Kimmunications

09-27-2006: Items of interest for the Family CFO

Yet another example that no one can predict the future direction of stock prices and reading the news on those stocks will cause you to buy when you should be selling and sell when you should be buying. Take a look at the news headlines from 1995-97 about Apple. (Tip of the hat to Barry Ritholtz of The Big Picture for this one.)

 

Health insurance continues to be the x factor in the future standard of living for many Americans. The New York Times (free subscription required) says the cost of insuring a family rose 7.7% last year. That is double the cost from seven years ago. It is also double the rate of wage increases and inflation.

 

Walter Updegrave, senior editor at Money Magazine (and previous guest on my radio show) lays out some of the reasons you should avoid annuities in 3 Retirement Deals You Can Do Without. He gives the sales pitch for equity indexed annuities, IRA rollover annuities and annuity swaps. Then he does a nice job of telling you what the pitch leaves out. (Thanks to Snider Investment Method™ graduate Taylor Stevens for the heads up on this one.)

 

Paul Farrell, of MarketWatch.com, illustrates one of the fundamental problems with investing: we are human. Being human, our brains play all sorts of dastardly tricks on us. One such trick is filtering out information that doesn't support our point of view. We all do it. It is one of the reasons why I say, when it comes to investing, we are our own worst enemy. We think we are being logical when really we make decisions in a totally illogical way, most of the time.

 

If you see something you think would be of interest to other Family CFOs, please pass it on. You can email it to me: kim (at) kimsnider.com. As always, your thoughts on these or any other topics are welcome. Leave them below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

The Power of a Portfolio Paycheck

I write often about the power of a portfolio paycheck. In other words, creating a portfolio whose main objective is to generate cash flow rather than capital appreciation. This is a ten minute video I did for KRLD's Online Investor Workshop on the topic.

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

A New Retirement Risk Index

Americans have become accustomed to a period of unparalleled prosperity which followed World War II. Those approaching retirement have fallen into the trap of expecting their retirement to resemble that of their parents.

 

Unfortunately, for most, the golden age of a secure retirement is fading fast. Baby Boomers and Gen X will have to fund an increasing number of years in retirement with less income relative to what they were bringing in pre-retirement.

 

A surprising number of people remain blissfully unaware of the rapidly changing landscape of retirement. The National Retirement Risk Index (NRRI) was developed by the Center for Retirement Research at Boston University to address the general lack of recognition of the scope of the impending retirement crisis.

 

The NRRI measures the percentage of working age households who are at risk of being unable to maintain their pre-retirement standard of living in retirement.

 

The key findings of the Retirement Risk Index, published in June, 2006, is that 45 percent of Boomer households are at risk. The numbers are even worse for Gen X'ers. 50% of Gen X households have not saved enough and are at risk of a diminished standard of living when they reach retirement age.

 

Studies by the Employee Benefit Research Institute put this number even higher. Their Retirement Confidence Survey puts 80% of Boomers at risk. The discrepancy between the two is explained, at least in part, by the assumptions made in each survey. The Center for Retirement Research says their assumptions are conservative:

 

The [National Retirement Risk Index] uses conservative assumptions and therefore may actually understate the size of the retirement challenge. For example, the Index assumes people retire at age 65, while most retire earlier.

 

The Index also assumes that households take full advantage of their available assets by purchasing an annuity with their financial wealth and taking out a reverse mortgage to tap their housing equity. Finally, the Index requires that household replacement rates only come within 10 percent of the target, not actually hit it.

 

What is causing the impending retirement income crisis? According to the press release from the Center for Retirement Research:

 

The reason for this gloomy picture is a rapidly changing retirement landscape defined by a rising Social Security retirement age, a sharp decline in traditional pensions coupled with modest 401(k) balances, low savings rates, and longer life spans.

 

What needs to happen to reverse this trend. There are no easy answers or silver bullets. If you are one of the hundred million or so Americans who are not on track, the only answer is to work longer and save more. The Center for Retirement Research says even two extra years of work and an extra 3% per year in savings can make a big difference.

 

The most important thing that you can do right now is get realistic about the problem, if you have one, and begin to take action. Every day you wait diminishes your chances of living out a comfortable retirement in control of your own future.

