Suitable Retirement Investments

Congratulations you have started and are contributing to a retirement account. The question is what should be your investments?

From a legal perspective a retirement account can include: Stocks, Bonds, Mutual Funds, Annuities, Limited Partnerships, & U.S. Minted Coins. It can not include: Margin Accounts, Short Sales, Tangibles/Collectibles/Art, Speculative Options Trading, Term Life Insurance, Rare Coins, & Real Estate.

From a tax perspective 2 important points should be remembered:

1. A retirement account grows either tax deferred, such as in a traditional IRA, or tax free, such as in a Roth IRA.
2. Investment losses can not be deducted in a retirement account. A loss can be deducted in a non-retirement account.

Since it grows without a concern on paying taxes it is important invest in taxable investments. A tax free bond, such as a municipal bond, would not be appropriate. The focus has to be on growing as fast as possible.

Since investment losses are not deductible in a retirement account, you need to be concerned about the amount of risk. A higher risk investment, such as an individual stock, would be more appropriate in a non-retirement account as you can deduct any potential loss. A mutual fund of stocks would be more appropriate in a retirement account. Even though it is possible for a mutual fund to go down an individual stock can go down even further due to a lack of diversification.

Would I invest in bonds or a bond mutual fund within a retirement account? Only when the timeframe is less than 8 years and investor preference. Personally, I doubt if I will ever own a bond or a bond fund because of my personal preference.

Happy Investing!!!

Retirement Mistakes to Avoid

In the current state of stock market volatility it is very easy to lose focus and discipline. Keep your perspective and avoid investing by emotion. This blog talks about common investment mistakes that can have a significant impact on creating wealth for retirement.

Mistake Number 1: Cutting back on contributions. Let me give you a personal example. I owned Avaya and it tumbled along with every other stock in the telecom crash. As it was going down, I stopped buying it in my Employee Stock Purchase Plan and I did not get the company funded 15% discount. The stock went down to about $2/share and initially I was glad that I had avoided the pain. As you may remember in 2007 all Avaya shareholders got about 8 times this amount. Every share that I would have purchased at $2/share and I could have bought quite a few increased by a factor of 8 in less than 8 years. In hindsight, this was a very dumb move on my part.

Mistake Number 2: Changing investment strategy in mid stream, aka Market Timing. This has to do with switching away from equities with long term growth into something safer in a downturn. The problem with this is that nobody makes an announcement that says this is the bottom now change back. By the time you realize that a stock market is now going up you have to switch everything back. Typically, this move costs you 2 ways, lost money from a slow growing investment as well as the transaction costs.

Mistake Number 3: Using retirement money as a bank. Since I have a farm background, let me illustrate this with a field of corn. Imagine you plant an acre of corn and you can get 100 bushel of corn from this acre. Now as the corn stalks are starting to grow, rip them all out and replant the field. You have lost both time and money because now you have the cost to replant (penalty for early withdrawal) and lost time because it takes a full season for the corn to grow (delay retirement date). Once you plant your corn, let it grow.

Mistake Number 4: Cashing out a retirement plan at a job change or transfer. Just like above, why do you want to rip out your corn stalks before harvest? If you find yourself in a financial situation with a job loss, Do Not Sell Everything and Go Into Cash. Get professional help as alternatives exist.

Mistake Number 5: Avoiding professional help. Being penny wise and pound foolish can be very bad. A $10,000 investment invested for 30 years at an average 5% return grows to about $40,000 while at an average 10% return grows to about $160,000. This was calculated using the rule of 72. I assure you that I will not come anywhere close to charging $120,000 in fees.

Learn and profit from my mistakes.

Index of Leading Economic Indicators

The last blog covered the current status of the United States Business Cycle based upon the most recent Gross Domestic Product, GDP, report. In the news, we hear doom and gloom and the discussion of the r word, recession. Based upon the GDP report, our economy is still expanding and not in a recession.

Previous blogs looked at three categories of economic indicators: leading, coincident and lagging indicators. Each category contain a grouping of individual indicators. These individual indicators within a category rarely if ever all are going in the same direction, up or down. Some very smart people figured out that you could give each individual indicator within a category a weight and a score. Once the score was tallied it could be called an index.

The end result is today we have an index of leading economic indicators, index of coincident indicators, and index of lagging indicators. Smart people figure this out every month and report it on a monthly basis.

