.

Fidelity Independent Adviser met with Paul Frank, portfolio manager of the ETF Market Opportunity Fund (ETFOX), formerly the Navigator Fund (NAVFX), to get an inside look at one of the top-rated ETF-comprised mutual funds available today. In the rapidly growing ETF industry, ETFOX will achieve the five-year mark in spring 2009, and it recently garnered a five-star rating from Morningstar and the distinction of Lipper Leader for Total Return and Preservation of assets from Lipper Fund Services.

Frank, who steers the fund from a red barn in rural New York, designed ETFOX with the objective of capital appreciation for investors. Born in Quebec, Canada, Frank earned his B.A. in 1984 from Drew University and his M.B.A. in 1992 from Fordham University’s Graduate School of Business Administration, where he was valedictorian and earned the Dean’s Award for academic excellence. After graduation, Frank joined Signalert, a registered investment advisor, as an analyst and trader. In 1993, Frank founded Aviemore Asset Management, LLC, and he has been managing assets since that time.

Q: Why use ETFs in a mutual fund?
A: Combining the transparency of ETFs with a mutual fund helps investors tackle both security-specific and systematic risks, the two types of risk that ETFOX addresses. I am a student of Markowitz and the modern portfolio theory, which has helped me combat market risk. By using ETFs, I am also taking security-specific risk out of the equation. Investors will not be wiped out if a component of one of the ETFs suffers a loss.

Q: How do you choose which ETFs comprise the portfolio?
A: I employ a two-step process in selecting ETFs for the fund. The first step relies on mathematics and the Sharpe ratio to break down return per unit of risk. From there, I use two different time frames to show which ETFs are returning more than their longer-term average. This methodology allows you to measure the relative momentum of different ETFs against one another. The second step, a fundamental filter, takes the fund beyond the numbers—a process that adds value and rationale to the decisions. I am a disciplined investor, and a close fundamental examination of the mathematical results allows me to stay invested and not go off on expensive tangents. Investors will get what they see in the prospectus—I’m not going to invest all their money in a passing trend.

Q: What kind of minimum standards do you apply for liquidity and market capitalization of the underlying funds? Are there any rules of thumb?
A: My goal is to get my orders filled without moving the market. I want to be able to unload any position in one day, so I won’t allow that position to be more than 10% of an ETF’s average daily trading volume. This has caused me to skip over some ETFs that have risen to the top of my rankings. Some of the smaller biotech ETFs were higher than IBB but had no volume or liquidity.

Q: Why do you think investors will be attracted to your fund at such a difficult time for the economy?
A: We are presently in a period of great turmoil in the asset management industry. Poor performance figures are being posted by previously stellar managers such as Bill Miller (Legg Mason). The rush into hedge fund investment vehicles has turned into a rush for the exits. Many investors are no longer willing to lock up their money for extended periods or to pay large management fees for average performance. I believe there will be a large amount of investor money looking for plain-vanilla investment vehicles that have managed the turmoil well. ETFOX has proven to be this type of fund, delivering positive alpha (above-average market returns) while taking below-average market risk. Personal service and market-beating returns are paramount concerns among investors today.

Q: The management fee for the fund is currently 1.75%. Is that typical for a fund of this type? What do investors get in return?
A: In any type of market conditions, it is important for investors to look at total return; focusing on just management fees can be a huge mistake in a difficult market. ETFOX is not an index fund like PowerShares QQQ; the fund’s beta, or market correlation, is 0.75, and I’m beating the S&P by more than 3% a year after fees.

Q: What kinds of “themes” has the fund taken historically? Has it leaned toward a particular sector over the past year? Which ETFs have risen to the top?
A: The fund’s main theme is large-growth U.S. equity ETFs. However, between 20% and 25% of the fund is placed in “opportunity” areas. Early in 2008, these areas were Brazil (EWZ) and gold (GLD). In the second half of 2008, I used two U.S. Treasury funds—TLT and SHY—to achieve both short- and long-term approaches. There was no place to hide in late 2008, and since ETFOX stays invested, we experienced losses along with the rest of the market. I’ve shied away from financials since summer 2007, which has meant a move away from the financial-heavy S&P 500 to overweight areas such as health care (IYH). As we moved into 2009, I reallocated assets into biotechnology (IBB), high-yield corporate bonds (JNK), investment-grade corporate bonds (LQD) and inverse treasury bonds (TBT). This year has also seen me shift back from value toward growth, using VUG and QQQQ in the core holdings.

Q: What kind of investor would benefit most from your fund?
A: Historically, the fund has returned above-market returns while taking only 75% of the market’s risk. An investor who is seeking capital appreciation from U.S. equities and has a time horizon of longer than one year should consider investing in the fund. The disciplined, quantitative approach I use is designed to keep volatility to a minimum and tries to ensure that an investor is well-compensated for any risk ETFOX takes.