 

SOURCE:

 

1. Alicia H. Munnell, Anthony Webb and Luke Delorme; "A New National Retirement Risk Index" An Issue In Brief: Center for Retirement Research at Boston College, Number 48.

http://www.bc.edu/centers/crr/issues/ib_48.pdf

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Edward Jones Pays $127M In Revenue-Sharing Suits

Edward D. Jones reached a tentative settlement on nine class-action lawsuits for not telling investors it accepted revenue-sharing payments from mutual fund companies to promote their funds. The settlement still must be approved by the United States District Court for the Eastern District of Missouri. The $127 million settlement calls for $55 million in cash and $72.5 million in non-cash vouchers to current customers over three years. In addition, the company must cover legal fees.

http://www.financial-planning.com/pubs/fpi/20060915102.html

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

The Housing Whammy

I have been trying to fashion a cohesive post about the potential aftermath of the housing bubble and refinancing frenzy. I have played with it for about two days now. So far I have failed. So instead, let me just give you a sampling of the issues and the impact we are already seeing.

 

A January, 2005 report from Dēmos, House of Cards, details the extent to which families have come to depend on credit to finance their life-style, much of it by depleting their home equity with loans that will likely come back to haunt them in the face of rising interest rates and falling home values:

http://www.demos-usa.org/pubs/AHouseofCards.pdf

 

Prices of U.S. homes grew at their slowest pace in six and a half years during the second quarter, the government said Tuesday. Home prices increased at a 4.7% annual rate in the quarter, barely keeping up with the 4.4% inflation rate. (MarketWatch requires free registration)

 

Home prices fell in one-fourth of the major metropolitan areas last quarter. (New York times article - free registration required)

 

Homebuilders are piling on incentives to move their inventory, including selling your old home. (WSJ requires subscription)

 

From MarketWatch.com, consumers with adjustable rate mortgages or option ARMS could soon see their mortgage payments double: Just how much are borrowers with option ARMs going to suffer?

 

A market research piece from Comstock lists facts that illustrate just how big the whammy could be. Among them: 32.6% of new mortgages and home equity loans in 2005 were interest only, up from 0.6% in 2000; 15.2% of 2005 home buyers owe at least 10% more than their home is worth; $2.7 trillion in loans will adjust to higher rates in 2006 and 2007; August foreclosures were up 23% over July and 53% over a year ago.

 

Many people were sold exotic adjustable rate mortgages by boiler room operations.

 

Now add in this fact from a NY Times article: Investors now hold $4.6 trillion in mortgage backed securities. That’s more than the outstanding value of the US Treasuries. (New York times article - free registration required)

 

Seems like déjà vu to me. What do you think? Specifically, what do you think the implications are? How will this affect you, if at all? Leave your thoughts and comments below.

 

TIP OF THE HAT: I found several of these links on Barry Ritholtz's excellent blog, The Big Picture. Thanks Barr.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Lights! Camera! Action!

Set your VCR, TiVo, DVR, Illudium 232 Space Demodulator, or whatever you use to record TV! NBC5 (Dallas - Fort Worth) just told me that my segment, Kim Snider's Four Steps To Financial Freedom, will air this Wednesday during the 5:00 news. It's part of a weeklong series on personal finance called "Pay It Off", and I'm featured along with Suze Orman and Dave Ramsey.

 

I would again like to thank the ninety-plus alumni who helped us fill up the auditorium at the Frontiers of Flight Museum last week. The NBC5 folks said they got some great shots, and I can't wait to see how it all comes together.

 

In case you can't watch it when it live, I plan to put a copy of the segment here after it airs. Hopefully, we will have that up by Thursday or Friday. NBC5 says they'll also post the video on their website at NBC5i.com.

 

UPDATE (9/20/2006):

 

Here is the teaser they ran on Thursday. I will post the full video as soon as possible.

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

You Decide

I posed the question a week or so ago, on this blog, "What would you like to see me write about?" The two year anniversary of the blog got me to thinking about how I could make it more relevant for my readers.

 

Now I have a much more specific question. I try to keep references to my Snider Investment Method™ very limited. This blog is not meant to be a sales tool as much as a thought leadership blog. It is a place for me to synthesize my thoughts on the concepts, statistics, and events relative to investing the way I do.

 

To the extent that my thoughts lead to sales, that is great. But I have always tried to keep the sales motive in the background.

 

That being said, there are many practitioners of the Snider Method who read this blog. There are many people who read this blog who may be considering the merits if the Snider Investment Method. And I need a forum to answer larger questions posed to me about the method and our workshops.

 

I can do one of two things. I can begin to discuss the Snider Method here, in addition to the topics I am already covering. Or, I can start a separate blog devoted only to the Snider Method. I would like to put it to you, the readers, as to which you would prefer?

 

Please take the poll below and let me know what you think. You can leave any other thoughts you may have in the comments section.

