Personal Finance Strategies: Dropping interest rates

As a guest on the IBA English news this week, I was asked to comment on the effects the recent interest-rate drops will have on the man in the street. I feel this is an important issue, and will address it here.

As has been reported in the media, the shekel interest-rate has followed the dollar interest-rate downward, and is currently at an historic low level. This interest-rate drop is a double-edged sword - good for some, and not for others.

Those people who have borrowed money from banks are happy about the fluctuating interest rates because their monthly repayments have dropped. Those who have money in the bank, and are living off the interest, will find that their income has dropped; they will be struggling to make ends meet.

Many savers, especially elderly people, are attracted to the relative security a fixed-income deposit offers. The cost for this, however, is being felt now, as their income is dropping. The question I have often been asked is, "What alternative is there?" My answer is simple: One needs to assume a greater investment risk, but in a calculated manner. That means exposing oneself to a diversity of investments that give a higher return than money in the bank, but not necessarily exposing oneself to an overall greater risk. This is achieved by diversifying an investment portfolio into different segments that are not affected by the performance of another segment.

Examples of investment strategies that are different than interest deposits include stocks, bonds, real estate, hedge funds and commodities such as energy or gold. At first glance, an investor who is unfamiliar with such strategies may be scared off, but it is possible to access these investments by using the skills of professionals in the specific area. The easiest way to do this is via a mutual fund. By using mutual funds as building blocks, it is easy to build and easy to manage a well-diversified investment portfolio.

One area of opportunity is bonds. They are basically IOUs issued by governments or companies that carry a fixed repayment rate. As interest rates in the market drop, the value of these bonds rise. So in an environment of falling interest rates, a bond investment can be very lucrative.

I would caution, however, not to buy only one bond, as there is always the risk that a bond issuer could default. In addition, one has to pay attention when interest rates begin to rise again; the bond's value will fall.

My last comment is the most important. I suggest that everyone needs to set long-term goals, such as " retire in comfort" or "educate the children," and not focus on the short-term results. Over a long-term period we are inevitably going to encounter periods of turbulence. But that should not mean the eventual goal will not be reached. If we set such goals, and stick to the strategies, they likely will be achieved.

pbraude@anglocapital.com

Philip Braude is an accountant, personal financial planner and licensed investment marketer. He is CEO of Anglo Capital Limited.

What is Standard & Poors 500?

Also called the S&P 500, the Standard & Poors index, which most professional money managers say that they use as the benchmark against which they measure their own investing prowess, is the one that has become the dominant benchmark in U.S. investing in recent years.
Although the S&P is not really the appropriate measure of performance for bonds or the stocks of small-sized companies, nor the apt standard against which to judge international investments, the index is still used to gauge these investments’ performances anyway.
The S&P 500 tracks the performance of 500 stocks, comprised of 400 industrial companies, 40 utilities, 20 transportation companies, and 40 financial firms. A committee at S&P reviews the companies periodically and may replace up to 30 for reasons that include, for example, bankruptcy. The performance of the 500 stocks is run through a computer software program that calculates a daily measure of the market’s rise or fall as well as an overall performance figure. These are the numbers you hear reported on the nightly news, see in the newspapers, and can view on your computer screen if you log on to a personal finance Web site.
The S&P tells you the average performance of the stocks in the index. This performance is reported as both numbers and percentages. If the S&P goes up, your newspaper might report that “ the S&P went up 2 points or 6% today.” When the stock market is doing well the numbers and percentages go up. When it’s doing poorly, they go down. The S&P 500 is home to some of the hottest stocks of the late 1990s, including AOL and Dell, the latter of which gave investors an unrivaled 79.7% average annual return, not for a day, not for a month, but for 10 years. With so much fanfare, the S&P has become the index to beat for mutual fund managers. Outperforming it is cause for celebration — only 1 out of 10 mutual fund managers do so in any five-year period.

What is Indexes?

An index is a statistical yardstick used to gauge the performance of a particular market or group of investments. By tracking average prices or the movement of prices of a group of similar investments, such as small or large company stocks or corporate bonds, an index produces a benchmark measure against which you can assess an individual investment’s performance.

