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Dennis Miller is the author of “Retirement Reboot”, a book chronicling his own journey to save his retirement in a low yield, turbulent investing environment. He works with some of the country’s top investment managers, authors and analysts to tackle the financial challenges faced by today’s... More
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  • Investing Inertia Won't Keep Your Cash Safe

    A dear friend asked for help-the sort of help you might need too. She's retired, lives alone, and has a modest nest egg. But the thought of losing any of her life savings terrifies her.

    Let's call my friend "Sally." Sally doesn't trust stockbrokers or any commission-based investment advisors, and she confided that all of her money is in a cash account, earning 0.01% interest.

    Sally understands that at that rate, she'll likely outlive her nest egg. She knows she needs to do something but is understandably afraid and feeling vulnerable.

    Sally played my own warnings right back to me…

    • The stock market is near an all-time high.
    • The government, not solid business fundamentals, is propping up the stock market.
    • Junk bonds have a higher rate of default than top-quality bonds and are currently paying some of the lowest interest rates in several decades.
    • Preserving capital and earning decent yields are both essential to making a lifetime portfolio last.
    • CDs are risky because they tie up your money and might lose against inflation.

    These are real fears. Sally understands the risks of investing; however, she underestimates consequence of doing nothing.

    Several Money Forever subscribers have expressed similar concerns. So, to answer Sally and company we're sharing a conversation between Money Forever chief analyst Andrey Dashkov, Casey Research senior analyst Chris Wood, and me.

    Dennis Miller: Andrey, I'll start with you because I know you're something of a financial advisor to your mother. What would you say if she asked these questions? Where would you tell her to start?

    Andrey Dashkov: Dennis, yes, my mother does indeed turn to me for financial advice. Let me start by giving you a little context. She still lives in Belarus, where I was born. I will not get into great detail about the country's crumbling economy, but as we speak, the Belarusian National Bank has hiked its interest rates (called refinancing rates) by 5 percentage points, from 20% to 25%. You can get 50% annually on a bank deposit denominated in rubles; consumer credit rates go upward of 70%.

    You heard me right. I never stop admiring people who can navigate an environment like this. Granted, some go the obvious route and spend their money as fast as they can, while others try to save. But despite the attractive deposit rates, few are willing to trust the banking system. Most of the people just buy foreign currency in cash, really. Almost every new year, rumors about another devaluation start popping up, and people line up at ATMs to withdraw US dollars and euros. At the beginning of this year, the ruble was devalued by 7% in an instant.

    So Belarusians are natural risk avoiders and natural hedgers. Earning interest is less of a concern; preserving buying power and liquidity is what matters. Most people just buy US dollars and euros, hoping that if one of the two depreciates, the other will move up. Compared to the local currency, they feel more comfortable.

    Back to your friend, though. Since her main concerns are liquidity and stability, I would recommend she try one of the six Stable Income funds in the Money Forever portfolio. She isn't mentally prepared to take on risk, so she needs to start slowly and build confidence. As you know, these funds function as cash alternatives. One in particular-a fund we've held since November 2012-comes to mind. While it pays a low rate of return, it's still 80 times more than she's currently earning. It's a step in the right direction.

    Diversification is important, though, so I'd also recommend that she add other vehicles to her portfolio. Her well-being shouldn't depend on any single position.

    This idea is easy to understand; my mother totally gets it. Many people of her generation have acted as amateur currency hedgers for the better part of the last decade.

    I'd start by taking easy steps, allocating some of your friend's cash into our cash-like investments. While they aren't as safe as cash or top-quality bonds, the additional returns would have an immediate, positive impact on her savings with minimal default risk.

    It's as simple as this. If she earned 4% interest and had a 1% default, her net gain would be 3%-300 times what she's earning now.

    When she's ready, I'd encourage her to buy some stocks, too.

    Dennis: Chris, where would you suggest she start?

    Chris Wood: Dennis, you aren't the only one who gets these types of questions. Once your friends and family learn what you do for a living, it's natural that they start asking these questions. Much like your friend, they know they should "do something." They just don't know how to go about it.