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Are Markets Random?

I ran across a post on Dr. Brett Steenbarger's blog this weekend that reminded me of an interesting experiment. I first read about this experiment in Burt Malkiel's Random Walk Down Wall Street. It demonstrates the concept of being fooled by randomness.

 

Malkiel would ask his students to draw a stock chart that was totally random. The charts would have wild swings all over the place and no discernable trend. Then he would have the students construct a chart by flipping a coin. Those charts looked like would you would see in the newspaper - complete with trends and the patterns of technical analysis.

 

This is from the post on TraderFeed:

 

It turns out that human beings are quite patterned in their efforts to produce randomness. Their random sequences have fewer runs of numbers than are found in true randomness. If we're tossing a fair coin, for example, we should get runs of five consecutive heads about 3% of the time. Interestingly, my attempt to generate a random sequence with 1's and 2's didn't even have runs of three (which should occur about 12.5% of the time). It was statistically significant at the .01 level!

 

The point is randomness doesn't look all that random. That is why it is difficult for most people to grasp the movement of stock prices are indeed random.

 

Now, you can prove this idea to yourself without being a mathematics genius. There are calculators on the web that test for randomness. You put in a series of numbers. If the analysis says there is probable or suggestive evidence against randomness, you do not have a random series. If it says no probable evidence against randomness, then you have something approaching a random set. The higher the P-Value, the more randomness there is.

 

Play with it yourself and see if your gut instinct about what is random really produces a random result. Then, go to Yahoo or Google Finance and find the closing prices of an index or stock that seems to be trending. Put those in the calculator and see what you get. Or try the coin toss. Put in a 1 for heads and a 0 for tails.

 

Let us know how your experiments turn out.

 

TIP OF THE HAT: To Brett Steenbarger for reminding me of this and providing the link to the randomness web site. I would have given him a Trackback on it, but apparently Blogger doesn't accept TrackBacks!?!

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

The Nest Egg Index

A.G. Edwards measured a dozen statistical factors -- including participation in retirement savings plans, personal debt levels and home ownership -- to compile what it calls the "Nest Egg Index." The Nest Egg Index is designed to highlight "geographic regions where people are succeeding and where they face the greatest difficulty in building and nurturing their nest eggs."

 

So where are we succeeding and where are we struggling? Of the 242 major metropolitan markets that made the list, Bridegport-Stamford-Norwalk, CT was the top of the list, followed by San Jose - Sunnyvale - Santa Clara, CA and Minneapolis - St. Paul, MN. The number one community overall, big or small, was Los Alamos, N.M..

 

At the bottom of the list for major metropolitan areas were Riverside-San Bernardino-Ontario, Calif., Miami-Fort Lauderdale-Miami Beach, Fla., Charleston-North Charleston, S.C., and Houston-Baytown-Sugar Land, Texas.

 

An A.G. Edward's press release says communities which ranked high on the list enjoyed strong housing markets and a propensity toward saving and investing, particularly in tax-deferred retirement plans such as IRAs and pension plans.

 

Compared with other countries, the United States is not a nation prone to save. The U.S. Department of Commerce reported that America’s 2005 personal savings rate was a negative 0.5 percent, the lowest in the industrialized world. By comparison, 2005 household net savings rates were 11.6 percent in France, 10.6 percent in Germany, 6.7 percent in Japan, 6.0 percent in the Netherlands and 5.3 percent in Korea, according to the Organization of Economic Co-operation and Development.

 

We know many Americans are not adequately preparing for retirement. According to the Nest Egg Survey, only 66 percent of Americans have a retirement plan in place. In addition, in a study released in November 2005, Hewitt Associates found that among employers offering a defined contribution plan, such as a 401(k), nearly a third of eligible employees do not participate.

 

Even as Americans underestimate their need for retirement funding, they are retiring earlier and living longer, increasing the need for a long-term source of income. Less than 20% of men aged 65 or older are in the U.S. labor force, compared with the year 1950, when 46 percent of men that age were working, according to the U.S. Census Bureau. At the same time, life spans have increased, with American men living an average 74.1 years in 2000, compared with 68.2 years in 1950, while women live to an average 79.5 years, compared with 71.1 years in 1950.

 

What do you think it will take to get Americans to start saving? Leave your thoughts and comments below.