Think of using an index the same way that you may use a list of comparable home sales when you shop for a house in a neighborhood. If the list of comparable homes shows you that the average three-bedroom colonial sells for $189,000, you can’t expect to buy a similar house for too much less than that. At the same time, you don’t want to pay too much more. In the same respect, the benchmarks produced by an index show you a reasonable performance target. A return is an investment’s performance over time. If you’re looking at performance for a period of time, say five years, look for an average annual return. If the same mutual fund returned 10% over the course of those five years, its average annual return would be 10%. Its cumulative return, which simply totals an investment’s performance year after year, would be 50% for those five years.

If an investment’s performance over the course of a year is vastly superior or inferior to the appropriate index’s return, you’ll want to know why. Your investment may be outpacing its peers because it’s a lot riskier. A mutual fund, for example, may invest in stocks or bonds that are far riskier than other funds it may resemble. On the other hand, an investment may be lagging its peers simply because it’s a poor performer. Bear in mind, however, that you have to build a performance history over time to determine the character of a particular investment. Notice that in Figure 8-1, the mutual fund is performing below average, which may prompt you to sell that investment.

The following sections offer a look at the indexes that are likely to come in handiest as you try to determine expected performance from your investments.
Start by tracking an index that represents or follows your stock or mutual fund. After you become familiar with that index, then pick up another index to follow. Be careful not to follow too many indexes, though — it can become confusing and time-consuming.

Gold is safe investment option during choppy markets

With the stock markets on a downhill trek, a wave of panic has gripped the retail investors. In these uncertain times, you may have also found yourself struggling, and sometimes worried, on how to get the right portfolio mix and avoid the bear’s claws.

The same stands true for 45-year old Anand Sharma, who ran out of his wits after his year-long investments eroded in a matter of few seconds. If analysts are to be believed, in such turbulent phases, you can always look up to gold as an investment option not only as an insurance against the choppy markets but for better returns as well.

The Golden Scenario
With an expected slower US growth momentum, Fed rate easing, a weakening dollar, rising oil prices and heightened geopolitical concerns, gold prices appear to be firmly supported in the months ahead. Strong investor demand coupled with strong jewellery demand from Asia and the Middle East is also likely to push the prices. “In the present context, gold is expected to provide better capital appreciation, provided it is bought at a right price. It is also a good hedge against inflation,” says Mukesh Agarwal, director of Wealthcare Securities.

Strong fundamentals put aside, gold has also given a return of 18% in the first two months of 2008. “Today, it is the most recession-proof asset and is actually playing the role of insurance in the investor’s portfolio,” says Vandana Bharti, senior research analyst (commodity) at SMC.

The ETF Route
Analysts feel that in the present market conditions gold is expected to provide better capital appreciation. While the sensex has fallen more than 20% in the last three months, gold Exchange Traded Funds (ETFs) have given returns of over 25%. “If you’re looking for gold as an investment then it is better to invest through ETFs instead of holding gold physically,” says Bharti of SMC.

Agarwal explains that it has a triple advantage. The first, that gold held via ETF would be treated as a long-term asset in one year whereas you’ll have to hold the physical gold for three years to classify it as long-term. “The other two benefits are that there is no wealth tax attached and if you hold it in demat form, there are no issues about its purity,” he adds.

Gold Funds
If you’re bullish about gold and other precious metals, it can be an interesting move to buy a mutual fund scheme which in turn invests in the shares of mining companies of gold, silver and platinum. Explains, Pankaj Sharma, executive vice-president and head of business development and risk at DSP Merrill Lynch: “If you invest through an ETF, it is kept for three years and the amount of gold backing remains the same (it does not grow). However, in those three years, a gold mining company could have increased in the share price, could have given dividends and achieved higher valuation (share price) on account of corporate actions (like mergers, acquisitions).”

Agarwal also feels that investing in a gold fund would benefit more as with the increase in gold prices, the profits of gold mining companies increase manifold on account of operating leverage. Launched in 2007 in India, DSP ML Gold Fund has given a return of over 60% in last six months.

Glitter Effect
According to analysts, though gold is expected to provide very good returns this year, it would also come with higher volatility. So before you plan to invest in ETFs or gold funds, it is pertinent that you should get an outlook of dollar and crude price behaviour, physical demand for gold in the global market and performance of equity markets. “The entry time is very important while investing in gold. One should consider the seasonal pattern such as wedding seasons,” says Bharti of SMC.