    But back to your friend-I think Andrey is spot-on. Her primary goal should be preserving capital, but she really does need to go into the market to have any chance of keeping up with inflation, actually growing her nest egg in real terms, and generating enough income to continue to live a long and happy life.

    A good way to start is to dip your toes into safe, cash-like instruments that provide a better yield than a cash account at a brokerage. Then branch out into dividend-paying stocks that also provide the opportunity for robust capital appreciation (diversified geographically and across sectors, of course). Finally, add in some higher-yield income vehicles, like floating-rate funds, preferred stocks, and even high-quality venture-debt BDCs. This three-tiered approach should provide the capital appreciation and income necessary for her nest egg to live as long as she does, and it should do that as safely as possible.

    Speaking of safety, as she adds to her positions, she should limit each investment to a small portion (say 2-5%) of her entire portfolio. Other things like rebalancing on a regular basis, using limit orders so she doesn't buy an investment at a price above what she's comfortable with, and setting trailing stops to prevent catastrophic losses and lock in gains are important too.

    Dennis: One of my fears with friends is giving good advice that later goes stale. How do you update friends and family? Chris, do you want to go first on this one?

    Chris: Sure. Unfortunately, there's no "set it and forget it" way to deal with markets à la the Ronco Rotisserie. Probably the most important thing to communicate to friends and relatives who ask for advice is that it will take some work on their part. Vigilance is paramount. Even if you're working with a financial professional, it's important to know what's going on, because the decisions you're making now will affect the rest of your life.

    Obviously, there are cost/benefit tradeoffs in terms how much time you have to dedicate to such things. But in general, the more self-directed you are, the better the outcome.

    Dennis: Andrey, do you have anything you want to add to Chris' remarks?

    Andrey: Sure. As Chris says, it's important to stay informed about what's going on around you, both in the economy and on the stock market. The caveat, though, is that there is just too much information around, and most of it is useless. So when people ask me how to become better informed, I recommend consuming less information, not more; however, you have to be selective.

    Pick a couple of weekly magazines that cover the economy and business from different angles, and you'll do two things: first, you'll dramatically reduce the amount of information you need to consume per week; and second, what you read will often be better researched and more comprehensive than the bite-sized, out-of-context crap scattered around the Internet in the form of news and blog posts written with speed in mind, not comprehension. Also, treat all TV as entertainment.

    So that's step one. Step two is finding reliable investment advice. Granted, there are excellent people in the business, but they're often slow to adapt to the changing environment. They keep selling you "100 minus your age," "60/40," or other schemes, even though they won't produce the results you need.

    Dennis: How do you deal with concerns about the stock market? When we put together the bulletproof income portfolio, we started by asking, "What's the smallest amount we can put in the market and still safely make enough yield to ensure the money lasts?"

    With the S&P 500 at all-time highs, the prices of companies like Apple are soaring. It's pretty hard to say, "Buy high and hope to sell higher."

    What are your thoughts in this regard? Andrey?

    Andrey: I don't think about the stock market in terms of aggregates; in a sense, I don't care how expensive the S&P 500 is. What I do care about is helping our subscribers enjoy the opportunities the market brings-and minimizing the risks.

    The first risk is in following the crowd. Most retail investors tend to hold the same 20-30 stocks in their portfolio: companies they know-or think they know about. This means brands like Apple, Chrysler, Coke, Ford, and now possibly Facebook, since it's so pervasive.

    This approach is a losing proposition for two reasons. First, buying what everybody else does is irrational investing. Crowds buying (and then selling) stocks en masse creates volatility and hurts returns. Second, brands are not companies: if you like your Apple computer (or your Ford car or your Diet Coke), it doesn't mean Apple or Ford or Coke are good investments.

    Investors should look at companies with as little emotion as possible. I read once that if you're excited about any of your investments, you're doing it wrong. Staying objective and disciplined is the way to go.

    In short, the market does what it wishes while we cut our own path. I think the Money Forever way, with our emphasis on risk management, income, and individual opportunities, is the right one.

    There are still opportunities out there for great appreciation and returns. It's a matter of finding them ahead of-and while mostly ignoring-the emotional crowd.