 

SOURCES:

 

1. "Invest In Your Future: Savings Statistics" A.G. Edwards Nest Egg Index Media Kit; 14 Sept 2006.

http://www.agedwards.com/public/content/sc/invedu/nest_egg_savings/media_kit.html

 

2. "Nest Egg Index Results" A.G. Edwards Nest Egg Index Media Kit; 14 Sept 2006.

http://www.agedwards.com/public/content/sc/invedu/nest_egg_savings/media_kit.html

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Boomer Entrepreneurs

I will be featured in a week-long series, on NBC5 in Dallas - Fort Worth, along with Suze Orman and Dave Ramsey, on making your dollars go farther. I was interviewed Friday by anchor Meredith Land. We focused on my four foundations for financial success: 1) a disciplined and conservative view of money; 2) diligent planning, budgeting and saving; 3) prudently investing what you save; and 4) the spirit of entrepreneurialism - whether you are one or not.

 

As you are also probably no doubt aware - the focus of my work is on investing for retirement, by which point you have to meet my definition of financial success - when you have enough passive income from your investments to pay all your bills - or you are screwed.

 

Many people are going to be screwed. That accounts for the fact that 66% of pre-retirees say they intend to work in retirement. Many cannot afford to do otherwise. But that does not mean they are opting for traditional employment.

 

Experts believe we are at the beginning of an unprecedented explosion in new business start-ups, greater even than the dot com boom of the 1990's, led this time by near-retirees. Surveys by Chicago outplacement firm Challenger, Gray & Christmas suggest the boom is already underway.

 

This is also supported by data from the Bureau of Labor Statistics, which reported the number 55 to 64 year olds categorized as self-employed has increased 29% since 2000. This increase is atypical. The number of entrepreneurs is stagnant or shrinking in all other age categories. Baby boomers and older entrepreneurs now make up 54% of the self-employed workforce.

 

It turns out, many of these boomer start-ups may have their former employer as their best customer. It is widely predicted that the job market will continue to tighten. I have seen many respected sources predict that it will be even worse than the 1990s when you hired anyone who was warm. As boomers leave the workforce, their employers will find it increasingly difficult to replace their skills, opening the door for the entrepreneur to sell their experience back to their employer in a new way.

 

It probably shouldn't be a surprise that boomers are opting to go the entrepreneurial route. After all, that is the appeal of being your own boss - the flexibility to run your own show, work as much or as little as you want, and, in theory at least, you get to keep more of the proceeds of your efforts.

 

Of course, we know it rarely works that way. Most entrepreneurs don't run their business - their business runs them. And few ever turn a profit. Something like 50% of new businesses fail within their first year and a large percentage of those fail within the first five years.

 

Still, you would think older, more experienced entrepreneurs would have as good or better chance as anybody. What do you think? Take our survey and leave your thoughts and comments below.

 

 

SOURCE:

 

1. Glenda Vosburgh, "Welcome to Boomerville." Dallas Business Journal 25 August 2006; 24.

http://dallas.bizjournals.com/dallas/stories/2006/08/28/editorial2.html

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Happy Birthday Blog

It was two years ago that I started this blog. It's hard to believe it has been that long!

 

Since I started Kimmunications, I have been writing diligently, for the most part, about the topics of cash flow investing and preparing financially for retirement . I have thrown in a smattering about healthcare costs, Social Security, taxes, and the scandalous behavior of the financial services industry. Along the way, there has been the occasional random musing, rant or diatribe.

 

As I begin the third year of this blog, it seemed like a good time to ask what else you would find helpful or interesting? Are there other topics you would like me to cover? What would you like me to write about more often? What would you like me to write about less, or not at all? What can I do to make this blog more relevant to your life?

 

Would you be interested in mp3 versions of the blog or a podcast? How many of you download audio content? What about video content? If you want audio or video content, how long should it be?

 

In short, what would make this blog "must reading" for you? If you have any ideas that you think would make my blog better, I would welcome them. Leave your thoughts and comments below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Are You Relying On A Pension?

DuPont and Tenneco continue the long line of companies who are shuttering or altering healthy pension plans in order to avoid the obligations and risks of defined benefits to retirees. DuPont will reduce benefits of current workers to 1/3 their current levels. New employees are not eligible for pension. Tenneco has frozen their plan for non-union workers effective January 1, 2007. Both companies will offer employees 401(k)s with a company match instead.

 

This is a continuation of a trend that has been accelerating. Verizon froze its plan in June and IBM will be freezing its plan effective January 1. Freezing means employees receive no further benefits but they do not lose benefits that are vested.

 

Why would a healthy company shutter a healthy pension plan? DuPont estimates that the changes will improve earnings by about 3 cents per share in 2007 and 5 cents per share beginning in 2008. Wall Street's response? DuPont shares rose on the news. Tenneco says their move will contribute as much as $7 million to fourth-quarter earnings and $11 million a year before taxes starting next year.