Analysts caution that if you don’t understand the dynamics of the commodity markets, avoid buying through futures because when the price goes against your position (price falls after you have bought) then you have to give the difference (known as marked-to-market) immediately to the broker.

Today, all major investors have 3-15% of their portfolio in gold, and as of now it looks like an opportune time to bet on the precious metal. And exercising a bit of caution will only add glitter to your investments.

Monitoring certificates of deposit

When you invest in a certificate of deposit, you receive an actual document that indicates the principal you invested, the interest rate, the length of time of the investment, and the final amount you will receive. Some institutions include your balance information on the statements you receive from other accounts you have with them, but not all do that. Possibly the most important thing to keep in mind with your CD investment is to keep track of the dates, because right around the time your CD matures you will receive a notice giving you the option to roll over the money from that account into an identical CD. You must respond during the 10-day period just prior to your maturation date or else it automatically rolls over.

If you miss that 10-day window of opportunity to cash in your CD, your investment automatically rolls over into an identical CD account and the financial penalty for withdrawing that money before it matures can in some cases cost you the amount you gained through interest.

Keeping saving accounts monitored

Monitoring your savings account is a lot like monitoring your checking account. You receive statements from the institution (bank, credit union, or savings and loan) that tell you your balance including accrued interest. Many institutions also have a telephone number — often toll-free — that allows you to access balance information by using your account number and your personal code number. In addition, more and more institutions have online banking that allows you to access your account information from your computer. Like savings accounts, you can access your money market account balance information either by reading the statements you regularly receive, by telephone, or via Internet connection to your account.

Purchasing Mutual Funds Tips

When you are ready to invest in a mutual fund, you can either work through a broker or, in many cases, you can buy directly from the mutual fund company. Many funds offer a toll-free number for placing orders, and you can buy shares of their funds.
Unlike stocks, you don’t have to specify the number of shares you want to buy. You tell the fund company or broker that you want to invest a stated amount, and the fund or broker tells you how many shares you will get. Unlike stocks, mutual funds sell partial or fractional shares.

A mutual fund company can’t sell you shares of a fund unless you have first received the prospectus for that fund. Whether you call or request the prospectus on the Web, you have to give your name and address. Fund managers need this data to prove that they have fulfilled their obligation to supply you with a prospectus.

When you begin to look into mutual funds, pay close attention to those that come in families — preferably big families. The term family refers to companies that offer several different kinds of funds. How big is big? Think in terms of ten or more funds. You can spot these families easily by looking at the mutual fund reports in the business section of your daily paper. You typically see some kind of headline in the columns followed by a list of funds offered by a particular firm. It’s easy to spot the big families at a glance; these include Fidelity, Oppenheimer, T. Rowe Price, and Vanguard. Families of funds that charge commissions (also called loads or load charges) provide the opportunity to switch among their funds without paying additional commissions. You can save considerable money with this option over the long term. Make sure to check out this possibility.

A mutual fund has professional management, which comes at a price. You, the investor, pay for this management, either through commissions you pay when you buy or when you sell and other fees that you are billed for periodically. These fees reduce your return on investment and can run as high as 7 to 8% a year, but 2% or lower is more common. No-load funds don’t charge sales loads. No-load funds are available in every major fund category.

Although not all mutual fund companies charge commission, you need to know that the term “ load” is often used in two ways. One is to specify commission charged when you buy a fund (referred to as front-end load), and the other refers to commission charged when you sell your shares in a fun (known as back-end load).
Many investors wonder why they should pay a commission to buy shares of a mutual fund when they can buy a similar fund without a commission. The answer is that, in most cases, there’s no good reason to buy a load fund rather than a no-load fund. Several studies have indicated that the performance of the two types of funds doesn’t differ. Unless you come across that rare case in which the performance of a load fund is so superior that it compensates for the load, save your money and buy no-load funds.

Almost all mutual funds charge some kind of annual fee. Analysts tally all these up into one measure called the expense ratio, expressed as a percentage of the invested funds. Expense ratios range from about 0.75% to 2%, but a few charge as much as 7%. The fund’s prospectus discloses the current schedule of fees.
Beware of any load fund with a high expense ratio. Avoid funds that charge a back-end load. These high fees and loads are a large drain on an investment’s overall return; few funds deliver performance consistently high enough to offset high expenses.