    When the crowd starts buying is when we start looking to lock in profits. In 2014, we did this in several ways: tightening up stop losses; selling off part of our position; and in the case of HES, selling it all for a nice 78% gain.

    Dennis: Chris, anything to add?

    Chris: No, I think Andrey summed that up very nicely.

    Dennis: Guys, thank you both for chiming in here.

    To distill it down, there are three basic steps that Sally and those in similar predicaments should take: stop doing nothing; start small; and, start now. Don't let investing worries paralyze you. You can check off the simplest first step-and find out if you're at risk of outliving your nest egg-in the next three minutes by running your personal portfolio projection here.

    Feb 26 3:08 PM | Link | Comment!
  • Safety In Numbers, Protection In Options

    If you want to fail as an investor, the possibilities are endless. Buying stocks on a whim, holding on to the losers for too long, and dumping winners too soon are just a few ways to start.

    Options, like anything else, can cost you money or make you money. Due to the leverage employed when trading options, they often add both a layer of potential profit and a layer of risk on top of their underlying assets. But a less-known benefit of trading options is that they can serve as a hedge or form of insurance.

    To illustrate, I'll use a strategy that may seem intimidating but shouldn't be: option collars.

    Even though it sounds technical, it's actually pretty simple. It boils down to holding an underlying asset (let's say shares of a stock) while simultaneously selling (i.e., writing) call options and buying put options on that holding. The premium received from selling the call covers (completely or mostly) the premium paid to buy the puts, and the two of them work together to limit portfolio risk.

    Let's take a look at how a collar works step by step.

    Suppose stock XYZ is trading at $40 a share on January 1. You want to invest in the stock, but you're worried that the market could tank within the next couple of months and take XYZ down with it. So you decide to set up a collar to limit your downside risk.

    You decide March 20 (more on the date in a moment) is far enough into the future to protect you from the imminent market decline you're worried about. You also decide that if you could sell XYZ for $50 between now and March 20, you'd be happy with that gain; but you don't want to have to sell XYZ for any less than $30 over that time period.

    So, to create a collar that meets all of your requirements, you do three things: buy 100 shares of XYZ at $40; sell one March call option on XYZ with a strike price of $50; and buy one March put option with a strike price of $30.

    (Please note that the third Friday of the contract month is the option expiration date. That's why we used March 20 above. Also, each options contract is written on 100 shares of the underlying asset. That's why we only need to sell one call option contract and buy one put option contract on XYZ to collar our 100 shares.)

    Now, back to creating the collar…

    Let's assume that the premium you receive from selling the March call option is $1 per share (i.e., $100 per contract), while buying the March put option will cost you $0.50 per share ($50 per contract).

    So your initial outlay is $4,000 for the 100 shares of XYZ and $50 for the put; and you receive $100 from writing the call. Your total investment is $3,950. (We're ignoring broker commissions throughout this illustration.)

    Now let's consider two scenarios:

    1. Before March 20, XYZ goes up to $55. In this case, your call option is exercised at $50, and you're forced to sell your shares at that price. That's fine, because you had already decided that you were willing to sell your shares for $50 within that time period. Your proceeds are $5,000, and the net gain is $1,050, or 26.6%. Not bad! The trade-off, however, is that the gain is limited: if the stock shoots to $80, you still have to sell it for that $50 strike price.
    2. Before March 20, the stock goes down to $25. Without the put protection, you'd incur a loss of $15 per share (approximately 38%), or $1,500 for the whole position. But that's not what happens: your protective put allows you to sell the shares for $30 each, establishing a floor for your losses. So you sell the shares for $3,000 and pocket a loss of $950, or 24.1%. Even if XYZ had gone to $0, your maximum loss would still only be 24%.

    The payoff would look like this.

    So while options are a powerful tool that can ruin an investor who doesn't understand them, here you see how they can be used as protection. Remember, however, that unless you're a seasoned options trader, it's wise to leave even protective strategies to the professionals. In fact, the Money Forever team only recommends one options strategy for individual investors: selling covered calls. Learn more about this straightforward, low-risk moneymaker and download our free option calculator here.