 

The bottom line is pension cuts increase corporate profits because they reduce the obligations companies carry on their books for future pension payments. Reducing the liability creates a gain, which is recognized either immediately or over time, depending on its structure.

 

Time and time again, I talk to people who are not saving money for retirement because they believe they work for a company with a healthy pension plan. In my view, you just can't count on that. Look at the Delta Airlines employees who thought they had a healthy retirement just ten years ago and now have to live on 60% less than they were promised.

 

If September 11th taught us anything it is that our world can change in a matter of seconds. Depending on someone or something else for your standard of living thirty years into the future just makes no sense to me at all. That includes pensions, Social Security, Medicare and inheritances.

 

If you are not prodigiously saving for retirement, in vehicles that are totally within your control, you are begging to live out the end of your life at the mercy of others.

 

Have you lost a pension or other retirement benefits unexpectedly at the last minute? It happens. How did that effect you? What did you do to make up the shortfall? Help others learn from your experience. Share your story with others below.

 

SOURCES:

 

1. Theo Francis "DuPont Aims To Slash Pension Plan"; Wall Street Journal; 28 August 2006; p A2

http://online.wsj.com/article/SB115677667042447307.html

 

2. "DuPont To End Pension For New Hires"; MSNBC; 28 August 2006

http://www.msnbc.msn.com/id/14559723/>

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Using Options To Manage Risk

Investors carry a lot of baggage. Much of it is erroneous information that takes on a life of its own. One of the most frequently maligned and misunderstood investments, even among financial professionals, are derivatives - namely, options and futures.

 

That is slowly changing as evidenced by this excerpt from an article in the July, 2006 edition of Financial Advisor:

 

Generally, derivatives used alone are considered to be inherently risky instruments. But when coupled with traditional assets in prudent strategies, they can actually mitigate market and other risks. Industry regulatory bodies have recognized this truth over the past dozen years, as is evident in the language of the Uniform Prudent Investor Act (UPIA) of 1994, Section 2.b, which specifically states that for trust portfolios (which are held to fiduciary standards), investment instruments, rather than considered individually, should be considered within “the context of the portfolio as a whole.” In light of UPIA guidelines and current market concerns, the prudent use of derivatives to mitigate risk may be in order, depending on a client’s investment objectives and other factors.

 

The article focuses on using derivatives to manage risk in separately managed accounts (SMAs). Although SMAs are generally held by higher net worth individuals, the techniques are applicable to the Family CFO managing his or her portfolio as well.

 

Options are extremely effective at managing risk because they are so flexible. The article goes on to say:

 

Along with the natural reaction to the term derivatives, the additional paperwork required for options accounts and margin requirements could be deterrents to employing derivatives in risk management. The mutual fund created at Brown’s firm, as the result of 1998 legislation allowing mutual funds to hold options, gets around those hurdles. Concern regarding investors’ ability to understand the strategies may also hinder such offerings. “We believe in keeping it simple,” says Harry Clark. “We just hedge the structural risks of markets going up and down.”

 

    Although it’s impossible to hedge all portfolio risk, the Clarks say such strategies have made wealthy investors much more comfortable about going back into the market after experiencing the 2000-2003 decline. For investors close to retirement, with unprotected portfolios, Harry adds, “If they take another hit of 20%, which we know we’re due for, they’re just going to be out of luck.”

 

    It bears repeating: Prudent risk management is part of the ongoing monitoring process. Advisors searching for unique and suitable strategies for SMA clients may find that using derivatives to implement risk management in their portfolios is another way of adding real value as well as portfolio protection in uncertain market environments.

 

Obviously, my readers who are Snider Method investors are using options every day to manage market risk and generate portfolio income. If you are a Snider Method investor, were the options a big hurdle you had to overcome in your mind before committing? I am also curious about the rest of you. I wonder how widespread the belief is that options are either too risky, too hard to understand, or both? I'd like to hear your thoughts. Please leave them below.

UPDATE:

Carolyn Vaught, a Snider Investment Method investor, sent me a link to a relevant article that appeared in the Fort Worth Star Telegram on September 5, 2006 titled "Another Option: 'Covered Calls' A Relatively Conservative Strategy."

 

SOURCE:

 

1. Sydney LeBlanc, "Derivative Use In SMA Portfolios"; Financial Advisor; July2006 pp 110-111

http://fa-mag.com/past_issues.php?id_content=3&idArticle=1258&idPastIssue=111

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.