Purchasing Bonds Tips

Buying bonds is a lot like buying stocks. You just get in touch with your broker, set up your account, and place your order.
If you already have an account with a broker, whether landbased or Internet, you shouldn’t have to fill out any additional paperwork to buy a bond. The one account should allow you to purchase stocks, bonds, and mutual funds as well. Unless you are going to concentrate most of your investment money in bonds, there’s usually no need to select a broker who specializes in this kind of security. You do, of course, have to pay for any bonds that you purchase. You pay in the same way and timeframe as with stocks (within three days of placing the buying order). Fortunately, you don’t get charged much in the way of miscellaneous fees when you buy bonds. These fees vary with the brokerage, but in almost all cases they are very small (sometimes less than $1 per transaction).

Commissions on bonds are about in the same range as those for stocks — high with full-service brokers and lower with discount and Internet brokers. Because investors show much less interest in bonds, competition has not yet brought bond commissions down to the very low levels that are paid for stock transactions on the Internet.

The Internet doesn’t have many Web sites devoted to information about investing in bonds. There is, however, one outstanding site that more than makes up for the lack of numbers: the Bond Market Association site at www.investinginbonds.com. This Web site offers advice on buying bonds, explains how bonds fit into a balanced portfolio, and answers just about any question you might have about bonds.

Bonds trade on a type of OTC market, and most trade without securities symbols you see on securities that are traded on an organized stock exchange, like the New York Stock Exchange. Therefore, the investor has to tell the broker the type (tax or tax-free), how long (time) the investor will hold the bond, and state the investor’s risk parameters. Most brokerages (discount and full-service) maintain a bond-trading department in order to meet varied customer needs and preferences.

Finding out about stock purchasing fees

The fees related to the purchase of stocks are few and easy to understand. You’ll be required to pay some kind of commission both when you buy and when you sell stocks, probably an annual account maintenance fee (usually not very large), and small paperwork fees.

The biggest fee is the commission on purchases. Because of the competition from online discount brokers, commissions have been falling. Flat-rate charges of under $20 are starting to appear. Rates this low were unknown 10 years ago. The practice of paying commissions as high as 4 or 5% of the amount of the purchase are disappearing. Some full-service brokers negotiate commissions. Be sure to ask and be sure to take the commissions and other fees into consideration when you select your broker.

How to Place an order for stocks?

Placing an order for stocks is simple. You need to know just two things: the name of the stock and the number of shares you want to buy.

If you are dealing with a live broker, the usual process is to place your order by phone. If you are dealing with an Internet broker, the transaction is made on your computer screen and you provide the same information that you would phone in to a broker.

Under federal regulations, the buyer must pay for stock purchases within three business days. Brokers are very concerned to see that you pay within this period because they can be penalized or disciplined if payment deadlines are not observed.
After transacting your order, your broker tells you what the total charge is and sends you a written confirmation. (You can also check the Web site for your filled order, or call your broker on the phone.) The charge includes the price of the shares, the broker’s commission, and usually some small fees. You then have three business days to get your payment to the broker. Both discount and full-service brokerages require that money be in the account within three business days. Many investors find it more convenient to have funds in a money market fund at the brokerage before a trade is placed in order to meet the three-day requirement.

Use an overnight delivery service to deliver your payment. Sometimes full-service brokers provide clients with prepaid overnight mailers to use in sending payments. These services almost always deliver checks in a timely way, and they also have the means to precisely track when and where your payment was delivered.

How to sign a customer service agreement and setting up an account?

After you figure out which broker you want to use to place your order, get back in touch with that person. The broker will ask you to fill out an application, called the customer agreement. You can’t avoid filling out this application. No broker can deal with you until you have provided him or her with information about yourself and your financial situation and goals. From the start, the broker will need accurate information to process stock purchases and, regrettably but necessarily, to keep the IRS informed about all the money you make from your investments. The application requires you to provide some common personal information such as your name, address, tax identification number (social security number for most people), current job (if employed), your bank, and an estimate of your net worth.