    Tags: retirement
    Feb 19 12:11 PM | Link | Comment!
  • Beware Of Bankers Bearing Gifts

    Childhood cartoons have programmed us to see bankers as evil, greedy businessmen who delight in preying on the poor. Case in point: Snidely Whiplash.

    Snidely Whiplash and Nell

    As children we latched onto stories of the evil banker who held the mortgage on poor Nell's ranch. Somehow a hero, Dudley Do-Right, emerged in the nick of time to save the day, and the banker was foiled again.

    Take Your Mortgage to the Grave

    Snidely Whiplash is at it again in the United Kingdom; only now he has a new scheme to snatch up the property of the poor: lifetime mortgages. It seems that Snidely has been so successful at lending to people who cannot repay their mortgages that he's overwhelmed the system.

    But beware of bankers bearing gifts. In the UK, interest-only mortgages allow borrowers to repay only interest during the life of the mortgage, usually twenty-five years. While that keeps month-to-month costs low, borrowers still have to repay the balance at the end of loan's term… You can see where this is headed.

    As Dan Hyde, Consumer Affairs Editor of the Telegraph reports,

    Around 130,000 interest-only mortgages are due to expire every year until 2020, with half facing a shortfall of £71,000 on average, according to the City watchdog.

    Of the 2.8 million interest-only mortgages in Britain, an estimated 1.3 million are ticking time bombs, so to speak. Banks touted interest-only loans when the industry was booming, but as these notes come due, borrowers are faced with losing their homes.

    The Poisonous Band-Aid

    In order to mitigate the crisis, magnanimous bankers are offering lifetime mortgages to borrowers in their 50s and 60s who are coming up short. How do these Band-Aids work? The borrower continues to pay interest and can remain in the home for life. When the borrower dies, the house reverts to the bank. (Sorry kids, no house to inherit.)

    During boom times, buyers on both sides of the Pond bought homes they could not realistically afford. No money to put down? No problem! Just sign here, move in, and start making the payments. It's as simple as that.

    "Don't worry," Snidely Whiplash said. "Real estate always increases in value."

    Now those notes are coming due, aging borrowers haven't saved nearly enough to pay the balance, and many if not most of their homes haven't increased in value.

    If an interest-only borrower's home had appreciated 10-20% (providing much-needed equity) during the life of the mortgage, which was the longtime norm, the bank would likely convert the original loan to a conventional mortgage. From the bank's perspective, why not convert if the home's value still covers the amount of the loan. And of course, it would pocket origination fees again and receive additional interest income.

    That's Not What Happened

    Sad to say, for the most part banks offering the lifetime-mortgage Band-Aid hold property that is worth far less than the mortgage. The bank is screwed if it forecloses because it will have to sell at a substantial loss. Oh my!

    Enter Snidely Whiplash, eager to let Grandma and Grandpa stay in their home. All they have to do is keep paying the interest. When they die, he'll then take the home.

    Well, any five-year-old can tell you that Dudley Do-Right saves the day, not Snidely Whiplash. So why would he propose such a scheme? It's pretty simple. If all those borrowers default, the bank is left with unpaid mortgages and homes worth less than the unpaid balances.

    Homeowners, wake up! This silly scheme will shackle you in poverty.

    The Stateside Equivalent

    I have yet to hear of lifetime interest-only mortgages in the US. The closest thing to it stateside is a reverse mortgage. While a reverse mortgage makes sense under very limited circumstances, vigilance is in order.

    When TV characters like the Fonz earn big bucks to promote reverse mortgages, you know the scheme must be profitable for the banking industry. I get it, folks. If you're considering a reverse mortgage you may feel as though you've run out of options. That's why the Miller's Money Forever team wrote The Reverse Mortgage Guide-to help seniors protect their wealth.

    Remember this universal truth: when a banker is concerned about you, it is for his own benefit, not yours. Come to think of it, give the Fonz a top hat, long twisted mustache and… Oh, never mind! Click here to find out more about our must-read special report, The Reverse Mortgage Guide now.

    Tags: retirement
    Feb 12 11:30 AM | Link | Comment!
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