Q: What are your predictions for the economy over both the short and the long term? How do your personal opinions affect your investment style?
A: The markets are the best discounter of all information—economic, political, social, etc. My model reads the markets through their price movements and volatility; however, I also use a fundamental filter in order to avoid walking off a cliff. Short term: I hope that the bottoming-out process has begun, or we could retest market lows this spring or summer.  Long term: I really like some sectors and see them as long-term growth plays. Some of these sectors/ETFs are starting to move up in my rankings, and I’ve established small positions in defense and aerospace (ITA) and U.S. telecommunications (IYZ).

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The “stock market” appears to want a rally. Of course, the market is just an aggregation of the millions of investors and traders who make buy and sell decisions every day. These market participants have, on average, become extremely short-term focused, but while this resulted in a panic drop last fall, it is now producing a surprisingly resilient market. Exports plunging 30 percent in Asian countries was cause for a sell-off, but the S&P 500 Index spent the better part of January bouncing between 825 and 850.

Jobs data out this morning was grounds for another sell-off, but again shares marched higher. The jobless rate in America rose to 7.6 percent as nearly 600,000 jobs were eliminated in January, consistent with the previous two months. As the Bureau of Labor Statistics pointed out, 3.6 million jobs have been lost since December 2007, but nearly half came in the previous three months. The U.S. is on pace for a loss of 7 million jobs in 2009, enough to lift the unemployment rate to around 12 percent.

The implications for the retail, consumer goods, consumer service, and housing sectors are going unexplored today, however, as investors look forward to a stimulus package and to the bank bailout details due Monday from the Obama administration. Shares of financials spiked higher today, with Bank of America up more than 22 percent in morning trading and Citigroup up 10 percent.

On January 28, the S&P 500 Index closed at 874 before sliding back into its trading range; it’s back over 860 today. Technicians will be looking for a higher high either today or sometime next week, and if we get it, perhaps a more significant rally will take place.

Last week I discussed a new position, ETF Market Opportunity fund (ETFOX) that I was adding to most client accounts. It continues to perform well, and as we rebalance your accounts moving forward, I expect this fund will become a larger holding among other growth positions. You can find a more detailed discussion of this fund and an interview with its manager, Paul Frank, in this month’s newsletter that will arrive in the next few days.

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By Bill Schmick, Portfolio Strategist, Dion Money Management

The above saying is one of the many myths of the markets. It’s called the “January Effect.” Given this month closed with hefty losses, it is just one more discouraging sign that the prospects for 2009 are less than encouraging.

Yet, the president’s stimulus package is right around the corner, and with luck it will pass by President’s Day. That should give the economy a boost although don’t look for anything immediately. It will take time for all that new spending to show up in the economic numbers.

In the meantime be prepared for even worse numbers in the months ahead. The preliminary estimate for fourth quarter GDP (Gross Domestic Product) was announced today—down 3.8%—the largest drop since 1982. The markets were actually relieved it wasn’t worse. Consensus forecasts from the majority of economists polled indicated as much as a 5.5% decline.

Unfortunately, the difference was in the build-up of unsold goods called inventory gains. Companies are now sitting on a huge stockpile of goods on the shelves, while you and I are on a spending strike. It doesn’t take a fortune teller to figure out what happens next. Companies will slow down the rate of production of additional goods. That will mean less sales, profits, and additional lay-offs in this quarter. So expect an equally poor showing this quarter and most likely for the one after that.

It is hard to believe that on the unemployment front things could get worse but so far this month over 233,000 jobs were cut and those are the ones that have been announced. How many more jobs have been lost among smaller companies is anyone’s guess, but I am prepared for at least 10%, if not higher, unemployment by June. However, unemployment and GDP are what we call lagging economic indicators (signs of what has already happened). The future, although murky at best, may see some first glimmer of a pick-up by the second half of the year. At least that is what the Federal Reserve is hoping for, although they did say there were many risks to that forecast.

As for the markets, I wrote last week that volatility has returned to global markets with daily moves up and down by 2-3%. That is not a healthy sign and certainly does not indicate that we have reached a bottom. Trading volume also remains fairly weak, which is an indication that many investors are sitting on the sidelines. I can’t blame them. The stock markets have become a daily casino where day traders bet on the black in the morning and red midway through the day and end back on the black at the close. When all is said and done, the S&P 500 is almost exactly where it was eight days ago. In markets like this, the only avenue is income and interest bearing investments. My advice is stick to that plan and keep cash on the sidelines until this market finally bottoms. We are now in our 14th month of declines. Hopefully at some point soon the bears will simply run out of ammunition and the markets will flatten out in exhaustion.

As for the January Effect, it is not the only indicator. The Super Bowl results are another market indicator. If the winner of the Super Bowl, so the legend goes, can trace its origins back to the old NFL, it would mean a positive year for the markets. So take heart, dear reader, the Pittsburgh Steelers qualify for the old NFL.

Bill Schmick is a Vice President and Portfolio Strategist for Dion Money Management, which offers managed account services for your IRA, Roth IRA, 401(k) and other retirement accounts. He can be reached at 800-432-7447, ext. 146 to learn about the benefits of our managed account programs.

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