If you are working with a full-service broker, you need to answer some broad questions about your investment goals and the kinds of stocks you are considering for investment. Some very personal questions about your finances and goals may puzzle you or even turn you off, but brokers require this information for good reasons. A full-service broker is required by regulation to provide stock advice appropriate to the client’s situation. This is often referred to as the “know your customer” rule.

There are two other aspects of the customer agreement that you should be aware of. The first is extensive and detailed information about how you will pay for your purchases and what happens if you are late in paying or don’t pay at all. This part of the application is complex and legalistic. I don’t want to exaggerate the complexity of the agreement in general. It is long and detailed, but your broker should be willing to answer your questions. The securities industry is closely regulated, and you can be quite sure that the customer agreement is not intended to deceive you. It just takes patience to wade through it.
If you can’t figure out what some parts of it mean, be persistent in asking your broker to explain the difficult parts to you. This could be a good test of whether you have picked
the right broker. You will have lots of questions all along the way. Don’t deal with a broker who doesn’t have the time or inclination to work with you.

Make sure that you read and understand the customer agreement before you sign it. Don’t be rushed into signing it. Almost all of the customer service agreements currently in use require that you, the client, sign away your right to sue the broker if you believe you actually have been wronged. You will almost certainly be informed that if you have a dispute or problem, you must take it to arbitration for resolution. Some brokers, especially Internet-based brokers, may require that when you establish your account with them, you also set up an account with sufficient funds in it to cover anticipated purchases. The brokerage then pays you interest on the funds you deposit with them.

How to choose a stock broker?

The first big choice you need to make is deciding which kind of broker you are going to deal with: full-service or discount. If you believe that you are going to need a lot of advice, a full-service broker will probably better serve you. If you are making your own decisions about stocks, by all means use a discount broker. Discount brokers charge much lower commissions than do full-service brokers.

Many discount brokers have both electronic and “bricks and mortar” systems of operation. If you discount broker is on the Web, you can enter your order electronically and receive confirmation the same way. Some discount brokers have branch offices where you can sit down with a broker and discuss your investment objectives and goals.
Either way, you can obtain commission costs and product information by visiting a discount broker’s Web site, by calling their phone number (usually toll-free), or by stopping by the branch office.

In addition to discount commissions, most discount brokers also offer other products and services, such as mutual funds, IRAs, research reports, bonds, and others. Full-service brokers are paid by the commissions they earn on buying and selling stocks and other products for clients. This arrangement can lead to a tendency on their part to recommend frequent trading of stocks rather than pursuing a “buy and hold” strategy. This advice can put their interests in conflict with yours. So if you use a full-service broker, avoid miscommunication by making sure that she or he knows that you are not interested in frequent trading but in buying good stocks and holding them for the long term. You may be better off if you find a good financial advisor to guide you on stock purchases and perhaps on other aspects of your financial program. These advisors often work for a flat fee on an hourly basis.

If you decide to work with a full-service broker, you have to choose a broker one way or another. How do you make this choice? You probably select a broker pretty much the same way you select a doctor, a lawyer, or other professional. You ask people for recommendations. You look in the phone book. You see ads in the paper or on TV. After you acquire a list of potential brokers, take the process at least one step further. After you get several names, make some calls. Call their offices and ask about account minimums and commission costs. Find out how convenient their services may be. If you’re put on hold for longer than a few minutes or the broker asks to call you back but never does, he or she may not be the broker for you.
Narrow your choices down to two or three brokers and then interview each of them.
Sooner or later, you will get on a mailing list that is sold to brokers. Then you start getting unsolicited calls. All brokers have a good line and can be very persuasive. My recommendation:
Find a financial planner in your area and deal with her or him face to face. A good financial planner whom you trust can be a very helpful to you as you work to achieve your financial goals.

Comparing certificates of deposit (CD)

When you shop around for a CD, ask the following questions. As with the other investments I discuss in this chapter, talk to at least three different institutions before you take the plunge.