What is the value of a monthly index of leading economic indicators? To Warren Buffet, it means very little as he stated during his annual meeting last weekend. Warren has a very long term view that goes beyond the timeframe of a single business cycle. To me, it gives me a sense of direction. It would mean a great deal if I was investing in options, which I do not.

It feels like things were better the middle of last year. Then things got worse last year until early this year, Not it feels like things are getting better again. This is what the stock market told me. The GDP numbers do not indicate this as the number has always been positive. Something else must be a better indicator than GDP.

If you look at the index of leading economic indicators, from September 2007 through March 2008, we see where the economy went down and in March is now positive once again. This makes me feel good about the direction of our economy and the US stock markets.

If you could choose between watching news reports or the index of leading economic indicators for investment advice which one is best? The answer is the index of leading economic indicators.

Current Status Business Cycle

Yesterday, April 30th, GDP was reported to have increased by 0.6% for the 1st Quarter of 2008. This period is from January - March 2008. I saw President Bush on TV giving a speech talking about how the economy had slowed and did not mention anything about a recession. I did not see any of the Democratic Party candidates talk about this economic data.

When GDP is negative for 6 months it indicates that our economy is in a recession. If the Quarterly GDP had been negative, the Democratic Party candidates would have been much more vocal. The data means that our economy is not in recession.

An excellent websites on economic data is www.bea.gov. This the website for the U.S. Department of Commerce, Bureau of Economic Analysis. GDP is reported 2 ways, in current dollars and inflation adjusted dollars. The below table shows Current GDP, in both current dollars, and Real GDP based upon 2000 dollars. Real GDP based on 2000 dollars is less than current dollars due to inflation.

Quarter/ Current GDP/ Real GDP (2000 Dollars)
2007Q1/ $13,551.9 Billion/ $11,412.6 Billion
2007Q2/ $13,768.8 Billion/ $11,520.1 Billion
2007Q3/ $13,970.5 Billion/ $11,658.9 Billion
2007Q4/ $14,074.2 Billion/ $11,675.7 Billion
2008Q1/ $14,185.2 Billion/ $11,693.1 Billion

This data shows that in current dollars GDP increased by $101 Billion or about 0.8%. Real GDP, taking out the impact of inflation, GDP increased only $17.4 Billion or about 0.1%. For the last 4 Quarters, GDP has increased in each Quarter with the last 2 Quarters having less growth.

Where are we in the Business Cycle? We are still in an expansion. We are not yet at the peak. We are not in a contraction. Does the news reports indicate that we are still in an expansion stage of the business cycle? No, it sounds like we are in a recession. Leading economic indicators suggest that we are not headed for a recession.

Bottom Line: If you invest by the news reports instead of real economic data, you will make very poor choices. Keep the faith in your investments.

Business Cycle Lagging Indicators

The previous blog gave information on the coincident indicators for a business cycle. This blog gives the lagging indicators or the indicators that will change in the future after a change in the Gross Domestic Product, GDP.

These lagging economic indicators include:

• Average Duration of Unemployment
• Labor Costs
• Corporate Profits or Earnings
• Consumer Debt Levels
• Commercial & Industrial Loans
• Business Loans

As GDP increases, Unemployment goes down (more people working), labor costs go up (more people working), earnings go up (higher revenue), debt levels go down (more money available)and the amount of loans should go down (less loans are required).If GDP decreases these indicators should act in a reverse fashion. As you watch the performance of these indicators, do not believe that they predict future performance of GDP.

While this is good economic data, using it as an investor is like driving a car while looking in the rear view mirror. I follow the 4 leading economic indicators more closely for making investment decisions rather than any lagging indicator. Do not confuse a lagging indicator with a leading indicator.

Note that corporate earnings are a lagging indicator instead of a leading indicator. This the one indicator that gives investors the most problem. Why? A good earnings report leads people to believe that good things are going to happen in the future so that an increase in earnings will increase stock price because we have a Price to Earnings number for a stock.

The key learning point is to pay much more attention to future revenue & earnings rather than earnings for a previous quarter. This is why a stock has a great earning report for a quarter and the stock goes down because of a comment about future revenue or profits.

The next blog will review the GDP for the 1st Quarter 2008 and see what it tells us about our current business cycle.