Fagan Associates Archive for June, 2009

Many investors found themselves with too much risk for their tolerance level as the market tanked last fall and then fell even further through early March. The rear view mirror approach of many advisors left people with the remnants of winners from 2006-2007. Emerging market funds as well as too much money allocated to those funds investing primarily in energy populated many accounts. The generic disclaimer that “past performance is no indication of future results” meant nothing to many until they were faced with the reality of losing large sums of money.

Having been in this business more than two decades, we have witnessed the bursting of many bubbles, the most recent being the internet and real estate bubbles. Investors, in lemming-like-fashion, after having overweighted industries that were too economically sensitive and thus fell like a rock as the economy tanked, then scurried into riskless money markets and government bonds after the damage had already been done to their portfolios. We believe that this has created a bubble of sorts in that many investors are finding themselves with little or no “risk” and consequently little chance for appreciation in their portfolios. With the market gyrations of the past eighteen months, it is not hard to understand that many investors want the certainty of guarantees. However, with that certainty, investors must be willing to accept miniscule returns.

These returns tend to be acceptable during periods of negative returns for riskier investments such as stock, stock-based mutual funds and even corporate bonds. In fact many investors find comfort and may experience almost a sense of “I told you so” when the stock market declines. That said, over the past quarter, the global stock market has risen more than thirty-five percent, perhaps luring some back in. We encourage investors to take a more balanced, longer-term and perhaps objective look at their financial goals and then design a strategy to help them achieve those goals rather than utilizing the “rear view mirror” approach noted above.

THE BOTTOM LINE - it is imperative to design your portfolio according to your objectives, your risk tolerance and to perhaps balance out your investments to weather difficult times. This balance enables investors to sleep at night by limiting the volatility of their account values and, during these times maintain and objective, rational approach to their portfolio rather than a subjective, emotional one. Investors have found that it is never easy to lose money but on the other hand it is also never easy to sit idly by while others make money. The diverse approach of a balanced portfolio gives investors the chance to participate in the upside when markets move higher as well as more easily weather the downside which will, at some point, inevitably return.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein.  Securities contain risks and fluctuations in principal will occur.  Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc or related persons buy or sell for itself securities that it also recommends to clients.  Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call 518-279-1044.

It’s easy to see where we have been, but much harder to predict where we are going. Earlier this year we had tons of financial “gurus” projecting bread lines, deflation and economic Armaggedon. Smaller investors, scared stiff by these predictions fled stocks at precisely the wrong time, March ninth, turning almost exclusively to longer-term bonds. Our twenty-plus years of experience industry has taught us many lessons, but one stands out at the current time and that is “as difficult as it can be, make certain to keep your head when everyone about you is losing theirs.” That is exactly what successful investors do.

For example, at the close of trading on March ninth, on a per share basis household names such as General Electric was at $7.41; Apple Computer at $83.11; Nike at $38.57; JP Morgan Chase $15.90; Pepsi $45.81 and Johnson & Johnson closed at $46.91.

A mere two months later General Electric has risen 82.32% to close at $13.51; Apple Computer is up 69.59% to $140.95; Nike is up 50.38% to close at $58.00 per share; JP Morgan Chase has skyrocketed 121.13% to close at $35.16; Pepsi is up 16.61% to $53.42 and Johnson & Johnson has risen 19.27% to close at $55.95.

Also approximately two months ago interest rates on 30-year U.S. Treasury Bonds were substantially lower at 3.59 % and the price of high-yield bonds were in freefall. Today, the current yield on a 30-year U.S. Treasury stands at 4.61 % and junk bonds (aka high yield bonds are 12-15% higher). The principal value of long-term U.S. Treasuries has fallen dramatically at the same time that “riskier” junk bond investments flourished. Please keep in mind that during this period many investors were being counseled by their Investment Advisors to avoid risk by buying bonds at a point in time which was the exact opposite of what was going to work. Over the past decade that this column has appeared in The Record we have written about all types of risk (principal, interest rate and reinvestment to name a few).

THE BOTTOM LINE. Our reason behind the above few paragraphs is not to suggest that now is the time to buy stock or not to buy stocks or to buy or sell bonds. Our point is merely that investors have the tendency to zig when they should zag and vice versa, ultimately ensuring mediocre returns.

We believe that stock investors will be rewarded over extended periods of time but will be tested time and time again. “Patience is a virtue” is another saying which could be heard in the Fagan household and it’s the virtue most needed for success in the markets.

The vast majority of investors are looking to enhance their income through the purchase of bonds, but are unaware of the pitfalls when investing into these securities. Given the recent moves by the Federal Reserve regarding interest rates as well as the action in the U.S. dollar, we thought that it would be an appropriate time to discuss the pros and cons of fixed income investing. Always keep in mind that, like stocks, investors do lose money in bonds!

The first fact that any investor in bonds should recognize is that the price of a bond responds inversely to interest rates. As an example, let us assume that you purchased a thirty year U.S. Treasury Bond (both principal and interest payments backed by the full faith and credit of the U.S. Government; widely accepted as the most secure fixed income investment in the world) for $10,000 and that bond pays a yield or interest rate of 4.00% semi-annually. Therefore, you would receive $400 per year or $200 every six months with your principal guaranteed upon maturity in thirty years. Now let us assume that after purchasing the bond, interest rates on thirty year U.S. Treasury Bonds rise to 6.00%. Therefore, should you purchase a bond at this time, you would receive interest payments of $600 per year or $300 every six months. However, in response to the rise in interest rates, what has happened to the interest rate and the value of the 4.00% bond that you purchased initially? Very succinctly, the interest payments of $200 semi-annually will remain the same for the balance of the life of the bond or until its maturity. However,the principal value of the bond, should you wish to sell it prior to its maturity, has declined! After all, who would give you $10,000 for a bond yielding 4.00% when they can go out today and buy their own bond that pays 6.00%? The answer, nobody in their right mind! You are stuck getting $400 per year for let us assume the remaining twenty-eight years until the maturity of the bond rather than the $600 that you would receive if you had waited until interest rates rose a bit. The loss to you is $200 per year over twenty-eight years or $5,600 in interest!

What conclusion should an investor draw from the above paragraph and slew of examples? Simply, of course that your bond or bond fund can decline in price or net asset value! Once again (for the benefit of both of us) bond prices respond inversely to interest rates! As interest rates go up, the value of bonds go down and as interest rates go down, the value of bonds go up! As interest rates have edged up slightly over the past year, the value of bonds has gone down. However, this does not affect the interest payments!

What should you now do? Be patient. Two of our principal tenets of investing are that asset allocation works best over the long haul and invest in bonds for income and stocks for growth. Asset allocation is defined as the percentage of your total financial assets that you allocate to equity, fixed income and cash investments. For the purpose of this column, investment real estate should fall under the fixed income heading. Invest in bonds for income. We referred to the yield curve above. Try to stick with the intermediate part of the yield curve. That would be bonds maturing between three and eight years. By so doing, you will receive nearly all of the interest of a thirty year bond with less than fifty percent of the principal risk should you wish to sell your bonds prior to their maturity.

One final comment, generally speaking, bonds react inversely to one to two year historical performance. This means that the more meager the returns during the past, the more lucrative the future may be. One more final thought, when measuring performance, always compare your bond or bond funds to similar investments. Do not compare your bond or bond fund to the stock market. Remember, asset allocation provides predictable returns and quantifies your risk. Give us a call should this column require any further clarification or generate any questions.