• What’s the minimum deposit to open the account? Usually this amount is $500.
• What’s the interest rate? What is the compounded annual yield? Interest is the percent that the bank pays you for your allowing them to keep your money. The rate of interest is also called yield. Compounded annual yield comes into play if a bank is paying interest monthly, for example. Once the first month’s interest is credited to your account, that interest starts earning interest, too, meaning that the compounded annual yield is slightly higher than the interest rate.
• How often is the interest compounded? Remember, the more frequently it’s compounded, the better it is for you. Continuous compounding is best.
• Is the interest rate fixed or variable? Make sure that the institution offers you a way to get current interest rates quickly and easily — by phone, for example.
• Can you add to your fund at a higher interest rate if the rate goes up while your money is invested? If the rate goes up substantially, and you can add to your fund, then you can significantly increase your yield.
• What’s the penalty for early withdrawal? These penalties can wipe out any interest you earn.
• What happens to the deposit when the CD matures? Does the institution roll a matured CD into a new one of a similar term? Does it mail a check? Credit your checking account?

How to Shop for Money Market Accounts?

When you open a money market account, as the song says, you’d better shop around. On any given day, certain banks may try to attract deposits. Those banks often offer money market accounts that yield over 5%, although the average yield nationwide is more in the range of 2.5%. In many cases, the yield also depends on the amount you deposit. The first step in opening a money market account is to decide which type best suits your needs. Money market accounts come in three types:

• The basic money market account: These usually require a minimum opening deposit of $ 100.
• The “tiered” money market account: These often require a minimum opening deposit in excess of $ 100 and pay a higher yield than most basic accounts. For example, you might earn 2.5% interest with a $500 account balance, but as much as 5% interest or more with a balance of $50,000.
• The package deal: This is a money market account coupled with a savings account, certificates of deposit, and other bank investments. Because the package deal utilizes several products, banks and credit unions may offer a slightly higher yield than they do for basic or tiered accounts. What’s more, the minimum deposit may be waived.

Diving into Savings Accounts

Rather than “taking the plunge,” opening a savings account is more like dipping your toe into the water. But, we’ve all got to start somewhere, and this is where many people start out. Opening a savings account can be the first step to a lifetime of good savings habits.

You’ve probably heard the advice, “Pay yourself first.” That doesn’t mean give yourself some cash so that you can go shopping. When you sit down to pay bills, write the first check to a savings or investment account. It doesn’t matter if you start with a very small amount, just make savings a habit. And when you get bonuses and raises, you can increase those checks you write to yourself.

When you shop for a bank, savings and loan, or credit union where you can open a savings account, make sure to ask the following questions:

• Is there a required minimum balance for a savings account? Some institutions charge a fee if your balance falls below a required minimum.
• What are your fees for savings accounts? You can expect to be charged either a monthly or quarterly maintenance fee. The institution may also charge you a fee if you close the account before a specified period of time.
• How much interest will I get on my savings? Expect around 2% interest. Is the account federally insured? Ask specifically whether the institution has Federal Deposit Insurance Corporation (FDIC) insurance. If it does, then you can get up to $100,000 of your savings back if the bank fails.
• What services do you offer? Many banks now offer banking by telephone or the Internet.
• Does the bank use a tiered account system? A tiered account system allows you to earn higher interest if your account balance is consistently over an amount specified by the bank.

Call around to at least three different institutions (banks, savings and loans, and/or credit unions) to compare their offerings. (You can also call brokerage firms, which offer CDs, to find out what their minimums and fees are.) If the answers to all of these questions come out about equal, choose the institution that’s most convenient for you and offers the best service, convenient hours, friendly tellers —whatever suits your banking habits best.

Don’t forget to do your homework

Wise investing relies on research, which can be hard work. Just because someone touts an investment in an Internet chat room or across the lunch table at work doesn’t mean it’s a good buy. Do your homework. If you wouldn’t buy an investment except for the go-go advice, don’t buy it.

Don’t put all your eggs in one basket

Just because one type of investment is doing well this month or this year doesn’t mean that its success will continue or that you should invest all your money in that arena. Also, you don’t want to scare yourself out of continued investing by choosing a highly volatile investment that may start losing your dollars immediately.

Don’t play with fire when investing

Avoid speculative, risky investments, especially those whose terms and properties you can’t understand no matter how many times a broker or friend explains them. Your comfort level is important, so remember that some of the best investment options can seem boring and mundane. Risky investments include those based on premises that seem farfetched, such as an underwater casino, or those that promise unbelievable returns. They may also have terms that are unfavorable, such as an investment that gives a company or other investors the right to buy you out at the price you paid if the investment turns profitable.
If an investment seems too good to be true, it is.